Companies & Sectors
Governance of MFIs: Time to implement ‘connected lending’ provisions of RBI circular of 2007

Is it appropriate for a company, established to provide access to finance to low-income people, to lend to its promoter and managing director to buy shares in the same company at par value?

Consider yourself as an institutional/retail investor in a micro-lender and you may have bought equity because you believe that microfinance institutions (MFIs) provide access to finance for low-income people and enable them to have a better life. Alternatively, you could be a development finance institution (DFI)/bank that has provided a loan to an NBFC MFI as part of the priority sector obligations and/or other schemes. Or you could be a multi-lateral or bi-lateral institution that seeks to improve the lot of excluded and disadvantaged people in an emerging market through development of the private (financial) sector using institutions like NBFC MFIs. How would you react when you hear that one such NBFC MFI, where you have either invested your hard-earned money or lent priority sector funds, has, in turn, lent to its own founder managing director, a huge sum of money to buy shares in the same MFI and especially, at par value?

Unbelievable but true. Such a transaction did take place at a large Indian NBFC MFIi . The incident first came to light through Professor MS Sriram's paperii , in the Economic and Political Weekly (June 2010), which noted that an NBFC MFI had lent its founder and managing director, a sum of Rs1.636 crore to enable him to buy shares in the same company. From a perusal of the published financial statements of this NBFC MFI, it is clear that an interest-free loan of Rs1.636 crore, was granted by the MFI [which was supposedly predominantly owned by the poor clients through several Mutual Benefit Trusts (MBTs) and also had key institutions as shareholdersiii ] to its then managing director and promoter to buy shares at par value. (Read relevant table below, reproduced from the MFI's audited statements for the year ended March 2007.)

Now, you may wonder whether this is legally permissible from the standpoint of corporate governance. In fact, I had a similar question and did some research on the matter and found that there is a Reserve Bank of India (RBI) circular that talks about this aspect of (not) providing credit facilities to the directorsiv . Specifically, the RBI circular on corporate governance for NBFCs, dated May 2007, notes that,

"In order to obviate conflict of interest in the lending operations of the NBFC, it should not grant any loan, advance or non-fund based facility or any other financial accommodation/facility to: (a) its directors or their relatives; (b) to any firm in which any of its directors is interested as partner, manager, employee or guarantor; (c) any individual in respect of whom any of its directors is a guarantor; (d) any company of which, or the subsidiary or the holding company of which, any of the directors of the NBFC is a director, managing agent, manager, employee or guarantor, or any firm in which he holds substantial interest; and (d) any entity, whether incorporated or not, which uses as a part of its name or in connection with its business, the name of the NBFC or any such word as would show its association with the NBFC."

Likewise, further research led me to believe that the spirit of the Companies Act, 1956 typically prohibits companies from directly buying its own shares and/or indirectly financing its directors to buy the same. In the present case, it must be noted that, the loan grantedv interest-free to the promoter managing director was towards purchase of shares in the same company.


My views apart, as I got deeper into the legal aspects, I got to know a very interesting aspect that the provisions relating to connected lending in the aforementioned RBI circular have been in abeyancevi since 11 July 2007. Likewise, it appears that the concerned MFI also publicly stated (prior to its IPO) that there was nothing illegal in what it had done (in so far as the connected lending was concerned) and further that the provisions of the Companies Act did not apply to private limited companies, which is what the NBFC MFI was when the said (connected lending) transaction took place.

Therefore, it seems prudent to conclude that as per the prevailing lawsvii , the connected lending that occurred at the NBFC MFI may not have been strictly illegal. However, I am not sure whether it is appropriate for a company-established, in the first place, to provide access to finance to low-income and vulnerable people, registered as an NBFC with RBI and using public deposits (by way of accessing priority sector bank loans)-to lend to its promoter and managing director to enable him to buy shares in the same company at par value, without being seen as a "misgoverned" company. This is something that all of us need to take a call on.

In my humble opinion, granting of such a huge interest-free loan to a director in a financial services company that is owned in majority by the poor clients in MBTs and DFIs (together, the MBTs and DFIs held 54% of the shares of the company then), and meant to service these poor clients in the first place, is not at all appropriate from a corporate governance perspective. Without question, this action of providing the loan to a director was certainly not, under any circumstance, in the interest of these shareholders, especially the minority (individual MBTs and/or individual women) shareholders. One can certainly make the argument that such a thing may not have happened if there had been someone on the NBFC's board protecting the interest of the (minority) shareholders. I am sure that whether an institutional/retail investor or a DFI/bank or a multi/bi-lateral agency, you will certainly not approve of such connected lending transactions as examples of good practices in corporate governance. {break}
Now, that is certainly an issue that the RBI, SEBI and Ministry of Company Affairsviii need to seriously ask and answer, and thereafter, amend the relevant circulars/laws accordingly. Some of the key questions that these regulators would need to ask and learn from are mentioned here.

