The RBI and the Union Finance Ministry must provide clear guidelines on the appointment, roles, compensation and evaluation of independent directors for microfinance companies, critical for effective and ethical operations
As the Reserve Bank of India (RBI) and the Union Ministry of Finance (MoF) work hard on building a clear regulatory architecture for microfinance, they would do well to remember that an important cog in the whole scheme of things is to ensure good corporate governance on the ground. There can be no compromise on that as much of the Andhra Pradesh and Indian microfinance crisis of 2010 can be traced to poor implementation of (existingi) corporate governance standards in MFIs. It goes without saying that 'independent directors' are indeed critical in real time for implementation of any such corporate governance standards in practice. Therefore, the RBI and Ministry of Finance, as part of their mandate to create a permanent regulatory architecture for microfinance, must provide clear (supervisable) guidelines with regard to appointment, roles, compensation and evaluation of independent directors, so that corporate governance in MFIs does not exist merely on paper.
The various specific issues that would have to be looked into by the RBI and MoF, in this regard, are highlighted below.
Practice of CEO hiring board/independent directors in many MFIs
First, in many MFIs, the promoter who is (often) also the CEO, hires the board and this practice needs to be questioned from the perspective of implementing corporate governance directives on the ground. The key questions are: How can boards hired by the promoter/CEO of an MFI be really independent? How will they perform the roles that they are supposed to, to safeguard the interests of various stakeholders including minority shareholders?
Criteria for being an independent director
Second, there is a lack of clear-cut eligibility requirement for independent directors—in terms of objective criteria such as age, expertise and experience (especially related to microfinance) as well as having had past relationships with the same MFI (which can result in significant conflicts of interest). And it goes without saying that the task of identifying independent directors (for MFIs) should indeed be made more transparent and relatively easier and there must be some regulatory guidelines for the same.
Appointment of independent directors
Third, it seems appropriate to vest the powers of appointment of new, independent and executive directors in board nomination committees (at MFIs) specifically constituted for this. These committees should follow a transparent process and lay down clear criteria for selecting board members. Further, an independent director must chair the board nomination committee so that 'truly' independent candidates are hired to the MFI board, and the climate for their 'real' independent functioning is ensured. This is another aspect that the RBI and the Ministry of Finance could look into as part of their ongoing work to create a regulatory architecture for microfinance.
Time spent by independent directors on work at MFIs
Fourth, is the issue of whether the independent directors should be mandated to spend a certain minimum time on work at the MFI and especially, in the field at the grassroots? As an industry observer argues that 'independent directors should be mandated to devote a certain minimum number of hours every quarter (or regular period) so as to understand the business of microfinance and gain insights about the MFIs in which they are serving as directors. This will enable them to examine the risks being taken and the appetite of their MFI to take such risks as well as understand and provide guidance on other strategic aspects, as may be required.' This again could be looked into by the RBI and MoF as part of the guidelines and regulatory architecture being framed.
Number of MFI boards on which an independent director can serve concurrently
Fifth, a related aspect is the amount of time spent by independent directors on board meetings at MFIs annually. When there are people who, at any one point in time, serve as independent directors on several MFI boards, the quality of directorship is naturally likely to suffer. This is especially true of microfinance. It may be appropriate for the RBI and/or MoF to recommend a threshold level for the number of MFIs, in which people (professionals) could serve as independent directors. This is a very critical aspect indeed.
Peer appraisal of independent directors must be made mandatory
Sixth, peer appraisal of independent directors is an option for enhancing their effectiveness in working, and this, again, needs to be examined from the perspective of independent directors in MFIs. While such an appraisal process would need to be managed with associated sensitivities, board members should also view this as an opportunity for continuous learning and improvement. Traditional methods of evaluation (in terms of share valuations/prices and strategy initiatives) perhaps would need to be augmented by a formal and objective appraisal of the independent directors' performance with regard to governance (in terms of various parameters). Such an appraisal should enable identification of gaps in governance, enhance the decision-making process and improve effectiveness of board meetings and various processes at the MFI. This is also an aspect that could be looked at by the RBI and MoF, in the context of MFIs.
Capacity building of first-time (independent) directors
Seventh, another critical area often ignored is the need for continuous education programmes for independent directors, especially for entry or first-time (independent) directors. This is very critical for microfinance which is a nascent field, and especially if we have to ensure that the same people do not serve on the boards of too many MFIs (again causing conflicts of interest). This capacity-building support could be offered through IIMs, or College of Agricultural Banking, or other appropriate institutions. This is a very critical issue and should be examined by the RBI and MoF as part of their mandate to draft detailed regulatory guidelines with regard to (corporate governance in) microfinance.
Compensation of independent directors
Eighth, the compensation of independent directors is a very critical issue and there have been a lot of controversiesii in recent months. The RBI and MoF must surely set standards for the same and ensure that the independence of the independent directors is not compromised under any circumstances. One option would be to entrust this task to the board nomination committee and ensure that the promoters/CEOs do not interfere in setting and implementing norms of compensation for independent directors. While there could be other strategies, I think this is one of the most important issues that the RBI and MoF would need to address.
