How to make the boards of large NBFC MFIs implement corporate governance norms in practice? (Part I)

Apart from looking after shareholders’ interests, the five star boards of microfinance companies need to take better account of other stakeholders’ interests and a proactive approach to put into practice their stated governance principles


It was almost two years ago that we had the first signs of the 2010 Andhra Pradesh microfinance crisis. And indeed a lot of water has flown under the bridge. But one aspect that I have been unable to come to grips with is how the (five star) boards of the MFIs (microfinance institutions) concerned—often filled with illustrious people—failed so miserably in discharging their fiduciary and other duties.

While there appears to be several reasons for this, in this brief article I am highlighting the key issues so that the ongoing process (by various stakeholders) of trying to revive the MFI model in India, at least focuses on some of these critical aspects. These are certainly very appropriate for the (large) MFIs as non-banking finance companies (NBFCs) —currently, a category proposed in the Malegam report of 2011 and the Reserve Bank of India’s (RBI) subsequent circulars.

What then are the major issues that require attention and change?
First, a key requirement is for MFI board’s to strike the right balance between independence and skills with regard to their directors. Boards will be able to effectively monitor senior management at MFIs provided their directors have the skills, experience, time, willingness, objectivity and independence to do so. And this needs to be ensured in real time. An additional aspect here is that in order to safeguard the objectivity and independence of directors, it is imperative for the MFI to put in place clear policies for managing conflicts of interest.  And given the diversity in MFI operations, directors must spend time in understanding the MFI’s specific operations so that institutional complexity does not come in the way of their effective functioning (an argument put forth by many so called independent directors at MFIs).

Second, it would be beneficial to review the level of diversity in the composition of MFI boards and ensure greater diversity (especially women, directors with different socio-cultural and educational backgrounds, etc). It is believed that diversity should contribute positively to the overall quality of the MFI board's actual working.  

Third, in view of the increasing scale of MFI operations together with enhanced complexity of microfinance activities, there is a critical need to enhance the efficiency of MFI directors. For example, one strategy could be to limit the number of MFI boards on which a director may sit—so as to ensure that they devote the time necessary for properly discharging their responsibilities.  

Fourth, MFIs must put in place an appropriate procedure (using external and independent people) for evaluating the performance of their board of directors. These evaluations should also be shared with the shareholders and other stakeholders (including supervisory authorities)—so that there is formal and explicit understanding of the skills, capabilities and effectiveness of directors in MFI boards.

Fifth, it is very critical that responsibilities of the board (of directors) at MFIs—especially with regard to its role in risk supervision—be made more explicit and thereby strengthened. In other words, it would be very prudent to consider creating a specialised risk supervision sub-committee within MFI boards. And it would also be critical for the MFI boards to publish their approval of the MFI’s overall risk strategy and profile through a transparent (public) document—this is the equivalent of a risk control declaration in common banking parlance. Such a public document should also contribute to prudent management and supervision of risks within MFIs and this is very important, given what happened in Andhra Pradesh in 2010.

Sixth, in practice, there seems to be a lot of overlap with regard to decision-making in many MFIs. Without any doubt, greater clarity is needed on what the respective roles and responsibilities (of the various stakeholders) are with regard to decision-making within the MFI. And this is especially true with regard to the roles and responsibilities of the board vis-à-vis senior management. Therefore, MFI boards must ensure that clear accountability and responsibility structures are in place with regard to the entire institution including subsidiaries (if any), related group entities, regional/state offices, branches etc.

Seventh, where possible, MFI boards must seek and have increased cooperation with the supervisory authorities so that any substantial/systemic risks, like what happened in Andhra Pradesh in 2010, are indeed nipped in the bud.

And last but not the least, apart from looking after shareholders’ interests, MFI boards also need to take better account of other stakeholders’ interests. And clients are especially very important here. Especially, the creation of a specific sub-committee in MFI boards to take account of the interests of other such stakeholders (like clients and their protection) in their decision-making (“duty of care”) could go a long way in alleviating some of the key issues that emanated from the 2010 Andhra Pradesh microfinance crisis. Whether the concerned MFI associations and the NBFC MFIs will take a proactive approach to putting into practice their stated governance principles is something that time only can tell…

(Ramesh Arunachalam has over two decades of strong grass-roots and institutional
experience in rural finance, MSME development, agriculture and rural livelihood systems, rural and urban development and urban poverty alleviation across Asia, Africa, North America and Europe. He has worked with national and state governments and multilateral agencies. His book—Indian Microfinance, The Way Forward—is the first authentic compendium on the history of microfinance in India and its possible future.)

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