(a) Was this connected lending by the NBFC MFI to the promoter (also the then managing director) to enable him to buy shares in the same company, a correct practice from a legal perspective? Given that the company was/is a financial institution registered under the Companies Act, 1956 and the RBI NBFC regulations with the primary purpose of lending to low-income people, how does this practice of connected lending to the promoter managing director relate to extant regulations and norms, both in letter and spirit?

(b) Was this correct practice from a shareholder perspective, given that the company was originally established to provide loans to low-income people and there were significant development funds in the company, and as at the time of granting the loan about 54% of the company was together owned by the MBTsix and DFIs?

(c) On what basis did the NBFC authorise this lending to the then promoter managing director? What were the independent and institutional nominee directors doing, even as the board approved this connected lending transaction?

(d) What was the source of funds from which this loan was made to the promoter managing director? This needs to be transparently understood in terms of whether so-called 'priority sector funds' and/or 'soft development funding' was used for providing the loan to the promoter managing director.

(e) Are not the consequent increases in capital and the associated leverage (without any change in the true financial condition of the NBFC)-serious misstatements of the financial condition, in the absolute sense of the word? Irrespective of the quantum of misstatements, is not the practice questionable, from a corporate governancex perspective?

(f) Ceteris paribus, is this connected lending a correct practice of corporate governance, especially in a financial institution?

The issues here  are especially serious because the company is now a listed NBFC MFI and much of the problems related to the 'perverse incentives' in Indian microfinance (to quote Vijay Mahajan's often mentioned phrase) could perhaps have been avoided, had only the instruction contained in the RBI circular been fully implemented on the ground, way back then.

Further, to the best of my knowledge, the various clauses in this well-intentioned RBI circular on corporate governance for NBFCs, and especially those relating to matters of connected lendingxi , have not yet been implemented as on datexii .

Without any doubt, the time is now ripe for all these provisions of the RBI circular to be fully implemented without any further delay so that such occurrences can be prevented forthwith! And last but not the least, I do hope that the Union Ministry of Finance, which is in the process of finalising a bill on microfinance, addresses these critical issues to ensure the orderly development of a vibrant microfinance industry in India that is really for the poor, in every sense of the word.

i The name of the company has been withheld as the idea is not to embarrass a particular MFI, but it can be provided if required!
ii Commercialisation of Microfinance in India: A Discussion of the Emperor's Apparel by Professor MS Sriram, (Economic and Political Weekly, 12 June 2010, Vol XLV No. 24, Page 70).
iii Development Finance Institutions
iv RBI Guidelines on Corporate Governance 2007, kept in abeyance for some reason. The guidelines were not to be practiced until further notice from the RBI.
v It must also be noted that the loan amount was much greater than the total of six months of his (then listed) salary and apparently, this interest-free loan was also not administered through a trust. Likewise, it seems that the shares were also not issued in the name of the trust.
vi In fact, the circular on Corporate Governance (dated 11 July 2007) on the RBI site still contains the following with regard to 'connected lending': "The Bank has received suggestions in the matter with reference to paragraph 2 (vi) of the circular dated 28 May 2007 containing instructions on connected lending. The suggestions are being studied and the instructions contained in paragraph 2 (vi) of the said circular will become operational after final evaluation of the suggestions and modifications, if any considered necessary."
vii The concerned MFI has all along maintained that these provisions of the Companies's Act did not apply to private limited companies, which is what the MFI was in 2006-7.
viii I am not trying to find fault with any stakeholder or the regulators, but rather I am merely highlighting an existing loophole that can perhaps be still misused. I recognise the tough task of implementing regulations and certainly do not wish to undermine the excellent work done by regulators (in many cases and instances) and this is indeed appreciated. At the same time, we also need to continuously learn from crisis and ensure that laws are indeed changed to suit ground level realities.
ix Despite the MBTs holding 47% of the shares, they appear to be weak shareholders and /or minority shareholders.
x It must be mentioned that all things begin small and eventually snowball.

(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.) 


