Ramesh S Arunachalam
In terms of board functioning, what can MFI
boards (themselves) do to improve the practice
(emphasis added) of corporate
governance in reality? Here are some initial practical suggestions based on
experience and this should go a long way in mitigating political risk!
1. Limit
the number of MFI boards on which an (independent) director may sit to not more
than three at any given point in time. This will
hopefully afford directors the time and space to understand how the MFIs, on
whose boards they serve as directors, are actually performing on the ground.
During and before the 2010 AP crisis in India, I had personally witnessed
directors—who were on multiple MFI boards (often exceeding three)—jumping
planes in a literal sense and having very little time to attend to their
fiduciary and other responsibilities. Many of them could not even visit the
field areas, even before the customary quarterly board review. Some of them who
served on subcommittees were even more harassed for time. And let me tell you that the perceptions of the bureaucrats in Andhra
Pradesh and elsewhere in India were similar with regard to little time and
effort spent by independent directors. Without any doubt, believe me, these
perceptions enhanced political risk, when it mattered! Therefore, it appears
necessary to ensure that there is a limit—in tune with physical reality—on the
number of MFI boards in which a director may sit. And three appears to be a good
permissible number but this could vary with context! My larger point is that it
makes little sense for independent directors to sit on a large number of boards
that they can do little justice towards!
2. Separate
the functions of the chairman of the board of directors and MD (or chief
executive officer or equivalent) in MFIs, where they are together and ensure
that appropriate outsiders at least occupy one of those posts. This
is very critical and should result in dispersed power, especially when the
founder promoter is the chairman and/or managing director. Much of the
excessive risk taking (in the form of multiple, sequential, and larger loans being given to subprime-like
clients) that occurred during the lead up to 2010 AP microfinance crisis
happened primarily because there was no one on the board to seriously question
the enthusiastic and entrepreneurial promoters, occupying one or both of these
positions. Often, this was because the promoter had, in the first place, appointed
these individuals to the board and this had caused a huge conflict of interest.
This is again an issue that was brought up in discussions during the 2010 AP
crisis, by both bureaucrats and politicians. In my opinion, conflicts of
interests were a huge issue that led to the burgeoning and unmanageable growth
of Indian microfinance, thereby, enhancing Political Risk!
3. Create
a transparent board recruitment
(or appointment) policy that clearly specifies the duties and profiles of MFI
directors, including the chairman. Such
a policy must also ensure that directors have adequate skills and experience
(apart from the availability of time to do their job).
The policy must also ensure that the overall composition
of the MFIs’ board of directors is suitably diverse—including more women,
youth, clients (or their interest groups), and individuals with the requisite
skills (but possibly different backgrounds) in the board is perhaps a way to
improve the boards’ overall functioning and effectiveness and also perceptions
about its effective functioning and effectiveness (which in turn should reduce
Political Risk). The policy must also ensure that conflict of interest issues
are taken into account with regard to board appointments so that the
independence of the directors is not compromised. This again is very
critical so that people don’t perceive the board to be a rubber stamp board.
There were what I call as five star boards at some large MFIs but the
functioning and effectiveness of these boards was poor and the perceptions of
these five star boards were that they were rubber stamp boards. That enhanced
Political Risk considerably.
4. Ensure
that MFI boards develop (on their own) a formal conflict of interest policy and
an objective set of compliance procedures
and processes for implementing the same. Such
a policy should ideally include: (a) an MFI director’s duty to avoid (if
possible) all activities and transactions that could either create a conflict
of interest or even the appearance of a conflict of interest; (b) a transparent
set of processes and procedures for MFI directors to follow before they engage
in certain types of activities (such as agreeing to
serve on the board of another MFI or that of a lender
or an investor etc.) so as to ensure that such activities will not create a
conflict of interest; (c) an MFI director’s duty to disclose any activity and
issue that may result, or has already resulted, in a conflict of interest; (d)
an MFI director’s (voluntary) responsibility to abstain from voting on any
matter where the director may have a conflict of interest or where the
director’s objectivity/ability to properly fulfill duties to the MFI may be
compromised; (e) adequate procedures and clear norms for transactions and
activities conducted with related parties on an arms-length basis; and (f)
transparent procedures by which the MFI board will deal with the issue of any
noncompliance with the (conflict of interest) policy. Ideally, it would be good
for the policy to contain specific (conflict of
interest policy) examples of where and how conflicts of interest can arise when
serving as an MFI board member. This should facilitate greater understanding of
conflict of interest issues, with regard to microfinance in general and the MFI
in particular. In my humble opinion, this is one aspect that could go a very
long way in mitigating Political Risk in microfinance!
