96022 Corporate governance in microfinance institutions Pasquale Di Benedetta, Ira W. Lieberman, and Laura Ard Governance affects the way an organization is directed, administered and/or controlled. Good governance can go a long way in preparing an MFI to better handle the risks that are inherently part of managing an MFI. Risk taking is at the heart of financial intermediation and the Board of Directors is ultimately responsible for the level of risk assumed by the institution. Corporate Governance in microfinance institutions Pasquale Di Benedetta, Ira W. Lieberman Ph.D., and Laura Ard © 2015 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This work is a product of the staff of The World Bank with external contributions. 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Any queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. The World Bank Graphic Design: Miki Fernández, miki@ultradesigns.com We gratefully acknowledge Calmeadow Foundation for their support in publishing this document. n n 3 FOREWORD As microfinance institutions (MFIs) scale up and commercialize, proper MFI governance becomes increasingly important. Current microfinance literature and forums do not sufficiently address MFI governance. The topic is not as ‘sexy’ as mobile or branchless banking, new product development or credit crisis. Yet good MFI governance plays a crucial role in product development, technological advancement, and more importantly, crisis management. Governance affects the way an organization is directed, ●● MFIs often operate in regions prone to natural or administered and/or controlled. Good governance can go socio-political crises (Nicaragua, Bosnia, Morocco and a long way in preparing an MFI to better handle the risks India are popular examples). During a crisis, the board that are inherently part of managing an MFI. Risk taking plays a critical role in ensuring the viability of the MFI. is at the heart of financial intermediation and the Board “Weathering the Storm” by Daniel Rozas and “Failures of Directors is ultimately responsible for the level of risk in Microfinance” by Beatriz Marulanda and others have assumed by the institution. documented institutional failures across the global micro- Boards should be making decisions that will result in fi- finance industry. The cardinal lesson in all those cases is nancial and organizational health, maintain mission that good MFI governance could have prevented or mit- focus, and assure institutional reputation and market po- igated the crises these MFIs faced. In most cases, they sitioning. Not only does the board appoint and review the could have prevented failure altogether. performance of the CEO but it should also decide which business opportunities to pursue, which market niches MFIs need to learn from the experiences of their peers are of interest, which products to introduce, and which that struggled before them. Development institutions and policies and procedures best support the organization. private investors are uniquely positioned to encourage And as MFIs’ operational and decision making complexity MFIs to do so. Holding a substantial equity stake, these has increased, so has the importance of good MFI gover- investors often play a prominent role on the boards of nance. Increased MFI complexity is exemplified in: MFIs. But before investors and stakeholders can push for better governance practices, they must first acknowledge ●● As MFIs have scaled up, their management has be- and internalize why good governance is important—par- come more complex due to greater outreach, product ticularly for an industry that is rapidly maturing. diversification, and entry into different markets. This background paper on microfinance governance aims ●● Many MFIs have transformed into regulated entities to greatly advance our thinking in the industry on why gov- and face the regulatory requirements associated with ernance is of such critical importance to MFIs, now more such a transformation. than ever. We hope it will shed some light in areas that ●● Scaling up and transformation requires additional, het- previously might have gone unnoticed and prompt MFI erogeneous funding and the financial prudence and stakeholders, DFIs and MIVs, to pay more attention to gov- guidance that implies. ernance; in turn encouraging MFIs to improve their gover- ●● Multinational MFI organizations (both global and re- nance principles. gional) face different governance standards requiring strong direction to keep the organization focused. Alex Silva ●● MFIs are maturing and many institutions are beginning Calmeadow Foundation to face succession issues for the first time. May 2014 ACRONYMS BANEX Banco del Exito, Nicaragua BRI Bank Rakyat of Indonesia BIO Belgian Investment Bank for Developing Countries BRAC Bangladesh Rural Advancement Committee CEO Chief Executive Officer CGAP Consultative Group to Assist the Poor CMEF The Council of Microfinance Equity Funds DFI Development Financial Institution EBL Equity Bank Limited of Kenya FINCA Foundation for International Community Assistance FMO Entrepreneurial Development Bank, Netherlands IIC Inter-American Investment Corporation at IADB IMF International Monetary Fund KEP Kosovo Enterprise Program KfW Kreditanstalt für Wiederaufbau, German Development Bank K-Rep Bank Commercial Kenyan Bank, formerly known as Kenya Rural Enterprise program MD Managing Director MFX Microfinance Exchange MFIs Micro-finance institutions MIS Management Information System MIV Microfinance Investment Vehicle MIX Microfinance Information Exchange MicroRate Rating Agency for MFIs NBFI Non-Bank Financial Institutions NGO Non-Government Organization OXFAM Oxford Committee for Famine Relief PROMIFIN Regional Central American Program for Enhancing the Financial Services for low-income populations PROPARCO Branch of the French Development Agency dedicated to Micro Finance SIFEM The Swiss Investment Fund for Emerging Markets SMART The SMART Campaign to promote responsible investment SKS Microfinance Limited SME Small and Medium Enterprises TABLE OF CONTENTS INTRODUCTION: WHY SHOULD WE BE CONCERNED ABOUT CORPORATE GOVERNANCE IN MICROFINANCE? 6 THE EVOLUTION OF THE MICROFINANCE SECTOR 9 A. Historical Evolution 9 B. Characteristics of Microfinance 12 INSTITUTIONAL TYPOLOGIES IN THE MICROFINANCE INDUSTRY 14 CORPORATE GOVERNANCE: HOW IT EVOLVES IN MFIs AS THEIR STRUCTURE AND OWNERSHIP CHANGE 16 A. The Board 16 B. Social Responsibility: The Role of the Board and Management 17 C. Succession Planning: The Role of Board and Management 28 D. Risk Management of MFIs: Six Recurrent Challenges 18 E. Risk-Management Challenges 20 EXTERNAL FACTORS INFLUENCING GOVERNANCE 30 CONCLUSIONS: INDUSTRY RESPONSES TO GOVERNANCE CHALLENGES 32 A. Governance Activities in the Sector 32 B. Proposed Next Steps 32 APPENDIX: WHAT MAKES EXCELLENT INSTITUTIONS IN MICROFINANCE? 34 6 n n INTRODUCTION Why Should We Be So Concerned about Corporate Governance in Microfinance? The microfinance market today looks much different from 2007. De- spite the worldwide financial crisis, the sector has doubled in size, transformed from mostly an NGO driven market to one increasingly dominated by regulated institutions, experienced a strong expan- sion of savings services, and held its first public listings and merg- ers. Microfinance is displaying the signs of a maturing industry. It has also weathered its first global downturn, lived through several major market crises, and is currently living through a crisis of percep- tions and confidence on whether microfinance actually helps allevi- ate poverty in the first place. None of these issues existed in 2007.1 —2011 MicroRate, MFI Rating Agency INTRODUCTION n n 7 T his paper discusses the corporate governance of mi- crofinance institutions (MFIs). It is not meant to be comprehensive by any means, but it aims to draw lessons euros at relatively high costs and are bearing the atten- dant foreign exchange risk in event of a devaluation of their local (national) currency. on governance from research studies, data analysis, and case studies of the failure or success of individual MFIs. Product-diversification risk: MFIs are adding new prod- uct lines and are moving away from “plain vanilla” Governance has been one of the most neglected sub- working capital loans with typical maturities of 12 jects in the microfinance sector. Relatively little has been months or less. They are adding small business loans, written about it, and the efforts of various governance housing-rehabilitation loans, and agricultural loans initiatives have been fragmented.2 Recently, however, that may carry different maturities, different payment attention directed toward governance in the sector has terms, and different associated risks. In many cases, increased significantly. insurance, money transfers, remittances, and even Why has it suddenly become so urgent to discuss corpo- mobile banking are becoming part of the mix. MFI rate governance in MFIs? In today’s expanded and more boards need to be able to evaluate the strategic fit, commercialized environment, several factors give rise to investment requirements, potential returns, and risks governance concerns: of such products. 1. Growth and scale of MFIs Political and/or operational risk: Political risks, such as state intervention and non-payment movements In several poorer countries, such as Mexico, Bolivia, as seen in India and Nicaragua, have damaged the Peru, Cambodia, Bangladesh, and Kenya, MFIs have sector’s reputation. In India, this has left several large become systemically important with respect to serving MFIs barely functioning and financially at risk, result- the poor or underserved. ing in millions of clients temporarily without access to services. 2. Emergence of legal and regulatory gaps Many MFIs have transformed, becoming microfinance Client Risks: Over-lending, high interest rates, and cri- banks that mobilize deposits. Banking supervisors need ses have increased the demand for client protection to understand how best to regulate these institutions and transparency in the sector. The SMART campaign to ensure sound governance practices, to safeguard is one of the best examples of an effort to improve the safety and soundness of these institutions, and to client protection while raising awareness of social im- protect depositors. pact. The boards of MFIs are feeling pressure to over- see the performance of their organization more closely Recent national crises in Nicaragua, India, Morocco, with respect to client protection, pricing transparency, Nigeria, and Bosnia signal that existing overcrowding and social impact, as well as operating and financial and over-lending are beginning to elevate risks for the performance. industry. 4. Diversification of MFI structure and type 3. Increasing industry risks Several groups or networks have expanded substantially Foreign exchange risk: Some commercial MFIs are to the point where they are systemically important to borrowing from international debt funds in dollars or the sector. Normally governance should be critically examined at the level of the individual institution, 1 “Role Reversal II Learning to Wield the Double Edged Sword,” but in several countries, groups have expanded and MicroRate, October 2011, p.4. become transnational institutions. This is the case of 2 Kate McKee, “Equity Investors Missing Opportunity to Influence Gov- non-governmental organization (NGO) networks, ernance in Microfinance,” CGAP Focus Note, May 20, 2012, is the first substantive document that the Consultative Group to Assist the such as the Foundation for International Community Poor (CGAP) has published on this subject. The Council of Microfi- Assistance (FINCA, today a holding company) and nance Equity Funds (CMEF) published governance guidelines for its Accion International (USA); bank-holding groups, member funds in 2005 and has updated these guidelines in light of changes in the industry such as increased emphasis on transparency such as ProCredit Holding (Germany); and previous and social protection for microfinance clients. national banks or NGOs, such as the Bangladesh Rural 8 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Advancement Committee (BRAC) (Bangladesh), ACP to pursue self-employment opportunities or to build (the parent holding company for Mi Banco, Peru), and a microenterprise that provides basic support to the Equity Bank (Kenya); family. Regulated microfinance banks also allow clients to have a safe place to save. As such, the performance Social-sector based institutions, such as Care Interna- of MFIs should not be judged only on a financial or tional, Save the Children, and Oxford Committee for operational basis but also with respect to social impact Famine Relief (OXFAM), have developed substantial on poverty alleviation and creation of employment op- microfinance activities. How they separate social ser- portunities. MFIs thus have a double bottom line, and vices from financial services and how they manage boards of directors need to have oversight of an MFI’s these distinct lines of business are important. How performance with respect to its social impact. these diverse groups provide governance support to their large network of affiliates or subsidiaries and This paper is organized as follows: This introduction is fol- how they, in turn, govern themselves is important not lowed by a primer on the industry and on the evolution of only for their clients, but also for the sector as a whole. the microfinance sector. We then examine the structure of the microfinance industry—(a) NGOs, cooperatives and 5. Entry of new institutional investors credit unions, and commercialized vehicles; how they dif- fer and why corporate governance differs according to Over the past 10 or so years, some 70 debt funds and the nature of the MFI; and (b) large networks, investment 30 equity funds, primarily with a mix of public develop- and bank-holding groups, and social services/faith-based ment finance institutions (DFIs) and private investors, groups. We then consider how corporate governance have emerged and are requiring that more attention evolves and develops in MFIs as their structure and own- be paid to the quality of governance in MFIs. ership changes. This is followed by an examination of the recurring issues and growing risks in the microfinance in- 6. The double bottom line dustry. We conclude with a look at the responses of gov- Microfinance is viewed as having an important social ernments, investors, and the industry itself to these issues purpose, providing the resources for the working poor and risks and propose some next steps. n n n 9 The evolution of the microfinance sector A. Historical Evolution percentage of the loan be kept on deposit as a form of collateral, so-called “forced deposits,” representing 10 In 1995, when the Consultative Group to Assist the Poor to15 percent of the loan principal. (CGAP) was founded,3 if people knew anything about the sector they knew of Grameen Bank (Bangladesh). At that By 2006, there were close to 199 commercialized MFIs time, with the exception of Bank Rakyat Indonesia and with portfolio holdings of US$8.7 billion and 11 million Banco Sol (Bolivia), most MFIs were small NGOs, region- clients. Twenty or so institutions had over 100,000 bor- ally focused and operating within a given country. They rowers and 20 more had assets over $100 million. NGOs primarily provided working capital loans to the working still far outnumbered commercialized institutions, but the poor, and almost none of these institutions mobilized de- tide was turning towards commercialized, fully sustain- posits. The exceptions were Bank Rykat Indonesia (BRI) able institutions. By 2008, some 619 MFIs were commer- which mobilized savings through its Uni Desa system cialized of which 310 held 98 percent of commercialized (village units) and Grameen Bank, which required that a assets in the industry.4 