Monday, May 7, 2012

Corporate Governance in MFIs

In order to achieve greater scalability, the microfinance sector has witnessed the emergence of for-profit microfinance institutions (MFIs) that are managed on similar lines as companies. They attract investors and lenders and they even list on the stock markets. That creates a dilemma as far as boards of MFIs are concerned, as they are required to manage two interests: one being the investors and the other being the customers (who are represented by the needy sections of society). The question of how the boards of MFIs have been able to address this dichotomy merits no easy answer, as this sector continues to evolve in terms of regulatory and governance issues.
In this background, it is interesting to note a keynote address by RBI’s Deputy Governor Mr. Anand Sinha at a recent FICCI workshop. The address, titled Strengthening Governance in Microfinance Institutions (MFIs) – Some Random Thoughts highlights some of the key governance issues affecting the microfinance sector. Here are some excerpts:
11.  Many analysts attribute the current crisis to the irrational exuberance of some MFIs who entered the segment with the sole emphasis on business growth and bottom lines.  They perhaps did not take due cognisance of the vulnerability of the borrowers and the potential socio-political ramifications their aggressive approach could possibly lead to.  The competition among MFIs led to these institutions chasing the same set of borrowers, by free riding on [self-help groups (SHGs)] and loading them with loans that borrowers, possibly, could not afford.
19.  There were serious deficiencies observed in the governance framework of some of the MFIs.  The corporate governance issues in the MFI sector were exacerbated by some of the ‘for profit’ MFIs, dominated and controlled by promoter shareholders which led to  inadequate internal checks and balances over executive decision making and conflict of interests at various levels. Other undesirable practices such as connected lending, excessively generous compensation practices for senior management, founders/ directors and failure of internal controls leading to frauds precipitated the crisis.   Some of the MFIs chased high growth trajectory at the expense of corporate best practices. The listing and trading of the shares of the ‘for profit’ MFIs generated a set of incentives which attracted capital looking for high returns whereas the capital suited for catering to the needs of the poor has to be patient capital. This disconnect led to further worsening of the situation.  What is more disturbing is that there were enough warning signals of trouble in making over an extended period of time but the MFIs, at least  some of them, carried away by their immediate success, failed to pay heed.
Ever since the listing of SKS Microfinance that was followed by the turmoil in the microfinance sector in Andhra Pradesh due to a stringent legislation being introduced, I have been interested in studying the governance issues pertaining to MFIs. I have attempted to address some of these in a paper titled Microfinance and the Corporate Governance Conundrum, the abstract of which is as follows:

Microfinance evolved as an instrument to reduce poverty and bring about sustainable development. As an alternative to traditional means of finance such as banking and insurance (which failed to meet the needs of poorer sections of society), microfinance was pioneered by self-help groups, non-governmental organizations and other non-profit institutions. However, with a view to building a scalable model that engenders overall sustainable development, the microfinance sector has witnessed the emergence of for-profit institutions that are structured along the lines of the modern business corporation. These microfinance companies adopt market-based mechanisms to raise capital that is employed in financing the poor and less-privileged.

From a corporate governance perspective, microfinance companies and their boards of directors are faced with the classic dilemma. On the one hand, it is recognized that the principal goal of microfinance is to reduce poverty; to that extent the interests of borrowers (or customers) as principal stakeholders becomes paramount. On the other hand, a shareholder-centric approach operates as a major countervailing factor by compelling microfinance companies to generate profits to service investors and maintain stock price. The current discourse in corporate governance does not appear to satisfactorily address the predicament of boards of microfinance companies. This is due to the fact that investors and stock markets judge them against standards imposed by corporate governance norms and practices that are generally applicable in the corporate sector.

This article argues that the employment of conventional concepts and doctrines in corporate governance to for-profit microfinance companies does not adequately address the issues specific to such companies. It calls for a paradigm-shift that necessitates examination of corporate governance in microfinance companies through an altogether different lens. After considering the available empirical evidence and analyzing qualitative data generated from case studies and field interviews, it seeks to develop separate parameters for measuring the correlation between corporate governance and performance of microfinance companies, such that the overarching goals of reducing poverty are not diluted.

1 comment:

Anonymous said...

It was interesting to read yr paper. I think the issue is more general and goes beyond MFIs. e.g. It could well apply to listed PSUs as well (the current controversy over Govt directive to Coal India to sign FSAs. If Coal India signs such agreements in the larger interest of the economy, can the directors have resort to a modified `business judgment’ rule as you suggest in yr paper?).

Mangesh Patwardhan