of growth) was developed first as a management tool and later became an effective supervisory mechanism.<sup>22</sup> PEARLS results in _objective measurements,_ whereas the CAMEL approach involves some degree of _subjective judgment_ by analysts or examiners particularly on management quality and capability. In addition, private commercial banks have developed their own financial monitoring and evaluation systems which isolate and measure different categories of risks.

55. The main thrust of this paper is to promote a standard application of risk management principles which would be useful to an institution's management and its governing board or trustees, shareholders or members, external auditors, the regulatory authorities, institutional creditors, donors and the general public.<sup>23</sup> This paper emphasizes that _the responsibility for risk management rests principally on voluntary regulation through internal governance, rather than on external supervision by regulatory authorities._ Risk-based financial regulation should identify and specify the following aspects:

- a) The particular risks that are most relevant to MFIs,

- b) For each relevant risk, the key indicators that are most important for risk management in MFI operations,

- c) The ranges of values and their trends over time which would be useful to directors and managers responsible for internal governance in monitoring the financial health ofMFIs that they manage, and

- d) The ranges of values and their trends over time which would be invaluable in establishing regulatory guidelines to be used by external supervisors who have the mandate to regulate MFIs under their jurisdiction.

56. Table 5 (together with its accompanying Notes) in the pages that follow summarizes the categories of risk and range of values of financial risk indicators for the three broad classes of MFIs in this paper's regulatory framework model. Table 5 highlights (i) the observed value ranges of selected financial risk indicators, (ii) recommended value ranges suitable for consideration in internal govemance and, where appropriate or warranted, (iii) suggested threshold values with respect to external regulation for each of the three categories of MFIs. The recommended and threshold values are neither absolute nor arbitrary, and it is emphasized that practical applications should take into account specific country conditions.

57. This paper has used values of certain indicators of financial and operating performance of MFIs which were readily available from published work, simply for the purpose of illustrating the application of risk management principles discussed in this paper to differern **t** ypes of MFIs. The basis for selecting the MFIs whose financial indicator values are being used for illustrative purposes was the closeness by which they _approximated the conceptual types of MFIs in the continuum_ discussed in this paper. However, no claim is being made that the MFIs selected confoirm strictly to the characteristics of each type of MFI in the continuum, and neither is it the intention to "force" these MFIs into any classifications. For illustrative purposes, the values of key indicators derived from the 1993 USAID-sponsored survey of eleven successful microfinance programs, the database developed by the Microfinance Program of the

> 22 David C. Richardson, "PEARLS - Financial Stabilization Monitoring andl Evaluation", World Council of Credit Unions Research Monograph Series, No. 4, August 1997 edition (processed).

> 23 A detailed discussion of financial performance and risk management indicators for banking institutions can be seen in (i) Jan Hendrik Van Greuning, "The Implementation of a Risk-Based Approach to Bank Supervision as a Micro-Economic Component of Monetary Policy", unpublished doctoral dissertation, Pretoria, South Africa: University of Pretoria, 1993; (ii) Chris Baltrop and Diana McNaughton, Banking Institutions in Developing Markets: Interpreting Financial Statements, vol. 2, Washington, DC: The World Bank, 1992 (1996) and (iii) for MIFIs in particular, the CGAP Appraisal Format, which is described in Chapter 5 of the CGAP/SBP Microfinance Practical Guide (1997).

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