From 2000 to 2011, the number of microfinance borrow- 3 CGAP is a microfinance secretariat housed within the World Bank, ers, based on institutions reporting to the Microfinance representing some 29 donor institutions and foundations. Initially it provided capacity-building grants to MFIs. It also developed best- Information Exchange (MIX), increased from 10.8 million practice notes for the sector. Since 2000, it has been primarily a knowledge-based institution. CGAP has an affiliated institution, the MIX Market, which houses a database that is an open source of infor- 4 Preetesh Kantak, “Growth in Commercial Microfinance: 2005-2008,” mation for industry analysts and for research on the sector. Council of Microfinance Equity Funds, Winter 2011. Figure 1: MFI Count (1998-2011) 600 500 400 300 200 100 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Bank Credit Union/Cooperative NBFI NGO Other Rural Bank Figure 2: Microfinance Borrowers (millions) 120 102.1 100 95.3 94.3 83.9 80 68.3 59.6 60 48.9 40 33.4 21.3 26.8 20 10.8 7.0 0 2001 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Mix Market 2012 10 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Figure 3: Percentage Increase Between 1998-2006 Figure 4: Percentage Increase Between 1998-2006 Non Regulated Non Regulated Regulated Regulated NGOs NGOs n Borrowing n ROE n Lending n Write-off NBFIs 1998 NBFIs n Assets n Par>30 Credit Unions Credit Unions Banks Banks 0 50 100 0 5 10 15 20 Figure 5: Percentage Increase Between 2007-2009 Figure 6: Percentage Increase Between 2007-2009 Non Regulated Non Regulated Regulated Regulated NGOs NGOs n Borrowing n ROE n Lending n Write-off NBFIs 1998 NBFIs n Assets n Par>30 Credit Unions Credit Unions Banks Banks 0 10 20 30 0 5 10 15 to 94.3 million (Figure 2)—an indication of the ability of the 2007 global financial crisis well: lending, borrowing, MFIs to scale up and of overall growth in the sector.5 and return on assets continued to increase, and write-offs kept the same pre-2007 pace. Figures 3 to 6 illustrate in- Indeed, the microfinance market has broadened and dustry performance over the decade 1998 to 2009 and deepened its operations across the different types of insti- are broken down in two periods, 1998 to 2006, and 2007 tutions in the past 15 years. The MFI industry weathered to 2009.6 5 Information obtained from MIX, which is a centralized information 6 Gabriel Di Bella, “The Impact of the Global Financial Crisis on Micro- organization to which MFIs choose to report financial and statistical finance and Policy Implications,” (International Monetary Fund (IMF) data. Working Paper WP/11/175, July 2011, p. 13. 2. THE EVOLUTION OF THE MICROFINANCE SECTOR n n 11 Table 1: MFI Performance by Region from 1998 to 20097 Sub- Middle East Saharan Asian Central South Eastern & Central 1998-2006 All Africa Pacific America America Europe Asia Assets % 36.0 34.8 36.1 31.7 33.5 43.9 36.8 Lending % 39.9 40.8 38.4 33.1 34.5 49.0 52.1 Borrowing % 51.7 40.9 49.2 51.0 43.6 52.0 76.8 PAR> 30 3.3 4.3 3.6 4.2 4.1 1.2 1.7 Write-offs % 1.0 1.4 0.9 1.4 1.2 0.6 0.6 ROE 9.8 4.5 11.8 13.6 12.0 9.1 6.0 2007-2009 Assets % 21.9 22.2 28.0 10.2 29.2 17.3 19.7 Lending % 23.7 24.1 28.6 9.7 27.8 16.2 25.4 Borrowing % 23.3 21.7 34.9 10.8 22.6 18.4 25.9 Par> 30 3.9 5.7 3.7 6.7 3.5 3.4 2.2 Write-offs % 1.2 1.8 0.5 2.3 1.2 1.3 0.7 ROE 9.7 6.4 14.0 7.3 11.7 4.8 12.5 Source: Gabriel Di Bella, IMF, and MIX Market data The sector has also deepened at the regional level. All re- exchange risk. The industry has developed some hedging gions have experienced growth in MFI assets, lending, and capacity through the MFX, an institution owned by private borrowing and write-offs have remained stable (Table 1). and public investors in the sector. A number of MIVs are also lending in local currency, generally hedging their risk Investment funds specializing in microfinance have also through exchange rate diversification, through the MFX or begun to emerge. Starting in 1995 with one investment a large wholesale facility managed by the Entrepreneurial fund, Pro Fund, by 2008 there were at least 30 equity Development Bank, Netherlands (FMO), a DFI owned by funds and 70 debt funds, and some groups are currently the Dutch Government. managing over US$1 billion in assets. Initially, these inves- tors considered only 100 MFIs to be of investible quality. A second risk, stemming from the financial crisis, has The number is now closer to 200.8 MicroRate has esti- been the result of a flight to quality by investors and has mated the total assets (debt and equity funds) of micro- led to a crowding-in effect in select markets (e.g., Peru, finance investment vehicles (MIVs) at US$7.0 billion as of Kyrgyzstan, and Cambodia), as well as in a relatively few December 31, 2010. During 2010, MIV assets grew 12 MFIs around the world, leading to concentrated invest- percent, significantly slower than 22 percent for 2009, ments/ lending. MIVs are aggressively competing with and far below the annualized growth rate of 50 percent development agencies, DFIs, and domestic and interna- from 2005 to 2009. Of microfinance assets held by MIVs, tional commercial banks. In each of the past five years, debt represents 82 percent and equity 18 percent. MIVs large MIVs with assets of US$200 million or more have have played an important role in funding the sector, par- increased their market share. By year-end 2010, these ticularly commercial MIVs. They also play an important agents held 52 percent of the microfinance assets in- role in the governance of these MFIs by taking board vested in by MIVs.9 An analysis of over-indebtedness and seats in the MFI to which they extend equity. investment in microfinance by MIVs found that, “Local concentration can be aggravated by credit considerations But this is not without risks. First, MIV loans have tradi- of funders that limit their lending to a limited number tionally been in dollars, presenting the MFI with a foreign of institutions.”10 Their analysis found that 50 percent of 7 Ibid., 13. 8 MicroRate Incorporated, The State of Microfinance Investment 2011, 9 Ibid., p.4–8 MicroRate’s 6th Annual Survey and Analysis of MIVs 10 Ibid 12 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS total MIV funding, some US$5 billion, was concentrated between the 1980s and mid-1990s as not-for-profit in- in 33 MFIs. The top 100 MFIs received 75 percent of fund- stitutions or NGOs, offering financial services to the de- ing, while 90 percent of funding went to the top 200 veloping world and later to the transition economies of MFIs. The remaining 10 percent was allocated to an ad- Eastern and Central Europe, the former Soviet Union and ditional 400 MFIs around the world.11 Southeast Europe (the Balkans). Increasingly, MFIs are changing to become commercial in- stitutions: non-bank financial institutions (NBFIs) or micro- B. Characteristics of Microfinance finance banks (MF banks). Many of these institutions are Microfinance operates in developing and transition regulated by national banking supervisors. Microfinance economies. It aims to provide financial services for that banks mobilize deposits, often on a large scale, but gen- segment of the population that does not generally have erally in small amounts. Commercial MFIs represent the access to formal financial services. Often called the un- majority of assets, loans, and savings in the sector. Com- derserved, this population is composed mainly of the mercial MFIs meet the following criteria: working poor, many of whom live on US$ 2 a day and ●● They are structured as shareholder-owned institutions, are either self-employed or are micro-entrepreneurs, op- joint stock, or limited-liability companies. erating a micro-business (defined as having 10 or less employees). Most of these people work in the informal ●● They seek to operate sustainably, covering all of their sector, which in poorer countries may constitute up to costs, including financing costs, and, in time, to oper- 80 percent or more of the employed. The underserved ate profitably, providing an adequate return on assets have various ways to secure financing: from family and and equity. friends, from money lenders, and from traditional fi- ●● They raise their funds in commercial markets through nancing schemes, such as rotating savings and credit various means. associations (ROSCAs).12 However, they do not usually ●● They operate as regulated non-bank financial institu- have access to banks, either for borrowing or, perhaps tions or commercial banks, the latter able to mobilize more importantly, for a safe place to save.13 deposits. Microfinance refers not only to a range of credit prod- ●● They increasingly expand their services to include prod- ucts for business purposes, for consumption/income ucts such as insurance, money transfers, housing-im- smoothing, and to fund social obligations, but also to provement loans, education loans, and small business transactional services, such as savings, money transfers, loans, as well as a variety of savings products. remittances, and insurance.14 Microfinance is provided by MFIs, which are generally thought to have originated ●● They strive to serve the double bottom line: to serve the poor while also operating in a sustainable manner. The cost of delivering microfinance services is not nec- essarily intuitive to those outside the industry: microfi- 11 Luis A. Viada, and Scott Gaul, “The Tipping Point: over-indebtedness and investment in microfinance,” MicroBankng Bulletin, February nance services are expensive to deliver on a sustainable 2012 basis. Overhead costs are very high since, to be sound, 12 ROSCAS are traditional, informal, rotating, financing schemes with MFIs need to operate directly in the communities they different names found in many developing countries. See David serve, which are sometimes located in remote rural areas Roodman, Due Diligence: An Impertinent Inquiry into Microfinance of the country or in urban slums. Adequate manage- (Washington DC: Center for Global Development, 2012), 39–40. ment information systems (MIS) are essential to capture, Daryl Collins, Jonathan Murdoch, Stuart Rutherford, and Orlanda 13 Ruthven, Portfolios of the Poor: How the World’s Poor Live on $2 a record, and monitor the characteristic high volume of Day (New Jersey: Princeton University Press, 2009) spells out in some small, short-term loans that typically have no or limited detail the diverse sources of financing for the poor and how they collateral. Likewise, savings accounts are numerous but manage their cash flow on $2 a day or less. In fact, $2 dollars a day, on average, may mean no cash flow some days and more on other incrementally small. High-volume transactions require days, so managing cash flow, including safe savings through MFIs, efficient systems and substantial human intervention to may, in fact, be more important to these individuals than loans. process, which raises the expense base of the operation. This definition borrows from Robert Christen, Kate Lauer, Timothy 14 Furthermore, MFIs that access funds from commercial Lyman, and Richard Rosenberg, “A Guide to Regulation and Super- vision of Microfinance, Microfinance Consensus Guidelines,” CGAP, banks or other institutions face funding costs that are Public Comment Version, April 1, 2011, 10. typically elevated because of risk perceptions. Together, 2. THE EVOLUTION OF THE MICROFINANCE SECTOR n n 13 these factors increase the ultimate cost to the MFI bor- underserved. In Kenya, for example, M-PESA has ap- rower through higher interest rates. proximately 14 million clients and has recently signed a joint-venture deal with the largest microfinance and Product diversification has increased. MFIs are also provid- small business bank in the country, Equity Bank, which ing other financial services, such as insurance, remittances has branches throughout the country to further extend or money transfers, and education and home-improve- the penetration of mobile banking in Kenya.16 As Mar- ment loans. Although these diverse products are still a guerite Robinson has noted: relatively small part of the product mix of most MFIs, the demand for them is growing. Once an MFI scales up and “The microfinance revolution is a commercial has a substantial client base, perhaps 30,000–50,000 cli- revolution based on new financial technology ents and mobilizes sufficient savings, it has a base from and greatly accelerated by the information revo- which to offer its clients life and health insurance (usually lution that developed concurrently. It began in as an agent for an insurance carrier), to deal with remit- the 1970s, developed in the 1980s, and took tances and money transfers, and to provide other diverse off in the 1990s….These combinations enabled products. This new array of products may require differ- institutional profitability and long-term viability, ent terms, maturities, and repayment conditions com- making possible large-scale formal-sector finan- pared with short-term working capital loans, the bread cial outreach to low income segments of the and butter of microfinance. population.”17 Rural microfinance differs from urban microfinance. Ru- Increasingly, the industry talks not just about microfi- ral clients require agricultural loans or credit to raise cash nance, but about access to finance or financial inclusion, crops or to purchase animals that can be raised and sold which would also include small business loans as MFIs in- for cash. Such loans differ from traditional microfinance creasingly reach up to service small versus micro-business credit in terms of tenor and risk. Rural microfinance is owners. Some MFIs, particularly those in transition econ- often provided by rural cooperatives such as the large, omies, such as the ProCredit Banks, have offered small savings oriented cooperatives, in West Africa or the Sac- business loans from the beginning and have succeeded cos in East Africa. very well with them. BRAC, as an alternative example, has started and publicly listed a small and medium-sized busi- Microfinance has traditionally been based on low-tech ness enterprise (SME) bank. But SME lending is quite a bit methods as developed initially in Bangladesh at Grameen different than microfinance and requires real underwrit- Bank,15 at Bank Rakyat in Indonesia, and Banco Sol in Bo- ing capacity, for example, the ability to perfect liens on livia. It has often involved peer-group or solidarity-group moving collateral such as accounts receivable, inventory, lending, with borrowers in a group cross-collateralizing and equipment. Most countries lack collateral registers. each other. Loans were working capital loans of short ma- MFIs in a number of countries have encountered difficulty turity—12 months or less—and there was an understand- when moving upstream to SME lending without under- ing that loan repayment of loans led to new loans, usually standing the attendant risks. n larger than the initial loans. Technology has increasingly become a powerful driver of access to finance, especially for reaching rural pop- ulations. In a number of developing countries, mobile phone providers are working with commercial banks or large MFIs to bring mobile phone banking to the Muhammed Yunnus is viewed as the father of the industry. He devel- 15 oped a specific methodology of lending at Grameen Bank that has 16 Elisabeth Rhyne, Microfinance for Bankers and Investors (McGraw been emulated around the world by hundreds of Grameen replicas. Hill, 2009) “Vodafone: A Bold Move Into Financial Services for Ke- Other important MFIs, such as Bank Rakyat in Indonesia and Banco nya’s Poor,” 204–8. Sol in Bolivia, developed at roughly the same time. Each institution 17 Marguerite S. Robinson, The Microfinance Revolution: Sustainable Fi- had different variations of this methodology, but in fact, it was a nance for the Poor, World Bank and the Open Society Institute, 2001, unique way of providing loans to the poor who had little collateral. 