Corporate Governance in MFIs

In order to achieve greater scalability, the
microfinance sector has witnessed the emergence of for-profit microfinance
institutions (MFIs) that are managed on similar lines as companies. They
attract investors and lenders and they even list on the stock markets. That
creates a dilemma as far as boards of MFIs are concerned, as they are required
to manage two interests: one being the investors and the other being the customers
(who are represented by the needy sections of society). The question of how the
boards of MFIs have been able to address this dichotomy merits no easy answer,
as this sector continues to evolve in terms of regulatory and governance
In this background, it is interesting to note
a keynote
by RBI’s Deputy Governor Mr. Anand Sinha at a recent FICCI
workshop. The address, titled Strengthening Governance in Microfinance
Institutions (MFIs) – Some Random Thoughts highlights some of the key
governance issues affecting the microfinance sector. Here are some excerpts:
Many analysts attribute the current crisis to the irrational exuberance
of some MFIs who entered the segment with the sole emphasis on business growth
and bottom lines.  They perhaps did not
take due cognisance of the vulnerability of the borrowers and the potential
socio-political ramifications their aggressive approach could possibly lead
to.  The competition among MFIs led to
these institutions chasing the same set of borrowers, by free riding on [self-help
groups (SHGs)] and loading them with loans that borrowers, possibly, could not
There were serious deficiencies observed in the governance framework of
some of the MFIs.  The corporate
governance issues in the MFI sector were exacerbated by some of the ‘for
profit’ MFIs, dominated and controlled by promoter shareholders which led to  inadequate internal checks and balances over executive
decision making and conflict of interests at various levels. Other undesirable
practices such as connected lending, excessively generous compensation
practices for senior management, founders/ directors and failure of internal
controls leading to frauds precipitated the crisis.   Some of the MFIs chased high growth
trajectory at the expense of corporate best practices. The listing and trading
of the shares of the ‘for profit’ MFIs generated a set of incentives which
attracted capital looking for high returns whereas the capital suited for
catering to the needs of the poor has to be patient capital. This disconnect
led to further worsening of the situation. 
What is more disturbing is that there were enough warning signals of
trouble in making over an extended period of time but the MFIs, at least  some of them, carried away by their immediate
success, failed to pay heed.
Ever since the listing of SKS Microfinance
that was followed by the turmoil in the microfinance sector in Andhra Pradesh
due to a stringent legislation being introduced, I have been interested in studying
the governance issues pertaining to MFIs. I have attempted to address some of
these in a paper titled Microfinance
and the Corporate Governance Conundrum
, the abstract of which is as

Microfinance evolved as an
instrument to reduce poverty and bring about sustainable development. As an
alternative to traditional means of finance such as banking and insurance
(which failed to meet the needs of poorer sections of society), microfinance
was pioneered by self-help groups, non-governmental organizations and other
non-profit institutions. However, with a view to building a scalable model that
engenders overall sustainable development, the microfinance sector has
witnessed the emergence of for-profit institutions that are structured along
the lines of the modern business corporation. These microfinance companies
adopt market-based mechanisms to raise capital that is employed in financing
the poor and less-privileged.

From a corporate governance perspective, microfinance companies and their
boards of directors are faced with the classic dilemma. On the one hand, it is
recognized that the principal goal of microfinance is to reduce poverty; to
that extent the interests of borrowers (or customers) as principal stakeholders
becomes paramount. On the other hand, a shareholder-centric approach operates
as a major countervailing factor by compelling microfinance companies to
generate profits to service investors and maintain stock price. The current
discourse in corporate governance does not appear to satisfactorily address the
predicament of boards of microfinance companies. This is due to the fact that
investors and stock markets judge them against standards imposed by corporate
governance norms and practices that are generally applicable in the corporate

This article argues that the employment of conventional concepts and doctrines
in corporate governance to for-profit microfinance companies does not
adequately address the issues specific to such companies. It calls for a
paradigm-shift that necessitates examination of corporate governance in
microfinance companies through an altogether different lens. After considering
the available empirical evidence and analyzing qualitative data generated from
case studies and field interviews, it seeks to develop separate parameters for
measuring the correlation between corporate governance and performance of
microfinance companies, such that the overarching goals of reducing poverty are
not diluted.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

1 comment

  • It was interesting to read yr paper. I think the issue is more general and goes beyond MFIs. e.g. It could well apply to listed PSUs as well (the current controversy over Govt directive to Coal India to sign FSAs. If Coal India signs such agreements in the larger interest of the economy, can the directors have resort to a modified `business judgment’ rule as you suggest in yr paper?).

    Mangesh Patwardhan

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