What MFI Boards Can Do to Mitigate Political Risk?

Ramesh S Arunachalam

MFI boards can play a major role in fostering good governance on the ground and thereby mitigate Political Risk. In fact, several ERUDITE politicians, with a good track record of work in Parliament/equivalent, that I have spoken to in the last few years have all espoused the view that a well functioning MFI’s board can go a long way in mitigating Political Risk in micro-finance. Many of them also articulated the view that a rubber stamp five star board cannot have the same impact.

Accordingly, I have put together several crucial aspects in this regard on how MFI boards can function to mitigate Political Risk!

First, a key requirement is for MFI boards 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 MFIs’ 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 during the 2010 AP crisis).

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 the 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 serving on MFI boards.

Fifth, it is 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 prudent to consider creating a specialised risk supervision subcommittee within MFI boards. And it would also be critical for the MFI boards to publish their approval of the MFIs’ 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 AP in 2010. This would go a long way in mitigating Political Risk

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, and so on.

Seventh, where possible, MFI boards must seek and have increased cooperation with the supervisory authorities so that any substantial/systemic risks, similar to what happened in AP in 2010, are 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 important here. Especially, the creation of a specific subcommittee in MFI boards to take account of the interests of other stakeholders (such as 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 AP microfinance crisis and thereby mitigate Political Risk

The regulatory framework, on its part must get the concerned MFI associations to ensure that (NBFC) MFI boards take a proactive approach of putting into practice their stated governance principles in real time. That again, will go a long way in mitigate Political Risk in the microfinance marketplace.