It is great for banks to appoint many nominee-directors to MFI boards, but they must act responsibly on the ground

It is great that banks have decided to appoint nominee directorsⁱ  on the board of MFIs (microfinance institutions), whose debt is being restructured. That banks are willing to assume a greater role in governance of MFIs is indeed fantastic news, but there are some important lessons from the 2010 microfinance crisis that need to be internalised and acted upon by banks. This article attempts to do the same for the benefit of all microfinance lenders.

First, the aspect of appointing nominee directors must be streamlined and institutionalised. A separate department (or cell) must be created for this purpose with a high-ranking official (at least at the level of chief general manager or equivalent) at the helm. And nominee-directors should be appointed on the boards of all systemically important MFIs and especially NBFC MFIs, who are clients of the bankⁱⁱ  and have a gross loan portfolio outstanding greater than Rs100 crore. The nominee-directors should exclusively represent their institutions on the boards of MFIs and must be staff from this department and not less than a deputy general manager or equivalent by rank. This way the work of nominee-directors will become an integral part of the overall operations. The proposed department/cell should function like any other department of the bank with normal rotation of officers and the like. Outsiders may be appointed as nominee-directors to boards of MFIs only as additional directors on MFI boards, wherein, because of the strategic importance and/or larger portfolio of the MFI concerned, the bank may aspire to have more than one nominee director.

Second, in terms of the officials who are to be nominee-directors, at no time, should any of them be on boards of more than three MFIs. Also, none of the nominee-directors should have had a past (working or lending) relationship (for at least three years) with the MFIs on whose boards they are to serve. Microfinance is not rocket science and it should not be difficult for the nominee-directors to gain reasonable expertise within 6 months or so through field visits at the MFIs concerned and other capacity-enhancing mechanisms. Of course, as a prerequisite, these nominee-directors could be exposed to contemporary microfinance knowledge through available courses such as at the College of Agricultural Banking, Pune and other institutions as appropriate.

Third, a very important issue that is relevant here is that banks (or for that matter DFIs like SIDBI, or Small Industry Development Bank of India), by nominating directors on the boards of MFIs, are giving tremendous legitimacy to the concerned MFI. In other words, apart from the quantum of loans given and/or investments made, the real additionality of their board participation lies in associating their well-established and highly-regarded brand name with the concerned MFIs. Therefore, the nominee-directors are under serious obligation to diligently perform their roles as directors in a professional and objective manner. And this is where we should not forget the fact that SIDBI's nominee-director remained a mute spectator when the founder-promoter-managing director of a large MFI gave himself a huge loan to buy shares (at par value) in the same MFI. That the SIDBI nominee-director again remained silent at the hurriedly-convened board meeting of a large MFI, that too on a Sunday, to sack an immensely successful CEO who led the MFI through a spectacular IPO, is again worrisome. These remain causes for great concern and are certainly not acceptable in any financial institution. They are, unquestionably acts of not-so-good governance.

Fourth, while I can cite many more such instances where SIDBI's nominee-directors turned a blind eye to the not-so-good governance and operational practices of several MFIs, the idea is not to single out SIDBI and/or blame themⁱⁱⁱ . Let bygones be bygones but the key point is that we should learn the lessons and make necessary changes. Thus, as representatives of banks (or other lenders), nominee-directors are expected to ensure good governance and transparent operations of the MFIs on whose board they serve. This, in turn, necessitates that banks (or other lenders): a) establish a transparent and effective process of appointing nominee-directors to MFIs; and b) have appropriate mechanisms for ensuring accountability of these directors including disincentives for irresponsible and/or non-performance.

Fifth, this also means that nominee-directors should be given clearly-identified responsibilities in a few areas which are important for public policy. The illustrative lists of these are given hereafter: a) Financial performance of the MFI; b) Payment of dues to lenders, governments and other institutions; c) Payment of government tax-related dues. And where the MFI feels that a particular tax demand is unjustified, nominee-directors should satisfy themselves about the prima facie reasonableness of the MFIs' case before action is recommended by the board; d) Inter-corporate/group investment in and loans to or from associated companies, concerns and/or related parties in which the promoter group and/or senior management have significant interest; e) All transactions in shares of any kind; f) Expenditure being incurred by the company on management group including total cost to MFI; and g) Policies relating to the award of contracts and purchases/sales etc.

Sixth, the nominee directors should also ensure that the tendencies of many MFIs towards inefficiency, extravagance, lavish expenditure and diversion of funds are curbed. With a view to achieve this objective, the banks/lenders should also necessitate that the MFIs concerned have a formal audit sub-committee of the board of directors for the purpose of periodic assessment of expenditure incurred by the MFI. Their institutional nominee-director will invariably have to be a member of these audit sub-committees.

Thus, while it is indeed very welcome news that banks will now participate on the boards of MFIs, they must use their position and leverage to ensure good governance, transparent and efficient operations and client responsiveness at the MFIs concerned. If that happens, we can surely begin to see light at the end of the long microfinance tunnel in India.
 

  ⁱPlease see following news item - http://www.business-standard.com/india/news/banks-to-have-more-say-in-mfi-boards/450964/
  ⁱⁱMuch of what is said here would apply to DFIs like SIDBI as well.
  ⁱⁱⁱThey have done a lot of good work in micro-finance but that does not absolve them of their responsibility in the 2010 micro-finance crisis.

(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).