28-29. 14 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Institutional typologies in the microfinance industry Good governance practices should not vary greatly across greater financial system), the Guidelines address the over- different MFI structures. However, a major question, not sight of such institutions from the angle of “permission to easily answered, is who should provide oversight for those lend”, whereby the registering authority or the financial institutions with no explicit ownership structure or those regulator provides limited or restricted rights. with highly diversified, non-strategic ownership? This is a “The regulatory framework should, absent local particularly relevant question for NGOs that may be very factors such as extreme corruption in the NGO large and of systemic importance. sector, permit both NGOs and commercial com- Non-Governmental Organizations: Most MFIs through- panies to engage in micro-lending; issuance of out the world are NGOs. NGOs are distinguished by the a permit to engage in micro-lending should be fact that they are not-for-profit institutions and have no straightforward involving a public registry and a owners that plow back their earnings, if any, into servic- simple process. . . . If regular reporting is required ing their clients. Most NGOs have received donor funding, of lending-only MFIs, then the requirements but most donors have little capacity or incentive to pro- should be tailored—both in terms of content vide systematic oversight for what may be thousands of and frequency—to the regulatory purpose and NGOs. Most NGOs are required to register with a social should be much lighter than prudential report- ministry in their respective country. These ministries gen- ing by deposit takers. The reporting requirements erally have oversight of NGOs in various sectors, such as should be harmonized as much as possible with health, education, and community development. For the reporting requirements imposed by other regula- most part, these ministries also lack the capacity to oversee tory authorities (e. g., the regulator of NGOs).”18 the relevant MFI. Finally, banking regulators/supervisors are Cooperatives and Credit Unions: There are also co- unlikely to be willing to take on this task unless the NGO operative institutions and credit unions that operate as represents a risk to the financial sector at large or is some- MFIs. Some are large cooperative institutions such as the how allowed to mobilize deposits. predominantly savings-focused institutions in West Africa and the rural cooperatives in East Africa and Peru. The CGAP’s Microfinance Consensus Guidelines, “A Guide Central Bank of West African States supervises several of to Regulation and Supervision of Microfinance”, tackles the large cooperatives in that region with priority given this issue under non-prudential regulatory issues. Given to large institutions. Cooperatives and credit unions are that NGO MFIs are typically not licensed to take deposits member governed, and credit unions normally have their (most regulatory frameworks require licensed deposit tak- ers to have identifiable owners whom the regulator can Christen et al., “A Guide to Regulation and Supervision of Microfi- 18 hold accountable for safe operation and protection of the nance,” 46–47. INSTITUTIONAL TYPOLOGIES IN THE MICROFINANCE INDUSTRY n n 15 own unique regulatory regime throughout the world. This Large Networks: A number of institutions have grown paper will not examine the unique governance issues of very large and operate transnationally. These institutions cooperatives and credit unions. are significant to the sector. How they are governed at the parent level and how they, in turn, govern down at the Commercialized Institutions: Finally, there are com- subsidiary MFI level is important to sector performance. mercialized institutions that have evolved into commercial These institutions include international networks such as banks able to mobilize deposits or non-bank financial in- Accion International, FINCA, today a holding company, stitutions (NBFIs) generally restricted from taking deposits. Many MFIs have moved through the process of transfor- Women’s World Banking, and Opportunities International. mation from NGO to NBFI and have then become commer- All of these institutions are NGOs that have MFIs as subsid- cialized microfinance banks. Such institutions have become iaries or affiliates that may be NGOs or, increasingly, com- critically important to the microfinance clients they serve mercialized vehicles. They operate globally with 20 to 30 in their country and, in some cases, have become systemi- subsidiary or affiliated operations or more, and they play cally important to the country’s financial sector as a whole. an important role in the microfinance sector. The quality of governance in these MFIs is very important. Bank or Investment Holding Companies: Institutions Therefore, banking regulators/supervisors should establish such as ProCredit Holdings, based in Germany, which, to- good governance standards for the sector, especially with gether with a consortium of investors, owns and operates respect to institutions that are systemically important. 20 micro and small business banks located in Eastern and MFIs in transformation: The transformation process Central Europe, the Balkans and the former Soviet Union, is a seminal point in the life of an MFI and usually in- Africa, and Latin America, is an example of this type of MFI. volves significant changes in governance. Transforma- ACP, the parent holding for Mi Banco in Peru, has invest- tion is often perceived as a temporary status but can, ments in other MFIs in Latin America, such as Bolivia and in fact, extend over several years. One of the unique Paraguay. Compartamos is a large MFI operating as a com- features of MFI transformation to a commercialized, mercial bank in Mexico that recently invested in an MFI in shareholding vehicle, most often regulated, is that the Guatemala and has banking interests in Peru. BRAC is one NGO often retains a substantial ownership stake in of the best and largest national NGOs in Bangladesh, and it the NBFI or microfinance bank by transferring its port- operates a very large MFI, among many other social inter- folio, liabilities, and staff into the new company. This ventions in that country. BRAC has recently branched out leads to potential issues between the NGO and the to manage MFIs in other parts of Asia, Afghanistan, and transformed MFI regarding their respective roles. In the Africa. Grameen Bank has a network of non-affiliated Gra- case of Banco Sol (Bolivia) and PRODEM—its original meen “replicas” throughout the world, as well as Grameen NGO—it was agreed that PRODEM would pursue rural America, an NGO, operating in svereal locations in the Unit- clients. PRODEM eventually became a very successful ed States and a Grameen Credit Agricole joint venture. and regulated MFI and broke away from Banco Sol. In the case of Commercial Kenyan Bank, formerly known Social-Impact Institutions: A variety of major social- as Kenya Rural Enterprise program (K-Rep Bank) in action and faith-based institutions have extensive involve- Kenya—the first NGO in Africa to convert to a micro- ment in microfinance. Among them are Care International, finance bank—the NGO was also to work with rural Save the Children, OXFAM, Mercy Corps, the Calmeadow clients and be used to reach further down the poverty Foundation, Habitat International (a new entrant), the Aga scale. The dual roles of the Bank and the NGO remained Khan Foundation, and Catholic Relief Services. The key in place under a holding-company structure. Transfor- for these institutions is the segregation of microfinance mation of MFIs also gives rise to regulatory issues when operations from their other social endeavors which usu- the MFI has an overconcentration of ownership and a ally involve grants to meet the needs of poor or distressed lack of qualified senior management to operate a bank. communities. Virtually all of these institutions are them- In some cases, banking regulations prohibit the transfer selves NGOs, although they might manage a mix of NGOs of a loan portfolio in exchange for an equity stake.19 and commercial institutions as part of their portfolio. n See Christen et al., “A Guide to Regulation and Supervision of Micro- 19 ments of certain prudential requirements: ownership diversification finance,” 35, where the authors note as follows: “to facilitate trans- rules, requirements that managers have prior banking experience, formation of NGO MFIs into for-profit companies licensed to accept and prohibitions against use of a transferred loan portfolio to satisfy retail deposits, regulators may want temporary or permanent adjust- initial capital requirements.” 16 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Corporate governance: How it evolves in MFIs as their structure and ownership change Governance focuses primarily on the relationship between CEO, have recruited board members with diverse skills a board and management. This is what most people refer and experience, and have established board committees. to when they discuss governance. Overall, the maturity Some have board oversight of the social performance of the board within an organization should be reflected (impact) of the MFI, even if most have not formed sepa- in its capacity for self-renewal, but there are governance rate board committees to monitor social performance. dynamics to consider. Inherent in the dynamics of boards MFIs do appear to address important strategic and policy is a tendency to follow a charismatic company executive issues at the board level. This is encouraging with re- and to be largely subservient to his/her wishes. This is spect to good practice, but this is just the basics. There known as management capture. Alternatively, boards can is room for improvement. be strong willed—often led by a powerful chairman— with a tendency for the board to manage. This is known MFI boards are likely to go through several stages as they as board capture. This dynamic of board versus manage- evolve and as the MFI matures: ment capture is always present in governance. To the ex- Stage 1: The Founding Board. At inception, a found- tent that a board can achieve equilibrium between board ing board is normally selected by the social entrepreneur capture and management capture, one normally observes who is establishing the MFI. Such a board is likely to be good governance. small, reflect deep commitment to the founder’s vision, Most MFIs were started by a social entrepreneur, and local (from the community or region in which the MFI members of the board were generally close associates initially operates), homogenous in terms of background of the founder who normally assumed the position of with the founder, and operate informally. These boards managing director and often chairman of the board as are sometimes known as “boards of convenience.” The well. As MFIs have scaled up and transformed, their gov- MFI is likely to be an NGO and operate in a single city ernance structures have had to evolve. Boards have had or region with few branches. The board is likely to be to become more sophisticated with more skills to assist chaired and directed by the NGO’s founder, operating as management and to maintain oversight of the MFI. As chairperson and CEO (managing director). boards have evolved, they have started to increase the scope of their governance structure, often through board Stage 2: The Governing Board. As the MFI, still an committees which are the “workhorses” of the board. NGO, grows and perhaps expands rapidly into new re- Below we describe the evolution of the governance pro- gions and adds a significant new client base, financing cess within MFIs. needs increase substantially. The board is likely to change and evolve for some, if not all, of the following reasons: ●● Board members are overwhelmed by the demands A. The Board placed on them by rapid expansion. Little work has been done in the sector to benchmark ●● Financial pressure requires the board to commit to sub- MFIs with respect to governance practices. However, in a stantial fundraising which absorbs a great deal of time. recent survey by the MIX Market, 162 MFIs (initial scope was 1,000) from 57 countries responded to a limited ●● New board members are recruited who may have wid- set of questions on governance.20 The responses indicate er experience, diverse skills, and less personal identifi- that both NGOs and commercial MFIs appear to have cation with the founder and his mission. well-structured boards that meet regularly. Some have Given the changing business and risk profile, the found- begun to separate the role of board chair from that of ing board is likely to become more formal and to assume a more responsible role in the direction and oversight of Micol Pistelli, Stephanie Geake, and Adrian Gonzalez, “Measuring 20 Governance in Microfinance: Initial Findings from a Pilot Project,” Mi- the institution. The characteristics of a governing board, croBanking Bulletin, The MIX, April 2012. as per good practice, can be summarized as follows: CORPORATE GOVERNANCE: HOW IT EVOLVES IN MFIs n n 17 ●● Size increases over-indebtedness of clients, a consensus has emerged ●● Homogeneity decreases in the sector, led by Accion International and the Cen- ter for Financial Inclusion and supported by CGAP among ●● Board manages less and governs more others, on the need for increased transparency in pricing ●● Board assumes more responsibility for oversight, practices and for improved client protection. This is best accountability, and organizational performance reflected in the SMART Campaign which has been widely ●● Responsibilities become more balanced between the adopted in the industry. Many MFIs have implemented a board and the managing director; a chair is likely to be set of Client Protection Principles (CPPs) including: appointed separate from the managing director ●● Appropriate product design and delivery ●● The board begins to organize and function increasingly ●● Prevention of over-indebtedness through committees ●● Transparency Stage 3: The Institutional Board. This further evolution is prompted by transformation to a shareholding MFI with ●● Responsible pricing external investors and a decision to become a licensed/ ●● Fair and respected treatment of clients regulated institution. There is now greater dependence ●● Privacy of client data on the board to raise funds or to approve fundraising. There is an increased need to elevate participation and ●● Mechanisms for complaint resolution representation in the community. Board size may ex- Although senior management and the board should take pand, and board committees may become more formal responsibility for ensuring that these principles are ad- to provide adequate expertise and focus for the board’s opted and implemented by the MFI, the SMART Cam- oversight and monitoring function. Characteristics of an institutional board are as follows: paign has increasingly pushed for external certification to allow MFIs worldwide to differentiate themselves as ●● Larger and more diverse pro-consumer and to allow potential investors to verify ●● Formal prestige attached to membership compliance with the CPPs. The campaign has enlisted mi- crofinance rating agencies to assist in this process which ●● More diverse skills among board members is still in early stages of implementation.21 In addition to ●● Board members sought who can assist with funding the SMART Campaign, there is a strong push in the in- and are able to work with local or regional govern- dustry to ensure that MFIs are able to measure their social ment, even federal government, as the need arises performance—i.e., that the MFI’s products and services ●● Committee chairs play an important role in