Protecting client interests on the MFI board
Last, but not the least, the RBI should also examine whether there could be specially designated independent directors, representing client interests. We have directors in banks representing staff interest and the same could be done in microfinance to safeguard client interests. This is especially crucial in MFIs that have and use the Mutual Benefit Trust (MBT) structure, which is indeed a client owned body-please recall that there have been many issues with regard to governance of MBTs in the recent past and the extent to which their interests are being protected in the boards of MFIs. This should be explored by the RBI and MoF as part of the process of drafting of detailed guidelines and building a regulatory architecture for microfinance and suitable recommendations provided. Like compensation, this is indeed a very important issue in MFI governance.
Thus, while enhancing the quality of independent directors would surely enhance governance, there is also a right mindset aspect that we should not forget. As Mr Kris Gopalakrishnan, CEO, Infosys, once said, "We may not be able to eliminate corporate frauds altogether. No amount of regulation will help to stop frauds. At the end of the day, corporate governance is a mindset issue. We need stricter, stronger and quick enforcement of law by regulatory agencies so that it will act as a deterrent for others.iii
Other observers agree. "As a rule rather than exception, MFIs need to practice good governance in order to sustain in the long run. And for this, promoters and senior management must practice good governance at all times including, when faced with the most difficult of situations."
Therefore, while practicing good governance at all times is certainly a mindset issue, the least we can do is to incentivise good governance and, perhaps, penalise bad governance, and do this consistently and without fear or favour. For this, we need a practical guiding (regulatory) framework pertaining to appointment, roles, responsibilities and compensation of independent directors in MFIs and this is something that the RBI/Union Ministry of Finance should gift to the Indian microfinance sector that is perhaps low on its governance quotient, at least at this moment. This is yet another place where regulatory reform could begin.
i There are existing corporate governance guidelines for NBFCs, but many of the aspects, including related party lending, have been kept in abeyance. This aspect assumes greater importance because most of the MFIs are not listed entities and hence, they do not come under the SEBI corporate guidelines/directions as well.
ii Please look at: 'Share Microfin MD takes home Rs7.4 cr, more than double HDFC Bank MD's salary' by John Samuel Raja D & M Rajshekhar, ET Bureau, 1 February 2011.
iii Quoted from The Satyam Saga, by Bupesh Bhandari, Prashanth Reddy Chintala, Vandana Gombar, Latha Jishnu, Shyamal Majumdar and Aanand Pandey, (2009), Business Standard Publication.
(The writer has over two decades of grassroots and institutional experience in rural finance, MSME development, agriculture and rural livelihood systems, rural/urban development and urban poverty alleviation/governance. He has worked extensively in Asia, Africa, North America and Europe with a wide range of stakeholders, from the private sector and academia to governments.)
Sucheta Dalal, trustee of Moneylife Foundation, warns investors against companies who use deceptive marketing, play on misplaced beliefs, social and personal needs, to collect huge funds, and then disappear
"Any scheme that asks you to introduce two more investors to get extraordinary returns is avoidable," warned Sucheta Dalal, trustee of Moneylife Foundation.
Ms Dalal was speaking at a workshop on "Understanding Pyramid Schemes" today, organised by Moneylife Foundation, a non-profit organisation whose principal objective is financial literacy.
Citing the examples of popular pyramid schemes such as Citi Limouzine, which duped gullible investors on the promise of exceptional returns, Ms Dalal explained how these schemes even target professionals such as lawyers, policemen, doctors, to gain legitimacy. Their modus operandi is simple-target people, pay them returns, then see their friends and relatives start investing.
Citi Limouzine, in fact, managed to dupe around 6,000 policemen, 200 income-tax and 15 Reserve Bank of India officials, as well as about 300 officials from the Mantralaya state headquarters and the defence services.
One other such scheme named Pearls, which is based in Jaipur, claims to be in the business of real estate development and promises 40% returns. It has collected a whopping Rs25,000 crore. The company is hiring top lawyers and trying to turn its fraudulent business into a legitimate one.
Ms Dalal also explained how various schemes like Time Share, Ad Review, JapanLife Mattresses and the recently-closed Nano Excel, managed to dupe investors through dubious businesses.
Pointing to Speak Asia, the ponzi scheme that has been the focus of attention recently with promises of as high as 500% returns, Ms Dalal regretted that the government and the apex bank had not taken strict action so far, despite banks reporting suspicious financial transactions to the finance ministry.
Ms Dalal explained at length the difference between pyramid schemes and multi-level marketing. "MLMs claim to be less dangerous than pyramids," she said. "Still they attract lawsuits due to high start-up costs, tiered sales and exploitation of personal relationships and cult-like sales technique."
