Economics Institute and CGAP,<sup>24</sup> guidelines developed and disseminated by WOCCU for universal use by credit unions, and the case study analyses of performance and financial results of various types of MFIs undertaken by the Sustainable Banking with the Poor Project (SBP), all of which were readily available in published form. 25 58. Because of the institutional structure of MFIs and the nature of the microfinance business, the categories of risk that are most relevant to MFIs are balance sheet structure, profitability, capital adequacy, credit risk, liquidity and operational risk. The aspects of these categories of risk as they apply to operations of different types of MFIs are discussed in the sections that follow. The discussions also identify the financial indicators that are considered to be important for internal governance and where warranted prudential external guidelines. It should be noted that the presentation of key indicators for categories of risks is not intended to provide across-the-board comparison among the different types of MFIs in the continuum. The proper comparison of MFIs should be limited to MFIs of the same type.

# **Risks in the balance sheet structure**

59. The risks embodied in the balance sheet structure should be analyzed to assess the significance of discrete changes in the composition and quality of asset and liability items because their structure has a direct impact on profitability. The growth in the size ofMFIs' balance sheets is usually higher than that for commercial banks and individual components of the balance sheet of a dynamic institution will be changing in response to market conditions. The important items for examination and measurement are those areas where the business and product mix of the institution change, resulting in important structural changes to its balance sheet and income statement and consequently how it should manage the diverse risks it faces.

60. The ability to source funds from the public results in less reliance on grants and donations, but it brings on the additional burden and responsibility of ensuring that revenue is sufficient to pay interest on wholesale deposits and that liquidity is maintained to service deposit withdrawals. A fewMFIs are able to access wholesale funding from offshore markets, such as ADEMI in the Dominican Republic and BancoSol in Bolivia. When an MFI takes out foreign currency loans or wholesale deposits it must have access to adequate mechanisms to mitigate foreign exchange risk, ensure convertibility and provide reserves for its exposure to foreign exchange risk.

61. The key indicators of risk from the balance sheet structure are changes in the size and composition of earning and non-earning assets relative to total assets not only for a given year but over several time periods. The experience of a number of MFIs indicates generally rapid expansion rates of loans and high growth rates of total assets over time, particularly in the first 5 - 7 years of operations. Rapid portfolio expansion and asset growth, however, should be managed carefully and matched by maintenance in overall asset quality. Growth has to be balanced with commensurate growth and diversification in funding sources as well as in capital, which sets constraints on overall asset growth.

24 The Microfinance Program of the Economics Institute has published information from its database in MicroBanking Bullettin, vol. I No. 1, 1997.

- 25 Robert Peck Christen, Elisabeth Rhyne, Robert C. Vogel and Cressida McKean, Maximizing the Outreach of Microenterprise Finance: An Analysis of Successful Microfinance Programs, USAID Program and Operations Assessment Report No. 10, Washington, DC, _July_ 1995; Richardson, op. cit., and McDonald P. Benjamin and Joanna Ledgerwood, "The Association for the Development of Microenterprises (ADEMI): Demnocratising Credit in the Dominican Republic", The World Bank Project on Sustainable Banking with the Poor (Draft), January 1998.

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