Rules and regulations are not enough. They must be implemented. Sadly, recent episodes have shown that even independent directors stayed silent when rules were violated

Very often, people look at high-profile membership of the board as a surrogate for good corporate governance, and micro-finance is no exception. But despite having the equivalent of five-star boards, many (NBFC) microfinance institutions (MFIs) in India have come under attack for various weaknesses in governanceⁱ . Here are some.

• Inadequate checks and balances over executive decision-making and whimsical behaviour by the board and/or senior managementⁱⁱ
   
• Insufficient transparency about ownership/control, related-party transactionsⁱⁱⁱ and the (MFIs/group's) operational strategies and overall financial position^iv
   
• High stake acquired by promoters' friends/well-wishers/families in order to maintain control over the MFI.
   
• Lack of transparent reporting to the outside world.
   
• Lack of truly independent directors and board nomination sub-committees.
   
• Conflicts of interest at various levels including on the board, in senior management and operations, and other aspects.

Interestingly, much of this is said to have happened despite many of these (NBFC) MFIs having, what bystanders would often call as the presence of a five-star board—a board packed with well known personalities from within and outside the industry. Indeed, this is where a common judgement made with regard to corporate governance has, often repeatedly, proved costly, both in microfinance, perhaps even in the broader corporate sector.

In fact, if you look at the credit rating reports of some of India's largest (NBFC) MFIs, this is apparent. These reports^v use the presence of a five-star board to claim that governance in these MFIs is very good. Yet, as the last several months have shown, there could be serious governance and related violations^vi as espoused by the following:

(a) The granting of a loan of Rs1.63 crore to the founder of an MFI to enable him to buy 16.36 lakh shares (of Rs10 par value) in the same MFI (Professor Sriram's article in Economic and Political Weekly, 12 June 2010). The most interesting part is that institutional nominees (of domestic financial institutions) were part of the board that made this decision.

(b) The sudden removal of the chief executive officer (CEO) of a large MFI who had just led the company through a spectacularly successful initial public offer (M Rajshekar, The Economic Times, October 2010). Interestingly, the same CEO had received a huge bonus/raise a few months earlier.

(c) Turbocharging growth and the use of (multiple and) over-lending as indicated in the following quotation: "That (following sound lending practices) is where we failed," says Sajeev Viswanathan, CEO of Basix, which is an MFI. MFIs lent liberally to individuals who didn't have the corresponding ability to repay. The mismatch had to hurt sometime...''^vii  

(d) Ghost lending and non-existent borrowers, which several MFI financial statements have themselves admitted to^viii, including the recent 2011 financial statement of SKS Microfinance (where the auditors claim that frauds due to non-existent clients and clients with false identity run into crores^ix ).

The cornerstone of this argument is essentially this. Many (NBFC) MFIs engaged in multiple and over-lending for consumption purposes, and they often granted loans without assessing the loan absorption capacity of the clients. Implied in this statement is the fact that these MFIs have pushed loans indiscriminately to low-income clients for consumption purposes without any sensitivity to their debt-servicing ability and they tried to grow (quickly) in this manner and make unnatural profits.

Again, as with the above, it is more and more clear that (NBFC) MFIs (perhaps) tried to grow fast to attract capital at high valuations and, thereafter, had to justify these high valuations by providing better returns to investors. And investors likewise, as they had paid huge premiums, wanted to recover their investment fast and hence, perhaps pushed these MFIs to grow faster.

Hence, as illustrated in the chart below, there appears to have been a mutually reinforcing cycle of multiple/over-lending/ghost lending, fast growth, high profits, very high share valuation, equity investments, faster growth, greater profits, more returns, turbocharged growth, and so on.

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