the life of are reaching low-income clients. the board Between January 2009 and June 2010, Triple Jump con- ●● Greater focus by the board on risks to the institution ducted 81 Social Performance Assessments (primarily through such functions/committees as a Risk Depart- through an in-depth questionnaire) of its investees under ment and a Risk Committee at board level, an Internal its Social Performance Evaluation Program. The database Audit Department reporting to the Audit Committee created with this information, together with MFI-specif- and a Compliance Officer reporting to a Compliance ic financial information on investees, now allows Triple Committee Jump to report both the financial and social performance of its investees to its investors.22A survey by the MIX on B. Social Responsibility: The Role of the the “State of Practice in Social Performance Reporting Board and Management As institutions with a double bottom line, MFIs should be The SMART Campaign Client Protection and Certification Program, 21 able to assess their social performance. This has perhaps 2011, available at http://www.smartcampaign.org/certification been one of the weakest areas of MFI performance and, Located in Amsterdam, Triple Jump manages and advises investment 22 thus, of board oversight. Owing to recent country crises funds focused on microfinance. As of November 2010, Triple Jump had invested US$270 million in 152 MFIs in 52 countries. See “Social in Nicaragua, Morocco, Bosnia, Pakistan, and India, as Performance Assessment, 2010” available at http://www.triplejump. well as concerns expressed by various analysts about the eu/page/Social+Performance/1939/ 18 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Figure 7: Governance Indicators MFIs that ensure that social performance issues are 77% identified as part of the MFIs strategy MFIs that organize visits by board members 45% with staff and clients MFIs with a standing social performance 21% committees 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% Source: MIX Market Survey Figure 8: Results of MIX Market Survey Internal Auditor 64 16 3 n Yes Risk manager 48 31 4 n No n No answer Risk Committee 48 40 26 0% 20% 40% 60% 80% 100% and Management”23 found that of 405 reporting MFIs led to a demand for incentives in the form of equity owner- during the period 2009–2010, the preponderance do, in ship, terminal bonuses or termination pay in recognition of fact, consider their social performance (Figure 7). the years of service and “sweat equity” by the MD and his senior management team.25 At the time of transformation, C. Succession Planning: The Role of Board some institutions have developed comprehensive share- and Management incentive schemes for directors, management, and staff, while others have limited incentives to the CEO and a few A major responsibility of all boards is to plan for succession senior managers to ensure that the transformation and in senior management, in particular, the managing director the closing of the investment occurs smoothly. The case (MD) or CEO. Many MFIs were founded by social entrepre- of Kosovo Enterprise Program (KEP) during transformation neurs who have remained with the MFI for many years as speaks clearly to the need for careful succession planning the MD or MD/executive chairman of the board.24 A criti- and control by the board over the process. cal issue in the sector is how to develop, train, or recruit qualified successors. Newly constituted boards frequently D. Risk Management of MFIs: Six Recurrent replace the MD, following the period of transformation, Challenges in order to ensure that adequate skills are in place to man- age and oversee the institution which often has a new and Strengthening risk-management systems has become different set of objectives, responsibilities, and account- critical to the long-term success of the microfinance in- abilities. This has led a number of MDs, supported by the dustry. The MIX Market’s survey sheds light on the current original boards, to resist transformation and the overtures status of the practices in the sector and shows how little of new investors. (See the case of KEP in Kosovo) It has also attention has been focused on this topic. The survey’s findings highlight the critical need to strengthen control and risk oversight (Figure 8). 23 Micol Pistelli, Anton Simanowitz, and Veronika Thiel, “A Survey of 405 MFIs Reporting to the MIX in 2009-2010.” MicroBanking Bul- letin, July 2011. See Ira W. Lieberman, Elisabeth Rhyne, Brian Busch, and Stephanie 25 24 Muhammad Yunus, Grameen Bank; Faizal Abed, BRAC; Kimanthi Dolan, “Aligning Interests: Addressing Management and Stake- Mutua, K-Rep Bank; and Rupert Scofield, Finca International are all holder Incentives during Microfinance Institution Transformations,” CEOs and, in some cases Chairman as well, that have managed their Calmeadow and Center for Financial Inclusion at Accion Internation- institutions for over 20 years. al, 2009. CORPORATE GOVERNANCE: HOW IT EVOLVES IN MFIs n n 19 ABOUT THE PHOTO Downtown Prishtina, Kosovo. The Case of KEP and filed a complaint with the Kosovo Tax Administration regarding the compensation package of the MD and recommended his removal. Further investigation by BACKGROUND: Kosovo Enterprise Program (KEP) was the board met with resistance from the MD in addition established by the International Catholic Migration to discovering non-compliance with the founding Committee (ICMC) in 1999 and is the largest MFI operating documents of KEP which required the board to be elected in Kosovo. The loan portfolio totaled over €37 million, on an annual basis. Based on a lack of information and on representing 42 percent of the sector, 33 percent in subsequent events, the board acted to dismiss the MD. terms of loan number, with over 20,000 clients. With 8 However, since the board appointment(s) had lapsed, the main branches located throughout the country, it has the broadest outreach in the sector. Loan amounts begin at decision was non-binding and the MD remained. €300 and range to €80,000 with loan rates averaging 15%. In addition to the internal tensions, further investigation ATTEMPT TO TRANSFORM: Operating issues began when, disclosed that management had established offshore unlike other MFIs, the organizer, ICMC, conveyed manage- vehicles with which KEP had been transacting. In 2011, ment of the capital to the local office and board. Thereafter, an administrator was appointed to disentangle the issues KEP was managed by its board, which was composed of in- and transactions, as well as to evaluate the viability of the dividuals with diverse backgrounds and expertise. In 2010, existing loan portfolio. Given the regulatory gaps at the KEP management declared its intention to transform into a time, no direction was given to close the institution, and bank, and in doing so, it initiated a number of changes and its future business prospects remained a work in progress. steps: prepared a transformation plan; positioned a new management structure; enhanced infrastructure; installed security in branches as well as renovated into bank-like of- GOVERNANCE ISSUES fices; changed the logo; and trained staff. The relevant ap- 1. Governance matters: to enable prudent decision plication was filed with the central bank, the plan being to making and responsible oversight. transform into a bank with 100 percent ownership as KEP NGO. The central bank rejected the application because of 2. Boards must be engaged, understand the terms unclear ownership structure and recommended that repu- of their appointments, and require sufficient table shareholders be solicited, such as the European Bank information and communication from management for Reconstruction and Development (EBRD), and other and organizers to be fully informed. Internal review/ banks, with a lesser stake held by the NGO itself. The de- control functions are critical, and boards should lays in the implementation of regulation contributed to an ensure access to and communication with relevant increased legal vacuum which was used by KEP manage- personnel apart from executive management. ment in absence of a proper board oversight. 3. The MFI lost its “double bottom line” focus and During this period, the transformation regulation was still, was not fulfilling its original mandate of lending de facto, on hold with no other transformations occurring. to specified segments, meeting a social need, and At the same time, the NGO office conducted an inspection achieving prudent commercial viability. 20 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Table 2: Financing Structures of MFIs in Ten Countries, 201026 # of Loans % of Financing Country (Thousands) Borrowing Deposits Equity Morocco* 919 81 0 19 India* 26,629 76 4 19 Bosnia* 375 64 18 18 Nicaragua* 391 64 21 16 Pakistan* 1,112 49 26 25 Mexico 4,508 29 47 24 Bolivia 873 17 70 13 Peru 3,089 25 59 16 Indonesia 3,597 5 89 5 Kenya 1,458 13 65 18 Table 3: Characteristics of MFIs by Size27 Share of Total Share of Assets/MFI Institutions Borrowers Share (US$ Profit % of No. of Borrowers28 # of MFIs (%) (millions) of Total (%) millions) Revenues <100,000 982 89 17.1 21.0 57.2 +1.0 1.000-10,000 401 36 1.8 2.0 7.0 -14.0 10,000-100,000 439 40 15.2 18.0 48 +3.0 >100,000 122 11 67.5 79.0 1,271 +20.0 100,000-1 million 109 10 26.8 32.0 193 +15 >1 million 13 1 40.7 48.0 1,078 +23 Source: Roodman’s calculations based on MIX data. Based on their financing structure, risk-management sys- ingly important systemically, within their country/mar- tems in the MFI industry face a number of challenges. ket and some to the industry as a whole. This type of Thus far, the most common relate to the scale of the cli- scale requires systems in place that can process client ent base, collection resulting from over-lending and over- information and a board that can assist management borrowing, product diversification, and operational and in developing a long-term strategy. It also requires reputational risk caused by political interference. Table 2 management that can execute strategies to build an illustrates the mix of financing in microfinance, including organization (human capital) and to expand and de- the dependence of many MFIs in recent crises on borrow- velop risk-management systems and controls that keep ing, much of it external, in order to scale their institutions. pace with lending as the institution scales up. Above all, the board will need to assist the MFI in manag- E. Risk-Management Challenges ing risks. Table 3 illustrates the importance of scale in MFI operations and the increasing concentration of Challenge #1: Scale of the client base assets and loans in very large MFIs. The scale of these Many MFIs now have more than 100,000 clients and MFIs makes good governance practices increasingly im- a portfolio of US$ 100million. A number of MFIs have portant. more than a million clients. These MFIs are increas- The case of EBL in Kenya illustrates the rapid growth of a number of commercialized MFIs. Equity Bank has contin- 26 Roodman, Due Diligence, 265. ued to grow rapidly as a full commercial bank in Kenya. It 27 Roodman, Due Diligence, 112. is listed on the Nairobi Stock Exchange, has a large branch 28 Note that two categories of MFIs with few borrowers have been dropped from the table, and therefore the numbers of institutions structure to mobilize savings, and partners with M-PESA will not total correctly. to provide mobile banking. n n 21 ABOUT THE PHOTO Maasai women make, sell and display their bead work in Kajiado, Kenya. Photo: © Georgina Goodwin/World Bank. Equity Bank Limited: restructuring growth and scaling-up of an excellent institution BACKGROUND: Equity Bank Limited (EBL) was founded as investment in MIS and with technical assistance on credit- the Equity Building Society (EBS) in Nairobi in 1984 and risk management, supported by CGAP. At the end of 2006, initially focused on providing term loans and in mobilizing the bank’s return on assets (ROA) was 4.85 percent, its deposits. The high risk of term loans, a stagnant deposit return on equity (ROE) 40.36 percent, its profit margin base, under capitalization, poor management, and a 31.53 percent, its capital adequacy was at 11 percent, and difficult macroeconomic and political environment led the its debt to equity ratio was 8.10 percent. Throughout this bank to the brink of collapse. In 1993, the Central Bank of period of explosive growth, the bank continued to reach Kenya declared EBS insolvent with more than 50 percent down scale, with an average loan balance of US$444, or of its loan portfolio at risk of default. 65.64 percent of GNI per capita. The bank also continued to RESTRUCTURING THE BANK: Under the leadership of James offer savings to the working poor which reached US$165 Mwangi, the current CEO, EBS began a major restructuring on average, or 36.73 percent of GNI per capita, as of 2006.30 effort that focused on the economically active poor. The LISTING ON THE NAIROBI EXCHANGE: The bank went from bank also began a marketing campaign aimed at mobilizing being traded over-the-counter (OTC) to being listed on the savings deposits. The vision was to become the leading Nairobi Stock Exchange on August 7, 2006. The purpose retail bank in East Africa by providing the full range of of the listing was “to offer shareholders and the Bank the financial services to the economically active poor. Loyal benefits of the stock market liquidity and price discovery.”31 savers were progressively converted into borrowers on the basis of their savings patterns. As a result, the company ATTRACTING A MAJOR INVESTOR: On November 14, 2007, incurred little additional marketing cost while building its EBL and Helios EB Investors, LP (“Helios”) subscribed for 90.5 loan portfolio.29 The company invested significant funds million new ordinary shares in the bank at KES 122 (US$1.94 and effort in MIS software and systems to manage credit per share, with 63 KES equal to US$1). The investment risk, to comply with changing banking regulations in Kenya substantially increased EBL’s capital, and Helios became and, perhaps more importantly, to tighten its control over the largest shareholder in EBL at 24.99 percent.32 EBL has its portfolio performance. subsequently purchased a transformed MF bank in Uganda. It has also entered in a joint venture with M-PESA/Safaricom MANAGING EXPLOSIVE GROWTH: The organization’s to extend mobile banking to its client base for both loans new strategy, new management team, external technical and savings products. assistance, and investors paid off. In 2004, EBS was given a full banking license, and following its turnaround and initial takeoff phase, the bank began to grow dramatically. GOVERNANCE ISSUES By 2006, when the bank decided to list on the Nairobi Stock 1. Managing explosive growth. Exchange, Equity Bank Limited, as the bank was renamed, 2. The need to continue to reduce portfolio at risk. was benchmarked versus other Kenyan banks. From 2003 3. The strengthening of risk-management systems to 2006, the number of borrowers increased from 59,000 to and controls, and continued investment in MIS and 240,000 at an annual average of 66 percent. The portfolio technology. grew from US$15 million in 2002 to US$158 million at year-end 2006—an annual average growth rate of 82 4. A need to reduce expenses while maintaining percent. At the same time, the number of savings accounts production efficiency, and the possible expansion increased from 156,000 to just over a million, an average into East Africa beyond Uganda. growth rate of 61 percent, while deposit balances grew from US$28 million to US$236 million—an annual average 29 AfriCap Investment Report, Opus Cited, p. 10. growth rate of 72 percent. Portfolio at risk remained a 30 The MIX Market. problem throughout this period, at 12.2 percent at end 31 See Bloomberg.com. 2006. EBL sought to address the problem with a significant 32 Equity Bank Limited, Press Release, 14 November 2007. 