Independent internal audit is the key to implementing responsible microfinance in MFIs

The MFI boards must recognise the need for strong, independent and objective internal audits which can go a long way in protecting their MFIs and enhancing their reputation

The microfinance institution (MFI) model in India has been through a (serious) crisis over the last few years (since 2005) and a lot of this has to do with the inability of the boards of MFIs to actually implement (in real time) some of the very (high sounding) concepts and prescriptions for responsible finance that came from various quarters.


While it cannot be denied that some MFIs were not (at all) interested in responsible microfinance, some others perhaps could not ensure the implementation of these well-meaning concepts on a consistent basis in real time. A classic example is the well intentioned (Sa-Dhan) code of conduct in 2006, which was often waved at meetings with the Andhra government but rarely visible, in terms of practice, on the ground. Slowly, perverse incentives (as Vijay Mahajan had famously noted in 2010) set in and eventually, led to what is called the 2010 Andhra Pradesh microfinance crisis.


In retrospect, what essentially happened was a failure of commercial microfinance—primarily because the checks and balances required for commercial microfinance (to actually work on the ground) were almost absent. By checks and balances, I mean two things including lack of: a) Supervisory oversight and that contributed in huge measure to the crisis; and b) a strong, independent and objective internal audit function within these MFIs. While even a single letter from the supervisor could have mitigated the scale of the problems that happened in Andhra Pradesh in the years preceding 2010, the absence of an independent and objective internal audit system certainly hurt the MFIs even much more.


Why is an independent and objective internal audit system critical for the well-being of MFIs, especially those desiring to practice responsible commercial microfinance? From a larger perspective, internal audits are perhaps the first means for well meaning MFI boards to get regular feedback on whether or not the concept of responsible microfinance is being implemented on the ground. In other words, an independent and objective internal audit system can provide very useful feedback on how processes and procedures (to promote responsible microfinance) are supposedly being implemented on the ground. Therefore, even before credit/social ratings and/or the newly established code of compliance assessments point out any discrepancies, it is the internal audit system that can provide very useful early warning signals for the MFIs and their boards. Without question, just as charity begins at home, the first step in responsible microfinance is therefore to ensure that MFIs have such an independent and objective internal audit system in the first place.


So, what do I mean by an independent and objective internal audit system? While this neglected concept is explored in a multi-part article, I start out here by setting the strategic context of internal audits from which their independence and objectivity stem. This strategic context clearly determines the extent to which internal audits can become a powerful and independent tool that boards of MFIs can use to ensure responsible micro-finance on the ground and in real time.


Essentially, according to The Institute of Internal Auditors (, internal auditing is defined as: “An independent, objective assurance... activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes”.


The above definition is very critical because it sets forth the parameters on which an internal audit system can be designed at the MFIs.


First and foremost, an internal audit system must be independent of the MFI activities being audited. This implies that internal auditors at MFIs don’t report to line management and/or senior management. Often, at some MFIs which had an elaborate internal audit function, the independence of this function was hugely compromised because the internal audit department came under senior management whose very activities were also to be assessed.


Tell me, how can an internal audit department that reports to the CEO or CFO (or anyone else who is part of the line/operational management) accurately assess and provide objective feedback on the working of processes and procedures? Therefore, the MFI boards must ensure that there is an internal audit department that reports directly to the board or its audit sub-committee. This is mandatory and this independence in functioning will facilitate greater objectivity in the working of the internal audit department. It will also position the internal audit department appropriately within the MFI


Second, an additional caveat is in order here. Many organisations including MFIs may find it tempting to get internal auditors to design their risk management, control and governance systems. While it is true that internal auditors have very intimate knowledge of what systems work on the ground and why, if they are asked to design these MFI systems, then, it is unlikely that they would be able to assess functioning of these systems dispassionately and objectively. This means that, at no time, should MFIs use their internal auditors to design the risk management, control and governance systems and processes. At best, feedback—through discussions with the internal auditors and/or studying of their internal audit reports—could be taken with regard to these systems so that appropriate on-course corrections are made. This again will ensure that the internal auditors are truly independent of the activities that they are auditing.


