It is about time that MFIN starts and delivers on the Promised Self-Cleansing!

Yes, I have the greatest respect and regard for Mr Vijay Mahajan, the President of MFIN and Chair Person BASIX, who has indeed been one of the most influential persons in the Indian and Global micro-finance industry (Mr Mahajan is currently also the Chair Person, CGAP Executive Committee) for the last two decades. I have personally learnt a lot from him and I gratefully acknowledge his significant contribution in attempting to provide India’s low income people with a wide range of innovative market led services. In fact, in my opinion, his Basix is one of the few institutions that has attempted to innovate and reach appropriate services to low income people including farmers.

His record as an institution builder is unparalleled and his integrity is beyond question and I would like to sincerely believe him to be perhaps right when he strongly puts forth the arguments about the so-called virtues of Indian Micro-finance and MFIs. But, then…for an ordinary grass-root practitioner like myself, there are many worrying aspects in the Indian micro-finance industry and it is time that the MFI leaders and torch-bearers, set the record straight!

As Mr Mahajan has time and again said (in a recent article in Economic Times and discussions with the media), “Every industry has its bad apples and we are committed to expose and expel them.” This is a very welcome attitude and I attempt to outline a few such issues here…and really hope that MFIN uses a qualified and objective set of people, with no conflict of interest what-so-ever, to provide answers to questions such as the following, in a rigorous and candid manner….This will set the stage for self-cleansing by the Micro-finance industry.

Let me start with Governance. Prof Sriram’s recent papers (Working Paper 2009 and EPW, 2010) serve as a very good reminder of the kind of Governance prevalent in MFIs in India. Without question, I am sure that all of us would agree that financial institutions (MFIs included) must follow (high) standards of corporate Governance including specific disclosure norms – otherwise, the institutional failures of 2008 and 2009, from the larger financial sector, will continue to haunt us. The following practices are perhaps critical elements of the governance process in a financial intermediary and they perhaps require greater attention in MFIs, given the volatile nature of their portfolio. It would be useful if MFIN allows an independent team of qualified people to research the same and throw light on the following questions:

1)   Whether Indian MFIs have established strategic objectives and a set of pro-poor corporate values, after taking into account the special nature of the micro-finance business and communicated the same throughout the organisation and whether indeed these are prevalent in implementation during real time?

It is often stated that with strategic objectives that call for rapid growth and increasing commercialisation, loans are being indiscriminately pushed to low income borrowers, who may not be in a position to repay these loans. Further, it is also stated that ‘greening’ of loans (apart from coercive practices), that all of us may have seen in the larger financial sector, is perhaps becoming the major strategy for ensuring high repayment in the Indian micro-finance industry

2)   Whether Indian MFIs have set and enforced clear lines of responsibility and accountability throughout the organization, after taking into account the special nature of the Micro-finance business? Are fair and standard business practices being followed by the MFIs?

It is believed that with burgeoning growth, the chain of command in MFIs is getting distorted and as a consequence, the head quarters and their staff have very little control over branch and/or field staff who may be functioning in a manner that runs counter to the very sprit of micro-finance, financial inclusion and/or other developmental objectives.

Two issues are especially relevant here. 

a)   There is one school of thought that suggests that the so-called control failures and frauds, said to be prevalent in the Indian Micro-finance industry (Thorat and Arunachalam, 2005), is because MFIs have not ensured appropriate oversight by their senior management. So, it would be useful to understand what MFIs have done in this regard, especially, given that they handle increasingly larger amounts of cash and their portfolios are burgeoning on a daily basis? While use of technology in the control environment is often mentioned as a solution, this is also perhaps over-hyped. Therefore, one really needs to understand the difference between technology deployed in pilots as opposed to being a full-fledged part of the MFI operations and the extent to which such technology is indeed contributing to stronger internal control and/or lower cost. A related aspect here is whether MFIs are effectively and appropriately utilising the work conducted by internal and external auditors, in recognition of the important control function they provide? Additionally, it seems necessary for MFIs to set the record straight with regard to their MIS and its functioning, the business rules therein, loan portfolio audits conducted (if any) and their details and other such actions that are part of a comprehensive risk management framework in their institutions.

b)   While Mr Mahajan alludes to a code of conduct, it must be highlighted that a similar code of conduct was drafted by Sa-Dhan after the AP crisis of 2005/6 when the Indian MF industry experienced several major problems. Sa-dhan did take a lead in this regard and introduced an ETHICAL CODE of CONDUCT for its member MFIs.  While the CODE of CONDUCT guidelines prepared by Sa-dhan were quite appropriate, unfortunately, its effective implementation and enforcement (including penal action) are questionable. In fact, if the Sa-Dhan CODE of CONDUCT had indeed been effectively implemented, then, where is the need for the MFIN CODE OF CONDUCT, especially given that the founding members of Sa-Dhan are also among the founding members of MFIN. So, where is the guarantee that the MFIN Code of Conduct will indeed work on the ground?

3)   Whether Indian MFIs have ensured that: a) board members are indeed qualified for their positions (either as truly independent directors and/or as experts); b) they have a clear understanding of their role in corporate governance in an MFI and are not subject to undue influence from management and/or outside concerns; c) they are not having any potential and/or real conflict of interest what-so-ever; and d) Board member compensation is indeed consistent with the ethical values, objectives, strategy and control environment of the Micro-finance industry

This is a very critical aspect that is at the heart of the governance process and especially important given Prof Sriram’s recent papers. Again, it would be useful if MFIN is able to provide objective real time data with regard to the same

A final question concerns public disclosure.

4)   Are Indian MFIs conducting corporate governance in a transparent manner? Transparency can reinforce sound corporate governance and therefore, public disclosure is desirable in the following areas:

a)        Board structure (size, membership, qualifications and committees);

b)        Senior management structure (responsibilities, reporting lines, qualifications and experience);

c)        Basic organisational structure (line of business structure, legal entity structure);

d)        Information about the incentive structure (remuneration policies, executive compensation, bonuses, stock options and the associated rationale) etc;

e)        Nature and extent of transactions with affiliates and related parties. For example, the International Accounting Standards Committee defines related parties as “those able to control or exercise significant influence. Such relationships include: (1) parent-subsidiary relationships; (2) entities under common control; (3) associates; (4) individuals who, through ownership, have significant influence over the enterprise and close members of their families; and (5) key management personnel. Disclosures in this area should include. (a) the nature of relationships where control exists, even if there were no transactions between the related parties; and (b) the nature and amount of transactions with related parties, grouped as appropriate. (IASC International Accounting Standard No. 24, Related Party Disclosures).

It would be useful if MFIN and its members provide and publish objective data with regard to the above aspects and act accordingly thereafter to expose and expel their bad apples.