ASSESSING CASH FLOW RISK IN MICROFINANCE INSTITUTIONS: A BOTTOM-UP APPROACH AND MONTE CARLO SIMULATION

Abstract

Microfinance institutions (MFIs) play a crucial role in the emerging financial system as well as in the innovation of rural financial systems. MFIs significantly promote capital flow, alleviate financing difficulties for small and micro enterprises, and address poverty in underserved areas. However, the demands to address poverty through development and meet social goals expose MFIs to financial risks, particularly cash flow risk associated with capital repayment, which can hinder normal operations. Therefore, it is essential to systematically study the cash flow risk faced by MFIs to enhance their sustainable development capabilities. This research utilizes the bottom-up approach along with Monte Carlo simulation (MCS) to compute the value at risk (VaR), assessing the financial flow of listed microfinance firms in China. The analysis provides a straightforward and specific measure of cash flow uncertainty for management, investors and analysts of microfinance institutions. By comparing the VaR of corporate cash flow and evaluating the VaR of cash flow, the study identifies the existence of cash flow risks within the entire microfinance industry. The study provides policy recommendations to mitigate cash flow risk in microfinance institutions, focusing on business strategy and internal control, to improve the industry’s ability to manage risks and promote sustainable development.