22 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Table 4: Anatomy of Four Microcredit Crises Annual Growth Rate Share of Borrowers with Loans Par>30 days Country of Loan Stock 2004-08 from Multiple Lenders 12/07 12/08 6/09 Bosnia 43 % 40 % 2 % 3 % 7% Morocco 59 % 29 % 2 5 10 Nicaragua 33 % 40 % 3 5 12 Pakistan 67 % 30 % 2 2 13 Source: Chen, Rasmussen and Reille Challenge #2: Collection due to over-lending of step with borrowers’ cash flow; and (v) overaggressive and over-borrowing collection practices that can worsen the problem of bor- rowers already in trouble.35 Recent analysis has demonstrated that in selected mar- kets there has been a tendency for MFIs to over-lend or This issue has been described as follows: for borrowers to be able to over-borrow. Few markets Under these circumstances (intense competition have adequate credit bureaus, and clients have been able and excess liquidity, authors’ insertion), MFIs to borrow from multiple MFIs. Portfolio at risk over 30 may be encouraged to increase loan portfolios days (PAR>30), which has long been assumed to be a to meet ambitious outreach goals or shareholder critical indicator in evaluating an MFI’s soundness, may demands. Boards may expect the MFI to increase in fact be a lagging indicator. An analysis by Chen , Ras- or at least maintain market share when facing mussen, and Reille notes that collection problems sud- increased competition. These competitive pres- denly arose in four major markets—Bosnia, Morocco, sures can foster aggressive loan origination poli- Nicaragua, and Pakistan. In 2009, delinquent loans that cies and staff incentives based on loan volume. averaged 2 percent in 2004 suddenly rose to 7 percent These will simultaneously contribute to declining in Bosnia-Herzegovina, to 10 percent in Morocco, to 12 portfolio quality and hastening of the market percent in Nicaragua, and to 13 percent in Pakistan. The saturation process.36 reported delinquencies jumped by multiples, particularly during the first 6 months of 2009 which corresponded to The MFI needs a board of directors that understands the the global financial crisis and slowdown.33 underlying economic, competitive environment and tem- The analysis by Chen, et al. concludes that in each case pers growth in line with market conditions. three vulnerabilities went to the heart of the problem: The case of SKS Microfinance Limited (SKS) in India illus- (i) concentrated market competition and extremely high trates the rapid growth of a commercialized MFI. In this rates of loan growth, (ii) inadequate risk systems and con- case, SKS was at the epicenter of the crisis in the state of trols, and (iii) erosion of underwriting standards.34 Andhra Pradesh in India. Schick and Rosenberg indicate that multiple causes of over-indebtedness often occur in competitive markets ap- proaching saturation and accompanied by MFIs lowering Challenge #3: Product diversification their underwriting standards. These causes are reported as (i) overaggressive marketing; (ii) non- transparency of As MFIs grow to become non-bank financial interme- lenders on pricing and terms; (iii) common methodology diaries or commercial banks, they increasingly seek to approaches to automatically and gradually increase loan diversify their product offerings. MFIs are now offering sizes that puts clients at risk if there has not been due such products as housing-rehabilitation loans, agricul- diligence on the client’s ability to pay; (iv) loan products 35 Jessica Schick and Richard Rosenberg, Too Much Microcredit? A that are too inflexible, and repayment terms that are out Survey of the Evidence on Over Indebtedness, Occasional Paper 19, CGAP, September 2011, 3. 33 Greg Chen, Stephen Rasmussen, and Xavier Reille, “Growth and 36 Adrian Gonzalez and Emmanuelle Javoy, “Microfinance and the Role Vulnerabilities in Microfinance,” CGAP Focus Note, February 1, 2010. of Policies and Procedures in Saturated Markets and During Periods 34 Ibid. of Fast Growth,” Microbanking Bulletin, September 2011. CORPORATE CORPORATE GOVERNANCE GOVERNANCE: IN MICROFINANCE HOW IT EVOLVES IN MFIs n n 23 INSTITUTIONS QUICK FACTS – SINCE 1988 3.9 million members n 7.8 million life insurance policies n US$451 million (Rs 2,284 crore) outstanding n US$1.3 billion (Rs 6,640 crore) disbursed n 1.8 million health insurance n 1.5 million retail insurance members n 99% repayment rate n 13,038 employees n 1,354 branches n Over 60,000 villages, 18 states n 200% Annual Growth SKS Capital, a Bank at the TECHNOLOGY FOCUS: A key strength in SKS’s aggressive growth was its ability to deploy technology to overcome Epicenter of the Indian Crisis high delivery costs. For example, SKS brought Adrenalin e-Systems Ltd. on board to put together a technology-based solution for the management of its human capital. BACKGROUND: Launched in India 1998 as a non-profit organization, SKS Microfinance was one of the fastest- GOING PUBLIC AND THE CRISIS IN ANDHRA PRADESH: In growing microfinance organizations in the world through August 2010, SKS went public through an IPO raising some 2010, reaching an estimated 25 percent share of the total US$350 million and valuing SKS at US$1.5 billion.37 Vikram microfinance market in India. In January 2005, SKS was con- Akula, the founder of SKS, and his investors were sharply verted to a for-profit non-banking financial company (NBFC). criticized in the Indian press for making large profits on NBFCs are regulated by the Reserve Bank of India (India’s cen- the backs of India’s poor. The State Administration of tral bank) and are unable to accept deposits. SKS delivered Andhra Pradesh, in a running dispute with the large and microfinance through a Grameen (village) banking program aggressive MFIs in the state (5 of India’s 10 largest MFIs using the joint-liability model developed by the Grameen had headquarters in Andhra Pradesh), chose this moment Bank. SKS also offered its members interest-free loans for to intervene in the sector and effectively bring payments emergencies, as well as life insurance. Its NGO affiliate, SKS to a standstill.38 The State Bank of India, the regulator Foundation, runs the Ultra Poor Program, one of the first for the sector, sought to diffuse the crisis through a programs in the country focused on bringing extreme poor commission that recommended comprehensive regulation populations into the realm of mainstream microfinance. of the sector. These regulations languished in the Indian Parliament, and the sector was left in limbo with many of SKS’s philosophy has been focused on aggressive growth the largest MFIs in India, including SKS, in some difficulty. and scale. They achieve this through a combination of ac- tivities, including entering a state or market where another MFI already exists in order to ensure that there is demand, GOVERNANCE ISSUES and then expanding in that market using technology to 1. Board’s role in managing excessive growth. automate/lower costs. The strategy is to go deep within 2. Board capture by a dynamic founder. the districts to increase the efficiency and productivity of 4. Capital market financing of rapid expansion. the branches and reduce operating costs. As a start-up, 5. Development of MIS and other technologies to SKS identified three main constraints to growth: capital, control growth. capacity, and costs. SKS therefore developed a plan to scale 6. Human resources management—contracting out the microfinance based on three inter-linked principles that process. would overcome those barriers. These were (i) applying 7. Making the decision to issue an IPO. a for-profit methodology so that an MFI did not have to 8. Failure to foresee and manage political risks, board/ depend on limited donor funding; (ii) using best practices shareholders role in a crisis. from the business world to speed growth; and (iii) deploy- ing technology to overcome high delivery costs. Raghuram Rajan, “Doing Poorly by Doing Good,” December 8, 2010, available at www.project-syndicate.org/commentary/doing-poorly-by-doing- 37 good. On 15 October 2010 the State of Andhra Pradesh promulgated an ordinance seeking to regulate the microfinance sector. “Indian Microfinance 38 Crisis of 2010: Finding the Silver Lining,” Intellecap, October 25, 2010. 24 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS ALCEDA Bank Plc., Cambodia 39 “ACLEDA Bank’s vision is to be Cambodia’s leading into a bank in 2000. Since then, both the loan portfolio commercial bank, providing superior financial services and savings have grown at an incredible pace: savings to all segments of the community.”40 at a cumulative growth rate of 137 percent and loans at a cumulative growth rate of over 50 percent a year. ACLEDA originated from the tragedy that befell Cambodia The Bank has expanded its base to almost all provinces with the assumption of power by the Khmer Rouge in of Cambodia. Based on the institution’s growth and 1975. The International Labour Organization (ILO) and Care International recruited the company’s management progress, it is widely considered a very successful case. from refugee camps on the Thai-Cambodian border. The transformation was driven largely by growth and The program’s initial aim was to develop LEDAs (Local by the need to secure funding to do so. As an NGO, Economic Development Agencies). ACLEDA was the the MFI would have quickly outpaced its ability to association of these independent regional agencies. In secure donations and even subordinated debt; savings 1996, because of a liquidity crisis, ACLEDA had to decide deposits offered an attractive source of leverage that between providing business development services and also provided an important service to clients. As an NGO, financial services—microfinance—to its constituency. the governance of the organization included a “General The General Assembly of the Association decided to Assembly” that included (or was perhaps exclusively) the merge ACLEDA’s agencies into a single unified institution. employees; thus, a strong sense of employee ownership ACLEDA began the transformation process to a bank in existed. When managers and directors began considering the mid-1990s and finalized the legal transformation the transformation, they took time to explain the process The original case was prepared by Lieberman et al. “Aligning Interests”. 39 Ibid. 40 (continued) tural loans, educational loans, insurance, money trans- investment funds. In this case, the role of the board in fers, and remittances. In addition, many MFIs have moved evaluating investment decisions, raising the capital, and upstream to small business lending in order to increase controlling the pace of growth is critical. average loan size and enhance profitability. Money trans- Commercialization requires transformation. That is trans- fers, remittances, and insurance are most often fee-based formation to a shareholding corporation, such as a joint product lines and generally do not represent the same stock company, non-bank financial intermediary, or com- risk considerations as other new product lines. Commer- mercial bank. The process of transformation may take cial banks will also invariably seek to mobilize deposits time and considerable investment. It includes: which requires important considerations as to product design, capacity of the branches to absorb long lines of ●● Raising sufficient capital to meet the minimum capital savers, and the economics of handling the accounts of requirements to obtain a license. small savers. Finally, as MFIs gain in sophistication, they ●● Investment in the MFI to bring physical facilities, such are seeking to add branchless and remote banking capa- as branches, up to banking/security standards. Branches bility and, increasingly, to participate in mobile banking. will need safes, counting rooms, and security systems. New products require MFI management to raise capital and recruit and train staff to develop these new offerings. ●● Investments in MIS software and related equipment Capital and staff are needed to launch and market the such as servers and computers for branch staff. These product, to manage its growth prudently, and to improve investments are expensive. They normally involve an risk-management systems to avoid losses. Loan maturities annual licensing fee and substantial consulting fees to are likely to increase as the MFI moves away from plain install the systems and train MFI staff. An IT manager vanilla working capital loans, and maturity mismatches capable of working with IT systems suitable for banks may arise between loans and sources of capital, such must also be recruited. The IT manager must also be as short-term deposits, interbank loans, and loans from able to evaluate emerging technologies in MFIs, such n n 25 ABOUT THE PHOTOS Providing superior financial services to all segments of the community: Handicraft – silk weaving, small enterprise and (inset) Footwear enterprise in Takeo province. / Micro entrepreneur in Phom Pehn. and motives to all employees. Part of this explanation GOVERNANCE ISSUES included the creation of an investment company, owned 1. Strong values and a shared vision of ACLEDA, which by the employees, which would hold shares in the emerged from shared experience of the tragedy bank—making the employees real owners. The MFI then which befell the country. “handpicked” the future external investors to ensure 2. Inclusive process by management, involving all that mission was not an issue. ACLEDA Bank purchased employees in the process. the NGO’s portfolio, and NGO received both shares (a 45 3. Employee incentives and intensive management percent stake in the bank) and a subordinated loan for training. the value of the portfolio. The institution invested heavily 4. Strong representation of the NGO and the staff in the training of the current management team and association on the board. ultimately kept most of the key managers. as branchless banking. This represents a significant up- Challenge #4: Political Risk/Operational Risk42 grade for many MFIs as they move from NGO status. Political risk has played a role in several crises—Nicaragua, ●● Recruiting risk-management and internal-audit special- Pakistan and India among others. But none has matched ists and training staff to create their respective depart- the Indian crisis with respect to reputation risk to the sec- ments. Bank staff will also require extensive training to tor as a whole. In 2010, a major crisis hit the sector that deal with new MIS systems and new products, and to continued for some time. MFIs in Andhra Pradesh were handle the mobilization of deposits. badly affected by political interference from the state ●● Frequently providing incentives to the senior manage- government and by charges of over-lending to the poor. ment team to align their interests with those of the Very rapid growth by major MFIs in India and cannibaliza- ownership.41 tion of a state government poverty program supporting self-help groups (small borrowing cooperatives) led to po- In all these areas senior management of the MFI and the litical backlash. Populist politicians supported a debtor’s board must carefully plan the transformation process, which invariably requires bringing on board external 42 There is a substantial literature on MF in India and the crisis. A select list equity investors and perhaps new commercial lenders. includes M-Cril Microfinance Review 2010 (M-Cril is a rating agency in India.); MS Sriram, “Commercialisation of MF in India: A Discussion of The cases of ACLEDA Bank (Cambodia) the Emperor’s Apparel,” W.P. 2010-03-04, Indian Institute of Manage- ment; Intellecap report, “Indian Microfinance in Crisis: Turf War or a and K-Rep Bank (Kenya) are examples Battle of Intentions?” October 2010; Intellecap, “Indian Microfinance of the most successful transformation Crisis of 2010: Finding the Silver Lining,” October 25, 2010; “Report of the Sub-Committee of the Central Board of Directors of Reserve Bank cases in the sector. of India to Study Issues and Concerns in the MFI Sector,” Reserve Bank of India, January 2011; “Response to the Malegam Committee Report 24th March 2011”; CGAP, “Andhra Pradesh 2010: Global Implications See Lieberman et al., “Aligning Interests.” 