A third issue is relevant here. That is the scope of internal audits and this again is very critical to understanding the reality from across the organisation (MFI). Very often, the activities of senior management are excluded from internal audits for various reasons. That should not be the case.


In short, internal audits must cover each and every activity at the MFI with the objective of evaluating (but not limited to) the following:

  • Integrity, reliability and effectiveness (including the relevance, accuracy and comprehensiveness) of risk management, control and governance processes and related systems;
  • Monitoring of legal compliances—with extant laws and regulations—including any changing requirements from regulator/supervisors; and
  • Safeguarding of all assets of the MFI.


Without question, the need for strong, independent and objective internal audits has never been more important in the Indian microfinance sector. I certainly hope that the boards (in MFIs) recognize this and facilitate the adoption of well functioning internal audit systems that can go a long way in protecting their MFIs and enhancing their reputation as REAL practitioners of responsible micro-finance in India…



Arun Sharma

4 years ago

Mr. Ramesh S Arunachalam's article of 12th of July really hits the nail on the head when he elucidates the importance of independent Internal Audit for MFIs. With same understanding and committment we at UNI FinTech Pvt. Ltd. Mumbai are realising that this cold fact is not appreciated by most MFIs, since we offer our professional expertise in Internal Audits and Risk Management of MFIs and find that very few respond to our professional enquiries. We would appreciate if you could view our Company profile on and help us to promote professionalism in Internal Audit in MFIs. - Mr. Arun Sharma, Director - UNI FinTech Pvt. Ltd.

Government to survey buildings handed over without OC in Mumbai

There are 5,000 odd buildings in Mumbai where builders have handed over occupation to the residents without OC and the residents are paying more taxes

Mumbai: Maharashtra Chief Minister Prithviraj Chavan on Thursday said a special drive will be undertaken to survey 5,000 buildings in Mumbai which have been handed over to residents without Occupation Certificate (OC), reports PTI.

He was responding to supplementaries during a calling attention notice in the Legislative Assembly that builders are not being penalised and residents end up paying more taxes due to lack of proper OC.

Chavan admitted that there are 5,000 odd buildings in Mumbai where builders have handed over occupation to the residents without OC.

Jeetendra Avhad (NCP) said developers take only construction certificate (CC) from the municipal authorities and violate building rules by not following proper guidelines.

"They get away with such irregularities and make the residents pay," he complained.

Avhad was supported by BJP legislator Yogesh Sagar and Subhash Desai (Shiv Sena). Desai asked if any legislation would be passed to prevent hardships to the common man.

Chavan said the suggestion of a separate legislation would be considered and a fresh policy would be made soon.

The legislator said developers were not paying development charges and transfer occupation to the flat owners without taking OC. He said developers had not paid Rs655 crore to the Mumbai municipality till June this year.

Chavan said developers have to pay 50% of the development charges before start of construction and 50% after permission of construction is given.

He admitted that Rs102 crore is awaited from developers of redevelopment projects adding that the projects are going slow due to various reasons.


Life insurance premium declines 3% in FY12

While linked new business tumbled 67% to Rs17,455 crore, non-linked new business premium rose over 32% to 96224 crore during 2011-12

Mumbai: Total premium of life insurers in India dropped 3% to Rs2.8 lakh crore during 2011-12 compared with Rs2.9 lakh crore in the year ago period, as per the provisional data released by Life Insurance Council, the industry body for all life insurance companies.

"This drop in total premium can be attributed to change in regulatory road map, declining number of products and disappearance of pension business in the individual segment," Life Insurance Council Secretary General SB Mathur said.

The total new business premium collected by the industry for FY 2011-12 declined 9.5% at Rs1.13 lakh crore from Rs1.3 lakh crore last year. Linked new business saw a significant drop of 67% to Rs17,455 crore against Rs52,739 crore last year.

However, Non-Linked new business premium showed a growth of more than 32% to Rs96,224 crore as on 31 March 2012, compared to Rs72,878 crore in 2010-11.

The total assets under management (AUM) of life insurers also increased by 9% to Rs16.2 lakh crore as on March 2012, compared to Rs14.8 lakh crore in the previous year, despite the apparent slow-down in the industry.


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