5. Have
a compulsory formal evaluation of the functioning of the MFI’s board of
directors by an external independent evaluator. This is a
critical issue and the results of this evaluation should be made available to
shareholders and supervisory authorities —officially publishing this evaluation
(on their website) is an aspect that could also be considered by the MFIs
concerned. Such a formal evaluation of the board should preferably be done in
the absence of the CEO or managing director or promoter (as applicable), so as
to ensure that the exercise is a free, fair, and
independent one. The services of independent evaluators—individuals and/or
institutions who have not had (or do not have) a material relationship (as
defined in common parlance) with the MFI—could be taken in this regard. In
India, premier management institutes (such as IIMs) and others (like the College
of Agricultural Banking, etc.) could be actively
involved in these (evaluation) processes and likewise, similar institutions
could be involved in other contexts. Again, this should serve to enhance the
perception that boards are indeed independent and are not likely to encourage
excessive sub-prime like risk taking by the CEO or the promoters. This again
should reduce Political Risk!
6. Suitably
compensate MFI board members for their time but do not incentivize their
working on the basis of stock options
or other such mechanisms that invariably encourage undue or excessive “risk”
taking as was witnessed during the 2010 AP microfinance crisis.
Even if the law permits, it seems prudent not to remunerate board members
through stock options and the like as the independence of (independent)
directors may be seriously compromised. Again, the happenings, in India, in the
run-up to the 2010 AP microfinance crisis clearly demonstrate the fact that
independent directors who had been so compensated had not performed their fiduciary and other duties appropriately. The key issue to note here is that much of
the 2010 crisis occurred because board members and senior management were
compensated heavily (in the short term), whereas the risks of their strategies
could be known only in the medium/long term. This mismatch created a huge
incentive for excessive risk taking, which, in turn, led to the 2010 AP
microfinance crisis. The parallels with the US subprime can hardly go
unnoticed. Thus, proper incentivisation of MFI board members and transparency
in this process should go a long way in mitigating Political Risk. Much of the
crisis in Andhra Pradesh 2010 emanated after an economic times article touched
on the actual bonus and kind of compensation that had been provided (5 months
earlier) to the now out of favour sacked CEO, who had led the MFI through a
spectacular IPO. That was not all! Other articles highlighted that independent
directors were compensated with (huge) stock options even as the promoter gave
himself a HUGE (as per the context) interest free loan from the MFI’s coffers.
Again, let us understand that, whether it is right or not, Political Risk stems
from perceptions about institutions, people and their actions and the larger
point here is that let us do things in a transparent manner and without
conflicts of interest!
7. Make
it mandatory for MFI boards to set up a risk committee and establish clear
rules regarding the composition and functioning of this committee. In addition,
make it compulsory for one or more members of the audit
committee to be a part of the risk committee and vice versa. Further,
the chairman of the risk committee should always report to the AGM and outline
the role that directors have played in shaping the MFI’s risk profile and
strategy. Also, the risk committee should frame a “risk control declaration,”
which should also be published so as to ensure its wider dissemination and
use—both within and outside the organization. This again, will go a long way in
mitigating Political Risk!
8. And
last but not the least, create an obligation for a specific duty (“duty of
care”) to be established for the board of directors so that they take into
explicit account the interests of various stakeholders (mainly, clients) during
the decision-making procedure. This
is especially critical and the 2010 AP microfinance crisis would (perhaps) not
have occurred, if only boards of MFIs had exercised such a duty of care that
explicitly looked after the interest of clients who were constantly
over-indebted. The desire for better operating performance at many MFIs meant
that the board of directors at these MFIs just did not bother about the impact
of their turbocharged growth on clients and their well-being. Therefore, there
is an explicit need to incorporate a duty of care—especially with regard to
clients—among MFI boards. This again, should go a long way in mitigating
Political Risk!
To summarize, for the microfinance sector
that has undergone a deep crisis in India, corporate governance has never been
more important than now and good governance can alter perceptions and mitigate
political risk! Corporate governance is not just the responsibility of an
individual MFI. Rather, it is the collective responsibility of all individuals
who become directors on the boards of an MFI and serve together. While we can
have great sounding norms and guidelines for corporate governance,
unfortunately, they cannot be effectively enforced through regulation alone.
They need to be practiced at all times (including difficult circumstances) and
that is where the individual initiative of directors (serving on MFI boards)
does really matter. And I sincerely hope that directors on MFI boards do ensure
that this happens in real time on the ground—by enabling and facilitating their
boards to reorient their functioning in the light of some of the suggestions
made. If this happens, many of the ills plaguing the (Indian) microfinance
sector and MFIs will slowly but surely start to vanish as also the Political
Risk associated with Microfinance!
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