41 of the Crisis in Indian Microfinance.” 26 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS The Kenya Rural Enterprise Program’s (K-Rep) Transformation Experience 43 BACKGROUND: K-Rep was founded in 1984 by a U.S. NGO and was subsequently funded by USAID that provided funding to existing NGOs involved in microfinance and small business development. In 1990, K-Rep established its own MFI and introduced peer-group lending to micro- entrepreneurs. By 1994, K-Rep decided to transform into a microfinance bank and focus on its own operations. This was the first NGO-to-bank conversion in Africa. It took K-Rep several years to transform, partly because of the ABOUT THE PHOTO A honey producer in Kenya. Photo: © Dana Smillie / World Bank. unfamiliarity of Kenya’s central bank with microfinance and how best to supervise such an entity.44 and highly respected in the microfinance sector. In time, OWNERSHIP STRUCTURE: After careful consideration of employees with specialized knowledge were recruited its options, the board of K-Rep decided to establish a from the banking sector. holding company to manage its various activities, which included the bank—K-Rep Bank Ltd.—the NGO, K-Rep GROWTH AND PERFORMANCE: K-Rep Bank grew steadily Development Agency, and a consulting company, K-Rep and strongly as a bank: between 2000 and 2007, clients grew Consulting Services. Initially, K-Rep Holdings sought to from 15,000 to 153,961, savers from 2,724 to 16,701, gross own 51 percent of the bank, but the central bank limited loan portfolio from US$4.6 million to US$ 110 million, ROE ownership concentration to 25 percent. K-Rep attracted from 13.4 percent to 22.3 percent. In 2007, the bank began several like-minded investors that would allow the bank to experience delinquency problems with portfolio at risk to retain its mission.45 moving from 3.6 percent to 12.6 percent. K-Rep’s problems increased partly because of the bank’s diversification into MANAGEMENT/EMPLOYEE INCENTIVES: With the support small business loans and a failed effort at succession. of CGAP, K-Rep set up a form of ESOP as a cooperative, Investors provided the bank with more liquidity in the form the KWA, so that existing and future directors, managers, of a rights offering. In time, a new managing director was and employees could purchase shares in the bank with a brought in as Kimanthi Mutua retired after some 25 years view that the bank would eventually undertake an IPO on of service. He remained as chair of the holding company, the Nairobi Stock Exchange. CGAP funding allowed the and the bank was restored to health. KWA to retain liquidity so that shares could be sold and purchased by employees, including future employees. The KWA retained a 10 percent interest in the bank but was GOVERNANCE ISSUES not allocated a board seat. 1. Planning and implementing transformation, MANAGEMENT CAPABILITY: Senior management of the attracting investors/raising capital. NGO remained with the bank; in particular, the long- 2. Management succession. serving CEO, Kimanthi Mutua, who was well known 3. Board role in managing losses. Original case was prepared by A2F Consulting for Lieberman et al.,“Aligning Interests.” 43 Subsequent transformations in Kenya have benefitted from the K-Rep case. See Frankfurt School of Finance and Management, Bankakademie, 44 HFB, “Transforming Microfinance in Kenya: The Experience of Falu Kenya and Kenya Women Finance Trust,” February 2012, for a detailed discus- sion of the transformation of two other MFIs in Kenya. As of 1999, ownership distribution/board seats were as follows: IFC 16.7 percent, 1 board seat; FMO and Triodos/Doen 5percent and 8.6 percent 45 1 board seat; Shore Bank, 13.2 percent, 1 Board seat; the African Development Bank, 14percent, 1 Board seat, and K-Rep group 32.5 percent, 2 board seats, as equity investors. In addition two Independent board seats were created. CORPORATE GOVERNANCE: HOW IT EVOLVES IN MFIs n n 27 “strike,” as in Nicaragua, that left a number of major senior managers, and work closely together to recruit a MFIs barely functioning. The IPO of SKS, the largest MFI new MD. The board will also need to work hard to as- in India, raised perceptions that the MFIs and their inves- sure and retain staff, inform investors, and also assure tors were enriching themselves on the backs of the poor. lenders and the banking supervisor. In the case of an The Malagrem Report, commissioned by the State Bank external shock, such as the type of political interference of India, proposed a strict regulatory regime for commer- experienced in Nicaragua and India, the board will need cial MFIs in India, but its recommendations were delayed to work closely with the MD to take many of the steps by the Indian Parliament, leaving the sector in limbo with previously noted. At times of crisis, the board will meet spillover effects in other states. more frequently and will take on a role that is closer to management than governance. At times, the sharehold- Challenge #5: The Risk Response of ers may need to step in and replace the board and key a Board and Investors During an Internal members of management. or External Crisis The BANEX case is an example of both political risk—in- Crises require strong intervention by the MFI board and terference by the government in the sector, fueling a non- sometimes by the shareholders. During times of internal payment crisis—mismanagement, and a slow governance institutional crisis or a crisis provoked by external events, response by the board and shareholders to a crisis, as well the board’s role often moves from governance to active as the failure of investors and creditors to agree on timely management. For example, at a time of previously undis- and appropriate debt restructuring. These failures result- closed fraud or large losses to the institution, the board ed in an intervention by the banking supervisor and the will need to step in, potentially appoint a new MD tem- liquidation of the bank. n porarily from among the board members or remaining ABOUT THE PHOTO Community meeting. Aurangabad, India. Photo: © Simone D. McCourtie / World Bank. 28 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS BANEX and the No Payment liquidity and capital to withstand the crisis. By May 2009, BANEX’s board had grown increasingly concerned. Movement in Nicaragua 46 Performance had begun to deteriorate, and the board asked management to consider a US$3 million recapitalization plan. Management resisted, expressing BACKGROUND: BANEX began as FINDE, a very successful, confidence that beef prices had bottomed out and that rapidly growing NGO in Nicaragua. In 2002, it converted cattle loans, perhaps the riskiest segment of the portfolio, to a NBFC, FINDESA, and in October 2008, it changed its would be safe. In September 2009, the shareholders met name to BANEX (Banco del Exito, success bank) when in Managua. Performance had continued to deteriorate. it received its full banking license. Starting with a loan Lack of agreement between international investors on portfolio of US$7 million in 2002, FINDESA grew rapidly, the size of the investment needed, resistance by local had 30 branches throughout the country, and also began to investors who lacked the resources to participate in the mobilize deposits. By 2008, the bank had 68,000 clients and rights movement, and a legal agreement with a lender a loan portfolio of US$125 million. BANEX began to move that required majority local ownership, all made the upstream to offer small business loans, cattle-raising loans recapitalization process difficult and less timely than it and agricultural loans, all of which had distinctly different needed to be. In addition, creditors, who had to be part risk profiles than the plain vanilla working capital loans of the solution, had not yet been approached. that were the staple of MFIs. BANEX’s success allowed A large number of loans were maturing in the first it to attract both domestic and international equity quarter of 2010, and it was clear that BANEX would face investors, including a large bloc owned and controlled by difficulty replacing those loans with new loans or having the bank’s chairman and managing director. International the creditors roll over their loans. Not only did BANEX equity investors were primarily microfinance investment need more equity, but perhaps more important, there vehicles (MIVs). BANEX also attracted a number of MIVs needed to be a debt restructuring as well, with creditors as lenders, as well as Development Finance Institutions converting a percentage of their loans to subordinated (DFIs)—the Inter-American Investment Corporation at loans which would serve as tier two capital and equity. In IADB (IIC)—and a local and regional development bank, September 2009, MicroRate was retained to do a special which provided lines of credit to the bank. As of year-end portfolio audit. Its audit showed clearly that provisions 2008, the bank had mobilized some US$100 million in loans for bad loans were significantly understated. and over US$30 million in deposits and was profitable. Local investors owned 57.8 percent of shares and foreign At the time of the MicroRate audit, the company was investors 42.2 percent. Of the eight board members, four reporting PAR > 30 days at 19 percent, while MicroRate represented local investors, three international investors, projected PAR>30 days at 30 percent. A financial advisory and one board member was independent. team (the Advisor) was hired just before the MicroRate report was finalized. It soon became clear to the Advisor THE NO PAYMENT MOVEMENT: In response to aggressive that the capitalization plan was in trouble. There was no legal action by one MFI (against its clients for non- agreement between international and local shareholders. payment of loans), a local protest movement began in Local shareholders severely resisted the dilution that a the summer of 2009 against all the MFIs, accusing them large equity investment would mean. They also objected of usurious interest rates. This soon evolved into a non- to the valuation of the bank by international investors payment movement, supported by the populist President which would further dilute their holdings. In addition, the of Nicaragua, Daniel Ortega, a former Sandinista. bank lacked any form of forward projections as a basis for BANEX IN CRISIS: Initial reaction by BANEX was to negotiating with creditors. A meeting of the investors, the assure its investors and creditors that the non-payment creditors, and the Advisor in Geneva seemed to offer some movement would slow and that BANEX had ample hope for a debt restructuring, but this was conditional on the equity investors recapitalizing the bank in the interim The information for this case is largely derived from publicly available 46 to prevent intervention by the banking supervisor who information contained in Cole et al., “Banex and the ‘No Pago’ Move- was now pushing the company hard to recapitalize to ment.” Also, an author of this paper, Ira W. Lieberman led an advisory maintain capital adequacy. Under Nicaraguan Banking team that tried to assist Banex’s international shareholders in reach- ing agreement with its creditors on a debt restructuring. The author is Law, if capital adequacy fell below 10 percent, the therefore intimately aware of the details of this case. supervisor was obliged to intervene the bank. With a very CORPORATE GOVERNANCE: HOW IT EVOLVES IN MFIs n n 29 diverse group of some 30 creditors and investors spread purpose vehicles (SPVs), made it very difficult for them over three different continents, getting agreement was to get agreement on a restructuring. As part of the not going to be easy under any circumstances. Following recapitalization agreement the managing director was a meeting between the investors, creditors, management, replaced, and the board composition was changed. and the banking supervisor in Managua on December Nevertheless, losses continued in 2010, and the bank 1, 2009, negotiations between the creditors and the was eventually intervened to protect the depositors. Its investors went on for an extended period as the bank portfolio was allocated to Nicaraguan banks. deteriorated. A restructuring plan was agreed to, in principle, with the creditors agreeing to restructure 13.6 percent of their senior debts to sub-debt and equity and GOVERNANCE ISSUES the equity investors agreeing to inject some US$8 million 1. Risks of rapid and diversified expansion. in new funds into equity, a package of some US$20 2. Problems of inadequate controls, MIS, and reporting million.47 Unfortunately, the debt restructuring was too systems. little too late. The restructuring called for an 18-month 3. Oversaturation of MF markets. agreement, rather than an intermediate-term agreement 4. Role of the board and shareholders in a crisis. Need of 5-6 years as recommended by the Advisor. The major for international equity investors and creditors to creditors, who controlled the creditors committee, were come together in a crisis to reach a realistic and hoping that the market would turn around and that they timely agreement on restructuring, with little to would be able to get paid since their loans were among no prior experience previously in the sector in the first due in the original maturity schedule. Creditors cooperating on workouts. International investors also indicated that the nature of their debt funds, special needed to reach agreements with local investors, particularly with the managing director who See Cole et al., “Banex and the ‘No Pago’ Movement,” 10 recap 47 controlled a significant bloc of shares. schedule. 5. The role of the Board and shareholders in a crisis. ABOUT THE PHOTO Agricultural loans: pile of beans at coffee farm in Nicaragua. 