"Pyramids are pure fraud. Their business is unsustainable-they promise payment for goods or services of dubious value. The hallmark of these schemes is the promise of sky-high returns in a short period of time, for doing nothing other than simply handing over your money to them, and getting others to do the same," Ms Dalal said. She also explained the mathematics followed by pyramid schemes.
On the subject of MLMs , Ms Dalal referred to the statement by Robert L FitzPatrick, president of Pyramid Scheme Alert and co-author of the book, False Profits: Seeking Financial and Spiritual Deliverance in Multi-level Marketing and Pyramid Schemes, that "50%-70% of 'distributors' quit in the first year and less than 1% of distributors make money."
"The MLMs economic scorecard is characterised by massive failure rates (over 99.5%) and financial losses for millions of people," Ms Dalal said. She attributed this to deceptive marketing, misplaced beliefs and social and personal needs that are used as promotional tactics by MLMs. Unemployed youth and housewives are the biggest target group of MLM companies, she said.
She pointed out that the Direct Selling Association was lobbying with the US government, saying that they are not pyramids. In India, the Indian Direct Selling Association, which has members such as Amway, Oriflame, Modicare, has tried to create a distinction between pyramids and MLMs, and is also lobbying hard with the government to get them out of the Prize Chits & Money Circulation (Banning) Act.
Ms Dalal spent some time on direct selling companies which have been in existence since a long time. Typically, companies like Amway, Gold Quest, Herbalife use film stars and have political connections, and they tie up with NGOs to gain popularity and legitimacy.
She also dwelt on the Prize Chits and Money Circulation Schemes (Banning) Act, 1978, which curbs such illegal activities. "The problem with this law," she said, "is that police refuse to lodge complaints until there is actual loss of money, which then is too late. And the companies pretend that it is not investment but sale of product/service to escape liability."
Several countries, including the US, the UK and Singapore, where Speak Asia is registered, have banned pyramid schemes.
Ms Dalal read from the Manipur legislation which said, "MLM schemes destroy the knitted social fabric of our society." Manipur government curbed all such MLM and pyramid scheme.She also explained various Supreme Court judgements relating to ponzi and pyramid schemes.
Concluding her presentation, Ms Dalal warned that, "Extraordinary returns are nothing but a sign of desperation, and hence, one should avoid such schemes."
Moneylife Foundation has demanded a ban on pyramid schemes and that MLM schemes should be brought under the regulation of the RBI or the Securities and Exchange Board of India (SEBI). "RBI would be the best regulator, since money is transferred through banks," Ms Dalal said. The Foundation has also demanded that The Prize Chits and Money Circulation Schemes (Banning) Act, must be administered by SEBI and complaints of new schemes must be lodged with this regulator before losses."
Replying to a participant who said she was convinced as an MLM product buyer and saw no harm in investing, Ms Dalal said, "A lot of people are convinced, but will start to complain only when the company vanishes. Commonly, we trust friends and family, who introduce us to the scheme, and this is what enables MLM companies to grow."
On another question about whether foreign exchange trading was based on MLMs or pyramids, Ms Dalal said, they were neither. "Forex trading is neither a pyramid or an MLM. It is pure speculation and betting on the share market. This is equally dangerous," she said.
The Committee of Secretaries, which met under the cabinet secretary Ajit Kumar Seth, also decided that the overseas mega retail chains will have to pump in at least half of their investment in the back-end supply chain
New Delhi: The Committee of Secretaries (CoS) on Friday recommended allowing 51% foreign direct investment (FDI) in the multi-brand retail, with a rider that the foreign investment should be at least $100 million, reports PTI.
"The Committee of Secretaries, which met under the cabinet secretary Ajit Kumar Seth, also decided that the overseas mega retail chains will have to pump in at least half of their investment in the back-end supply chain," a source said.
The politically sensitive issue will soon be taken to the Cabinet, the source added.
Several global retailers like Wal-Mart are waiting in the wings for a full-scale entry into India's multi-brand retail segment. India's retail sector estimated at about $590 billion, according to an Icrier report, is dominated by mom & pop stores.
India has already allowed FDI of up to 51% in the single brand retail and 100% in cash and carry format of the business.
"This probably the last meeting of CoS on the issue," the official added.
The CoS meeting, attended by 10 secretaries, deliberated on the issue for nearly three-hours. It is understood to have rejected a proposal that stores with FDI should be asked to sell at least 30% of their goods to small retailers.
A few secretaries favoured opening the sector for FDI up to 49% only, while the majority favoured 51%.
The CoS recommendations came after about a year of the Department of Industrial Policy and Promotion (DIPP) floating the idea of opening the sector for FDI.
While the CoS has given its recommendations, the Union Cabinet would have to vet it before FDI could be allowed into the sector.
"This was probably the last meeting of CoS on the issue.
Now it will go to the Cabinet," sources added. The DIPP would move the Cabinet note.
India has already allowed 51% FDI in single-brand retail and 100% in wholesale cash-and-carry format of the business.
Since large stores require huge space and if the same is not available, the CoS opined that the retailer should be allowed to open shop even within 10km radius of cities with population of over one million.