HUL Q1 net up 17.62% to Rs627.18 crore

Commenting on the results HUL chairman Harish Manwani said, “This is the fourth consecutive quarter of double-digit growth, led by a combination of innovations, market development and relentless focus on execution”

New Delhi: Boosted by strong sales across segments and lesser spending on advertisements, fast moving consumer goods (FMCG) giant Hindustan Unilever (HUL) today posted a 17.62% increase in net profit to Rs627.18 crore for the quarter ended June 30, up from Rs533.21 crore for the same period of the last fiscal, reports PTI.

In the first quarter this fiscal, the company’s net sales jumped by 35.67% to Rs6,503.89 crore from Rs4,793.89 crore in the corresponding quarter of the last fiscal.

“This is the fourth consecutive quarter of double-digit growth, led by a combination of innovations, market development and relentless focus on execution,” HUL chairman Harish Manwani said in a statement.

During the quarter, the firm said its domestic consumer business grew by 15% to Rs5,100.37 crore, while the home and personal care business grew by 15.4% to Rs4,133.24 crore.

Revenues from HUL’s foods business grew by 14.9% to Rs967.13 crore during the reporting quarter, with both beverages and packaged foods delivering strong performance, it said.

The company, one of the biggest spenders on advertisements in the country, also tightened its purse strings during the quarter. Its ad spend was 15.74% lower at Rs632.95 crore during the quarter compared to Rs751.21 crore in the same period a year ago.

“In a challenging business environment, we are managing our business dynamically to ensure that we remain competitive and cost-efficient,” Mr Manwani said.

Advertising spends were stepped up in the personal products and packaged foods segments, while spending on soaps and detergents was calibrated in line with industry trends, HUL said, adding “advertising and promotion spends, at 11.5% of sales, remained competitive.”

Market analysts said HUL’s growth momentum, which they have been able to sustain in volume terms, is quite positive.

“Because of the volume growth, they have been able to up the margin. Now the key challenge for them going ahead will be to sustain this decent number,” IDFC SSKI Securities managing director Nikhil Vora told PTI.

HUL said its board of directors has approved the proposal to demerge its exports business, including specific exports related manufacturing units, into a wholly-owned subsidiary, Unilever India Exports, with retrospective effect from 1 April 2011.

The HUL scrip was being quoted at Rs 324.50 apiece on the BSE in post-noon trade, down 0.43% from its previous close.


Hinduja Ashok Leyland introduces the user-friendly Dost in a low-key launch

The small, full-forward mini-pickup has become the visible face of the new Indian auto evolution—just like what the Maruti 800 and Omni vans managed about 20-30 years ago

There have been a lot of big-bang launches lately from the likes of Chevrolet and Ford. But what many might have missed is the rather low-key launch of the small goods- & people-carrier from Hinduja Ashok Leyland. Named the 'Dost', this lands up straight in Tata Ace territory, but with a bigger engine, bigger cabin, bigger tyres and bigger payload. The on-road cost, however, is close to that of the Tata Ace. And the man behind it, Dr V Sumantran, was there at Tata Motors for the Ace too. As Moneylife readers will know, this is a very interesting segment.

With the changing landscape in the non-Metro areas, this small all-products and passenger-carrier category, becomes an even more interesting upcountry vehicle. Take a drive anywhere in India and you will see how, from nowhere, the small full-forward cab kind of mini-pickup has become the visible face of automobile evolution in India-just like the Maruti 800 and Omni vans did about 20-30 years ago. Only, this lot, the Tata Ace, Hinduja AL Dost and similar vehicles, run on diesel and can lug a lot more. And retain resale value quite well, too.

Volvo trucks, which have an interesting joint venture with Eicher Motors for larger engines, are doing the same in India. After a decade and a bit more of a sort of monopoly in the luxury bus and high-powered trucks business, they are suddenly in the line of competition in this segment from India and abroad with Mercedes-Benz, MAN, Tata Daewoo Commercial, Hinduja Ashok Leyland—and that home-grown dark-horse, Asia Motor Works from Bhuj.

In a recent initiative, Volvo Eicher has tied up with specific engineering colleges in Mohali/Chandigarh, Ahmedabad and Mysore to train young people in specific automobile fields. This is social responsibility with a vision and it is hoped that other manufacturers also do something similar soon, instead of constantly complaining about the lack of trained manpower.




5 years ago

vechicle is very nice, your colour selection is very good, i like this vehical because appearance is very good,compare to other company vechical our ashok lyland company product is very nice to all purpose

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