Where Angels Prey

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Tuesday, November 30, 2010

The Role of Independent Directors in Enhancing Corporate Governance in Indian MFIs: Specific Issues That Need To Be Examined By The RBI Board Sub-Committee

Ramesh S Arunachalam
Rural Finance Practitioner

A lot has been heard about the role of independent directors in MFIs during the last few months and I will not get into the specifics but there are numerous examples of situations (at MFIs) which could been salvaged, had only the independent directors acted 'independently'. The fact of the matter is that the image of micro-finance did take a beating and could have been avoided, had only the independent directors acted swiftly and appropriately...Never mind and let bygones be bygones…

Given below are several critical issues - with regard to the roles, appointment, compensation and other aspects - pertaining to independent directors. It would be useful if the RBI sub-committee looks closely at these issues and provides some clarity on how best independent directors can be used to enhance/improve governance of MFIs in India. The various specific issues are listed hereafter:

How To Hire The Independent Directors?: First, in many MFIs, the promoter, who is (often) also the CEO, hires the board rather than the desired practice of the board hiring the CEO. That practice needs to be looked at from a corporate governance standpoint. The key question is “how can boards hired by the Promoter/CEO be really independent?” While declarations provided periodically by independent directors could be used to monitor their independence, this is certainly an issue that the RBI sub-committee must ponder about and try to work out a solution.

Who Can Become Independent Directors?: Second, there is a lack of clear cut eligibility requirement for independent directors - in terms of objective criteria such as age, expertise and experience (especially related to micro-finance). The RBI sub-committee could attempt to spell out such criteria including age, experience, knowledge and expertise (in finance, micro-finance etc) and also specify operational standards for these criteria so that the task of identifying independent directors (for MFIs) perhaps becomes more transparent and relatively easier.

Who is An Independent Director?: Third, we need clarity regarding the definition of 'independent directors', especially in line with globally-accepted standards. The RBI sub-committee could try to define the same with regard to MFIs and may be SEBI could also be involved in the process so that the same can be broad based later. Without question, there is an immediate need is to adopt a clearer definition of 'independent director' in line with the criteria recommended by leading governance codes such as those of the New York Stock Exchange, UK's Combined Code and others etc.

Should There Be A Board Nomination Committee With Vesting Powers?: Fourth, whether it would be desirable to have the vesting powers of appointment of new independent and executive directors in specially constituted board nomination committees is something that needs to be examined, in the context of MFIs. These committees would have to follow a process and lay down clear criteria for selecting board members. The nomination committee chaired by an independent director should not only hire independent candidates to the board, but also be made responsible for ensuring the 'real independence' of the proposed appointment. This is another aspect that the RBI sub-committee could look into as part of its mandate and provide suitable recommendations

How Much Time Should Be Spent by Independent Directors on Their Work?: Fifth, should the independent directors be mandated to spend a certain minimum time on work at the MFI? As an industry observer argues, 'independent directors should be required to devote a certain minimum number of hours every quarter or so to understand the business of micro-finance and gain insights of the MFIs in which they are serving as directors. This will enable them to examine the risks being taken and the appetite of their MFI to take such risks as well as understand and provide guidance on other strategic aspects, as may be required.’ This again could be looked into by the RBI sub-committee

How Many MFIs To Serve as an Independent Director?: Sixth, a related aspect is the time spent by independent directors on board meetings of a single MFI, annually. When there are people who have at any one point in time, serve as independent directors on several MFI boards, naturally, the quality of directorship is likely to suffer. It may appropriate for the RBI sub-committee to recommend a threshold level for number of MFIs, in which people (professionals) could serve as independent directors.

Should Peer Appraisal of Independent Directors Be Made Mandatory?: Seventh, peer appraisal of independent directors is an option for enhancing their effectiveness and this needs to be examined from the perspective of MFIs. While such an appraisal process would need to be managed with associated sensitivities, board members should also view this as an opportunity for continuous improvement and enhancing the corporate governance framework. Traditional methods of evaluation (in terms of share prices and strategy initiatives) can be augmented with a formal and objective appraisal of the governance framework. The appraisal should enable identification of gaps, better decision making, improve effectiveness of meetings, etc. This is also an aspect that could be looked at by the RBI sub-committee, in the context of MFIs

Do First Time (Independent) Directors Need Capacity Building?: Eighth, another critical area often ignored is the need for continuous director education programs, especially for the entry or first time (independent) directors. This is very critical for micro-finance and especially, if we want to ensure that the same people do not serve on the boards of too many MFIs. This capacity support could be done through the College of Agricultural Banking or any other appropriate institute. This is a very critical issue and could be examined by the RBI sub-committee

How Should Independent Directors Be Compensated?: Ninth, the compensation of independent directors is a very critical and contentious issue and there have been a lot of controversies in the recent months. The RBI sub-committee must surely set standards for the same and ensure that the independence of the independent directors is not compromised, under any circumstances. One option would be to entrust this to the board nomination committee and ensure that the promoter/CEO do not interfere in setting and implementing norms of compensation for independent directors. While there could be other strategies, I think that this is one of the most important issues that needs to be looked at by the RBI sub-committee.

How to Protect Client Interests on The MFI Board?: The RBI sub-committee could also examine whether there could be specially designated independent directors, representing client interests. This is especially crucial in MFIs that have and use the Mutual Benefit Trust (MBT) structure, which is indeed a client owned body – please recall that there have been many issues with regard to governance of MBTs in the recent past and the extent to which their interests are being protected in the boards of MFIs. The same should be explored by the RBI sub-committee and suitable recommendations provided and like compensation, this is a very important issue in MFI governance.

Finally, while enhancing the quality of independent directors would surely enhance governance, there is also a right mindset aspect that we should not forget. As Mr Kris Gopalakrishnan, (Infosys CEO) says, 'We may not be able to eliminate corporate frauds altogether. No amount of regulation will help to stop frauds. At the end of the day, corporate governance is a mindset issue. We need stricter, stronger and quick enforcement of law by regulatory agencies so that it will act as a deterrent for others.[i]  Other observers agree, “As a baseline, MFIs need to have good governance in case they need to sustain and be profitable in the long run. Governance needs to be lived and practiced by the promoters and senior management at all times – and most importantly, when faced with the most difficult of situations.”

Therefore, while practicing good governance at all times is certainly a mindset issue, the least we can do is to incentivize good governance and perhaps penalize bad governance and do this consistently and without fear or favour. For this, we need a practical guiding framework pertaining to appointment, roles, responsibilities and compensation of independent directors and this is something that the RBI sub-committee could gift to the Indian micro-finance sector…that is perhaps low on its governance quotient...at least at this moment...  

[i] Quoted with Adaptation from The Satyam Saga, Business Standard Publication

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