30 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS External Factors Influencing Governance While we have focused mainly on the board of directors and ment institutions such as the European Investment Bank its role in governance, we should not discount the important (EIB) and the Commonwealth Development Corporation role that external factors play in influencing MFIs. When an (CDC), are substantial investors in these funds. Therefore MFI transforms and becomes both a shareholding company most of the funds are, in fact, private-public partnerships. and a regulated non-bank financial institution or a commer- Each of these investors will require board seats as part of cial bank, its shareholders assume the responsibility to for- their commitment to invest in a transformed MFI. They malize and ensure effective corporate governance. will also require that governance be strengthened. They will want to see adherence to social responsibility and en- Investors Due Diligence/Post Closing of the Investment vironmental policies, anti-money-laundering policies and, Governance Requirements. During their due diligence increasingly, consumer protection through the SMART investors will examine the governance capacity of the MFI. Campaign. As a result of their entry, the existing board After investing, the investor will generally want to have a will invariably be reshaped. In some cases, where multiple position on the board of directors and also have a say in the investors take a stake in the transformed MFI, an entirely number of directors, the role of independent directors, ap- new board will be appointed. pointment of a board chair, issues requiring super-majority votes of the board versus simple majorities, and the creation Banking regulation and the role of the banking su- of board committees among other governance issues. pervisor.50 Most regulated MFIs fall under the regulatory and supervisory auspices of the banking regulator in their The role of rating agencies. A rating services industry country. This control and oversight generates more strin- has developed in the MFI sector. They are increasingly fo- gent adoption of good governance practices, especially cusing on governance as one aspect of their overall rating in the nomination of “fit and proper” management and of the MFI, and many investors/lenders require an MFI to board members51 and in approving individual board ap- be rated before they will invest or lend. Rating agencies pointments. Regulatory issues may arise if the primary are also increasingly providing social-performance ratings. experience of management and board members is with Equity and debt investors require stronger governance and MFIs and not with banks or other depository institutions. direct board participation. During the transformation pro- Financial reporting to the MIX Market. This require- cess, the existing board of directors will need to carefully ment exerts a discipline on the MFI to report key financial evaluate the entry of equity investors. This will be critical and operational numbers in a consistent way. The MIX to the future development of the MFI as it moves from and the MicroBanking Bulletin (its affiliated reporting ve- NGO status to a share-holding company and a regulated, hicle) allow the MFI to be benchmarked against its peers. commercialized institution. Options may be the direct It is also the basis for most investor review and analysis of participation of DFIs such as the IFC (World Bank Group) institutions in the sector. or the IFC’s bilateral equivalents.48 In addition, there are at least 30 private equity funds that have DFIs as investors, External audit. The quality of the audit firm, the scope some are global in nature, some have a regional orien- of the audit, and the standard governance requirement tation, and some are country funds (e.g., funds focused that the auditors report their findings to the audit com- solely on the Indian market).49 The DFIs, as well as develop- mittee of the board all play an important part in external Some of the DFIs most active in equity investments in the sector 48 Services, Gray Ghost, Grass Roots/Caspian Capital Partners, Triple are Kreditanstalt für Wiederaufbau, German Development Bank Jump, Incofin, Developing World Markets, MicroVest and Accion In- (KfW), (Germany); FMO (Netherlands); Swiss Investment Fund for ternational, all of which have played a prominent role in injecting Emerging Markets (SIFEM), (Switzerland); Branch of the French equity into the sector. Development Agency dedicated to Micro Finance (PROPARCO), See “Principles for Enhancing Corporate Governance,” Basel Com- 50 (France); Belgian Investment Bank for Developing Coun- mittee on Banking Supervision, BIS, October 2010, for a more tries (BIO), (Belgium); and the Nordic Investors—Swedfund, complete discussion of good governance principles and the role of Norfund, and Finnfund. banking supervisors in this process. See the Council of Microfinance Equity Funds.org for a list of member 49 See CGAP “Consensus Guidelines on Prudential Regulation of De- 51 equity funds such as Blue Orchard, responsAbility Social Investment posit Taking Microfinance,” 36. EXTERNAL FACOTRS INFLUENCING GOVERNANCE n n 31 governance, especially since investors and lenders will sia. These papers have developed a typology of problems look to a clean audit opinion prior to committing resourc- or risks, many of which were highlighted or came to the es to the MFI. surface during the crisis: External stakeholders. To the extent that the MFI pro- ●● Poor governance practices, particularly noteworthy as vides timely and efficient service to its clients, MFIs are MFIs transformed from NGOs to regulated MFIs (com- able to build a loyal client base—both borrowers and de- mercial MFIs)—either non-bank financial intermediar- positors—that will make every effort to pay on time, to ies or microfinance banks secure the next round of loans, and to retain their savings ●● Systemic fraud within the institution. To the extent that the MFI does not provide such service, clients have been known to dissert ●● Methodological flaws the institution. High levels of client desertion are a signal ●● Uncontrolled growth of poorly managed and poorly governed MFIs. ●● Mission drift—loss of focus, especially trying to do Exogenous Shocks. The recent financial/economic crisis SME lending (perhaps we should say the ongoing crisis) has focused at- ●● Financial vulnerability tention on several problems with microfinance. Although ●● Macroeconomic shocks growth rates in the industry slowed overall, there were other unique problems in several countries/markets, not ●● State intervention—political risks necessarily directly related to the crisis but exacerbated by ●● Uncontrolled market growth and over-lending, leading it. An IMF working paper by Gabriel Di Bella,54 analyzes to over-indebtedness the impact of the crisis on MFIs and concludes, Despite this long list of problems primarily associated with This paper revisits the issue of systemic the rapid scaling up of the sector and the introduction of commercially focused microfinance, there were no risks of mfis and finds that contrary systemic crises in the sector. Individual markets and indi- to the evidence before the crisis, MFI vidual MFIs experienced crises; for example, there were serious problems in Bosnia, Nicaragua, Morocco, Nigeria, performance is correlated not only to and India. One estimate is that from 2002 to 2008 some domestic economic conditions but also to 93 percent of MFIs experienced no crisis while 7 percent of MFIs had some form of crisis. Of those that experi- changes in international capital markets. enced crisis, 5.3 percent recovered, 1 percent failed, 0.6 (Abstract) percent possibly failed (status undetermined), and 1.3 percent stopped reporting but show no sign of failure.56 Complementary papers on the crisis and problems in the This is certainly far from the type of systemic failure seen sector (one focused on Latin America, the other on the in the banking sector in individual crisis countries such global outlook)55 analyze individual problem cases around as Mexico and Argentina (1995 and 2001, respectively), the world, throughout Latin America, and in such diverse Turkey (2001), East Asia (1997 to1999), the United States countries as Ghana, Nigeria, Morocco, Europe and Central (2008), or, in euro zone countires—Greece, Ireland, and Asia, Southeast Europe (particularly Bosnia), and Indone- Portugal as examples. n Gabriel Di Bella, “The Impact of the Global Financial Crisis on Micro- 52 finance and Policy Implications,” IMF Working Paper No. WP/11/175. 2011. Beatriz Marulanda, Lizbeth Fajury, Mariana Paredes, and Franz Go- 53 mez, “Lo Bueno de Lo Malo en Microfinanzas: Lecciones Apprendido de Experincias Falladas en America L atina,” (Take the Good from the Bad in Microfinance: Lessons Learned from Failed Experiences in Latin America) Calmeadow, June 2010; Daniel Rozas, “Weathering the Storm: Hazards, Beacons, and Life Rafts,” Center for Financial Inclu- sion at Accion International, Publication 11, 2011. See Rozas, “Weathering the Storm,” 8. 54 32 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Conclusions: Industry Responses to Governance Challenges In the past couple of years, there has been clear recognition ●● 167 MFIs responded to a MIX Market survey of 1,000 that the microfinance industry needs to improve gover- MFIs, answering a limited set of governance questions nance standards: MFIs have scaled up, some markets have as well as a survey of their social performance. These become more competitive/crowded, and crises—institu- efforts are enlightening but need to be followed up tional, country, and macro crises—have affected the sector. with a much deeper analysis in order to benchmark As transformations from NGOs to commercialized institu- what is happening with respect to governance in the tions have occurred, there has been a heightened aware- sector. An in depth survey, supported by case studies of ness of governance, based on investors’ due diligence and good practices and peer-to-peer education in the sec- investors’ demands for board representation and stronger tor, could do a lot to improve governance standards. governance practices. In addition, concerns related to po- ●● There has been a strong push to create governance tential client abuses with respect to excessive interest rates dialogue in Latin America. This has been the stron- and lack of transparency on the effective costs of fees and gest, most effective, effort in the industry but is small interest rates have led to an industry-wide campaign on relative the need. It has reflected a highly dedicated client protection—the SMART Campaign—and improved effort at Regional Central American Program for En- monitoring of the social performance of MFIs. hancing the Financial Services for low-income popu- This increased attention to governance in the sector has lations (PROMIFIN), a Central America program based led to a variety of independent initiatives. A steering com- in Nicaragua with the Swiss Government as its donor, mittee of various industry representatives, with overall co- and from Calmeadow, the later an active foundation ordination through the Center for Financial Inclusion at in the sector. PROMIFIN has developed a series of pilot Accion International, is trying to organize these various programs with MFIs, workshops, and working guides. initiatives. But resources dedicated to this effort, both hu- ●● The Multilateral Investment Fund (MIF) of the Inter- man and financial capital, are inadequate, and all of the American Development Bank in a joint effort with the individual activities, as noted below, are somehow insuf- Swiss Agency for Development and Cooperation (SDC) ficient relative to the need. With a few exceptions there will launch by late 2014 a project to support the adop- is little direct involvement with MFIs which should be the tion of good governance principles and practices in subject or focus of all this effort. There is a need to do MFIs, cooperatives, and credit unions in the LAC re- more to convene the industry as a whole and to do more gion. This technical cooperation initiative is designed on the ground with peer-to-peer (P2P) efforts with the se- to deal exclusively with the governance issues of these nior management and board members of MFIs engaged. financial institutions. A. Governance Activities in the Sector ●● There has been a push by a select group of MFIs to in- ●● CGAP is has completed an extensive technical paper crease governance efforts with respect to social perfor- on the supervision and regulation of MFIs. This is im- mance above and beyond the SMART Campaign. The portant for the sector but is not heavilly focused on SMART Campaign has been widely adopted by the sec- governance and on the necessary role of regulators in tor at the MFI level. It is not yet clear where this push at overseeing good governance in MFIs. social responsibility is headed. ●● The CMEF revised its governance guidelines in 2012, In total, this effort at improved governance in the sector first published in 2005, and continues to call attention remains fairly fragmented and its outreach is insufficient to the concerns of equity investors about improved for the scope of the issues now facing the sector. Gover- governance in the sector. nance remains one of the least-addressed concerns in the sector and requires an important institutional player to fill ●● A recent CGAP note on governance seeks to address the gap. investor issues in the sector and will surely raise aware- ness of governance. CONCLUSIONS: INDUSTRY RESPONSE TO GOVERNANCE CHALLENGES n n 33 Governance remains one of the least-addressed concerns in the sector and requires an important institutional player to fill the gap. B. Proposed Next Steps ●● Large microfinance networks, such as FINCA, Accion International, Opportunities International, Woman’s The proposed governance package being prepared by World Banking and social networks, should be brought the World Bank consists of this background paper on into this effort because of their own needs, their inter- governance, an in-depth survey on governance, and est in improving governance standards in their captive governance guidelines in line with the Basel Committe’s networks, and their ability to reach out to a large num- Governance Principles for Banks and CMEF Governance ber of MFIs. Consensus Guidelines. But this package needs to be in- tegrated with the already existing initiatives of the World ●● The World Bank Group should work closely with the Bank Group (IBRD and IFC) in coordination with other in- four rating agencies in the sector to have the rating dustry players (CGAP and the MIX, Center for Financial process do more to evaluate the standard of gover- Inclusion, CMEF, Calmeadow, the Boulder Institute at the nance in the sector. ILO Training Center in Turin) as examples. This would en- ●● This material should be packaged such that it would be able the World Bank Group to extend its outreach to the easy for MFIs to adapt it to their own needs. The CGAP industry relatively quickly and effectively. Microfinance Gateway would be an important vehicle for disseminating this information. A number of other steps could also be taken to deepen our knowledge of what is happening on the ground with ●● A Directors Institute should be organized at the Boul- MFIs and to extend the information available in this World der Institute or another training institute, such as the Bank MF Governance Package: Bank Akadameie in Germany, to train directors and senior management with respect to good governance ●● A series of cases should be prepared, using the survey practices prepared by the World Bank and based on face-to-face The World Bank Governance Practice Group and the IFC interviews with management and board representa- Governance Group have the appropriate expertise and tives of MFIs. convening power in the industry to lead an industry effort ●● Based on the survey instrument, the MIX could under- in this area with support from CGAP and institutions such take another more extensive and in-depth survey, to- as the CMEF, the Center for Financial Inclusion at Accion, tally focused on governance. and Calmeadow. n 34 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Appendix: What Makes Excellent Institutions in Microfinance The objective of good governance is to create well-man- Bank, the subject of the IPO, was established, BRAC’s se- aged, efficient, and sustainable MFIs that also meet their nior management hired highly experienced bankers to social responsibilities to their clients. Between 2003 and run the bank rather than using the NGO management 2006, four MFIs had initial public offerings (IPOs) or were who were directing the microfinance operations. listed on their local stock exchange. These institutions are Banco Compartamos (Mexico), Bank Rakyat (Indone- sia), BRAC Bank (an SME bank belonging to the BRAC Good Governance Group, while its microfinance operations remain within the A second condition required for an IPO is the existence of structure of an NGO), and Equity Bank (Kenya). Detailed a serious board, together with well-instituted good-gov- information provided to the MIX, their information memo- ernance practices. For international institutional investors randums/prospectuses for the IPO listing, and various press financing under U.S. SEC Rule 144A, that would include offerings allowed us to analyze these institutions in some practices that comply closely with the U.S. Sarbanes– depth. In addition, each of the institutions carries an im- Oxley Act guidelines respecting such matters as indepen- portant brand or image in the sector. From our analysis and dent and qualified audit committees and MIS and ac- firsthand knowledge of the institutions, we produced a de- counting systems that provide high standards of internal tailed research report on the institutions and their IPOs.55 controls. They will also look to the independence and We also sought to answer a few critical questions. qualifications of directors. The four institutions examined all made a serious effort to recruit serious boards of di- What is it about these four institutions that has qualified rectors and to implement good-governance practices. Be- them for capital market listings and IPOs? What makes coming regulated financial institutions has certainly been these institutions excellent? an important factor in these institutions’ improving their governance and going public. Management Excellence Each of the institutions in question had long-serving senior Ownership Incentives management who were outstanding social entrepreneurs In two of the institutions that listed—Equity Bank and and managers. Their respective institutions have consis- Compartamos—management and director ownership has tently generated profits. The exception is Bank Rakyat become an important issue. It stands to reason that long- (BRI), which had very dedicated heads of the unit desa serving management and directors should have incentives program and the bank, including former managing direc- tied closely to the long-range success of their institution. tor of the unit desa system, Sugianto; former president The fact that these individuals have been rewarded for of BRI, Kamardy Arief; and former Indonesian Minister of their success is a good signal to the industry in general Finance (1968–1983), Ali Wardhana, whose leadership and should also enable the industry to attract first-class was concentrated in the larger banks and who was less talent as the very critical issue of management succession known in the microfinance industry.56 Also, when BRAC is addressed in a number of MFIs.57 In both of these cases, management acquired their shares through investment. Ira W. Lieberman, Anne Anderson, Zach Graffe, Bruce Campbell and 55 Daniel Kopf, “Microfinance and Capital Markets: The Initial Listing/ However, as public entities they will be able to use incen- Public Offering of Four Leading Institutions” Council of Microfinance tives, such as options or stock grants, as incentives for ex- Equity Funds, May 2008. Ali Wardhana became Coordinating Minister of Economics, Finance 56 and Industry and continues to serve as an economic advisor to the The management and directors of Compartamos were severely criti- 57 government. Although he remained in the background, Wardhana cized by some factions in the MF industry for generating a substantial has been a vital supporter to the unit desa system. See also Mar- personal profit on their investment in shares of the company. Com- guerite Robinson, The Microfinance Revolution Volume 2 (Washing- partamos was also seen as charging excessive interest rates. Having ton DC: International Bank for Reconstruction and Development/The known the management for many years, author Ira Liberman felt that World Bank, 2001), xxxi. the criticisms were misplaced. APPENDIX n n 35 isting management and employees and, as appropriate, in their respective financial sectors. In marketing terms, to attract new management into the company. they carry a very strong brand image that is recognized favorably by the investing public in their countries and Many MFIs have operated with the same senior manage- increasingly by knowledgeable investors in international ment team over the past 15–20 years or more, from the markets. early emergence of microfinance in the developing world. Incentive compensation could play an important role in an orderly succession both out of and into these insti- Quality of Products and Services58 tutions. That is the normal case in for-profit institutions, It seems clear that each of the institutions has figured out both financial and industrial. BRI, with majority ownership what it takes to meet and anticipate client needs. Microfi- by the Indonesian government, could presumably not of- nance institutions operating within a bank are better able fer such incentives. In the case of BRAC Bank, the very to offer their clients a full range of products and services, small ownership stake of the senior management in the including a diversity of savings products, insurance, mon- SME Bank speaks highly of their individual commitments ey transfers, remittances, e-banking, and mobile banking to the Bangladeshi poor. as circumstances warrant. To date, the four institutions Despite these two examples, incentives have an impor- have not expanded to offer a full suite of financial prod- tant role to play as MFIs structure themselves on commer- ucts and services. However, BRI does offer a range of sav- cial terms and become shareholder-owned institutions. ings products, and Equity Bank offers products for both We would expect to see stock options as an important savings and loans. Equity Bank has also been an innova- form of incentive compensation for management recruit- tor in financing private education in Kenya. Compartamos ment, as well as employee stock plans, as more MFIs go serves as an agent for insurance products. public in the future. Moreover, as these banks add small-business finance on a sound basis, they are able to improve their economics— Scale for example, through larger average size of loans and deposits— without abandoning their social mission. For Each of these institutions has achieved massive scale the moment, BRAC has chosen to keep the microfinance within its respective market, translating into a strong capi- and SME operations separate. Compartamos is strictly a tal base and profits. As banks by any international mea- microfinance bank and has yet to mobilize savings in a sure, the four are quite small, but within their markets BRI meaningful way. However, BRI and Equity Bank combine and Equity Bank are important. BRAC has also reached these offerings. substantial scale, especially if we look at the combined microfinance and SME operations (the latter within BRAC In contrast to these four institutions, the ProCredit Banks, Bank). Compartamos is a niche bank in Mexico, but it is a holding of some twenty Greenfield Micro and Small among the largest MFIs in the country and in Latin Amer- Business banks around the world have been very success- ica. The profitability, return on assets, return on equity, ful in difficult markets, keeping their microfinance and and low loan-loss ratios of these institutions rank them small-business lending at the core of their financial ser- among the best-performing banks and financial institu- vices and then adding a full array of financial services as tions in their respective markets. Clearly, these four in- client demand requires.59 stitutions are among the best of the MFIs. As such, they The quality of services and products is reflected not only were able to list and issue their shares to both domestic in high profits, low loan-loss ratios, and low portfolio at and international investors. risk (Equity Bank was something of an outlier with respect to portfolio at risk when it listed). In the cases of BRI and Brand Image and Market For an interesting discussion of this issue see Elisabeth Rhyne and Recognition 58 María Otero, “Microfinance Through the Next Decade,” Accion In- When an investment advisor looks towards taking these ternational, November 2006, 14 (See “Quality Gap”) and 21–28 (See “Who Will Deliver Microfinance”). institutions public, a convincing story can be told. Simply, Ira W. Lieberman, “Appraisal of ProCredit Bank Serbia, Microfinance 59 the four institutions have performed exceptionally well, Program for the Bor Region, World Bank Bor Regional Development and they benchmark well within the industry and with- Project,” June 6, 2007 (mimeo). 36 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Equity Bank, their ability to develop savings products and such as Blue Orchard, the respons Ability Fund, Deutsche mobilize savings efficiently also provides a reliable and ac- Bank’s Microfinance Fund, and the Calvert Foundation, ceptable cost of funds to these institutions. BRAC Bank, which all make loans to and invest in MFIs. Sound MFIs Equity Bank, and ProCredit Banks have seen the advan- with the qualifications to go public are perfectly placed tage of serving the “missing middle”—small business in to tap into this positive market sentiment and growing addition to micro-entrepreneurs—but BRAC does this by segment of investors keen to invest in socially responsible separating the two sets of target clients between its NGO, institutions. offering microfinance, and its bank, offering financing to small and medium-sized enterprises, while the other two offer a range of financial services through their commer- Outside Strategic Investors cial banks. Again, these actions serve to add to the quality With the exception of BRI, these institutions had partici- and branding of each bank. pating, internationally recognized external investors take equity stakes prior to the IPO. In addition to the capital they provided, strategic investors brought an important Technology and Infrastructure measure of confidence to the market prior to the IPO/list- Each of the four institutions discussed have had to build ing. In addition, each of these institutions, with the pos- an extensive infrastructure of branches or service offic- sible exception of BRAC, has received significant technical es to reach their clients. For example, in its prospectus, assistance from the donor community and microfinance Equity Bank discusses moving from 31 branches in 2005 experts in order to ensure that their product lines, lending to 61 branches by 2009. Since its founding in 2001, BRAC methodologies, credit management systems, MIS, man- Bank (SME bank) has grown to 18 branches and 313 re- agement structures, and governance processes, among gional marketing/field offices. BRI has an extensive village other areas, meet or exceed industry standards. network that exceeded 3,900 unit desas at its peak, and Compartamos faced the task of converting a very exten- sive service-office network to full bank branches, espe- Benchmarking cially if they were going to intermediate savings (which, Each of these institutions is being benchmarked or mea- to date, they have moved very slowly to do). Along with sured in terms of performance against regulated financial this growth, however, comes a need to continuously in- institutions. They are all supervised by the banking regula- vest in technology, such as ATMs, credit and debit cards, tion and supervisory authority in their respective countries and MIS systems. BRI and Equity Bank have discussed the and are increasingly being rated by international rating extensive investments required in MIS systems, the for- agencies such as Fitch and Moody.62 Also, market re- mer as a use of proceeds and the latter before listing. search on these institutions from investment banks and It seems clear that MFIs that want to scale and diversify their products need to be up-to-date technologically and brokerage firms will rate them against banks rather than demonstrate their ability to compete in the banking sec- other microfinance institutions. tor with the latest in technological products and systems. Accounting and Management The Social Bottom Line Information Systems Microfinance has received a great deal of positive public- Each of the institutions was audited by internationally ity in the past few years. There seems to be an important recognized accountants. Without adequate investment in market segment of individual investors and organizations software, accounting systems, and MIS, it is difficult to that will invest a portion of their funds in institutions that prepare the years of audited financial statements, disclose support a double bottom line. Initially, debt funds that financial information, and reconcile the documents with could guarantee their investors a minimum social return U.S. GAAP or international accounting standards. Each of were uniquely placed to tap into this market segment. We the institutions that listed and/or went through the IPO, have seen this in the development of microfinance funds was able to meet disclosure requirements. n ANNEX II n n 37 Annex II: Consolidated Survey for Regulated Microfinance Institutions and NBIF Name of Institution   Address of Institution   Contact Person   Office Phone Number   Cell Phone Number   Email   Institution website   38 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS A. Institution A.1. What is the legal status of the institution? (Please tick one answer) NGO NBFII Commercial MFI Cooperatives Credit Unions Other: A.2. Are you primarily an urban or a rural institution? (Please tick) Rural Urban A.3. Is your institution is supervised by the banking supervisory agency? If not, please specify by whom or none (please tick one answer) Regulator for the Banking Sector Social Ministry and Government Agency Other (please specify : ) A.4. What information do you report to MIX? (Please tick one answer) No information Financial Information Social Performance Information Financial and Social Performance Information A.5. Please indicate the primary (holding 10% or more) shareholders of the institution (please tick all that apply and give names) Primary Shareholders Name Investment Funds DFIs (IFC, KfW, FMO, etc.) Original NGO (as a result of NGO transformation) International non-fund private shareholders Domestic non-fund private shareholders Network Holding such as Accion, Finca, Grameen, Opportunities, Brac Government Other (please specify: ) ANNEX II n n 39 A.6. Please specify the institutions Number of Clients as of latest fiscal year (for example fiscal year December 31, XXX) Portfolio size (amount in millions of USD $) as of latest fiscal year (for example fiscal year ending December 31, XXX) Percentage (%) women clients Number of deposit accounts as of latest fiscal year (for example fiscal year December 31, XXX) Total deposit holdings (US$mn) Number of branches Product lines (please tick all that apply) Credit and Saving Methodology (Group Lending) Product lines (please tick all that apply) and revenue percentage Individual Loans Village Banking Deposit-taking as collateral Deposit-taking as product Educational Loans Life Insurance Health Insurance Other Insurance (please specify) Remittances House Rehabilitation Agricultural Loans Other (please specify) 40 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS B. Board B.1. Where can details on board structure and composition be found? Board composition and Board voting requirements (majorities, super majorities) By-Laws Shareholders Agreements Other (please specify) B.2. Please provide the (other please specify) B.3. Number of Board members B.4. Number of non-resident Board members B.5. Titles of the management team who are on the Board CEO CFO Other (please specify) B.6. Number of Board members who represent individual investors B.7. Number of independent, representing neither management nor investors, Board members B.8. Who nominates and appoints Board members? (Please tick all that apply) Chairman CEO Board as a whole Majority Shareholder Shareholders through shareholder meeting Governance or Nominating Committee Other (please specify) ANNEX II n n 41 B.9. Identify Board member expertise: In your opinion, what main criteria do shareholders use when they elect members of the board? (Please tick all that apply) Work experience in the financial sector Work experience in the institution Special knowledge Loyalty to major shareholders Useful contacts Availability to fulfill Board member duties Reputation Community Involvement Other (please specify) B.10. Is the position of chairman of the board and chief executive officer combined in one person? Yes No If NO, is the Board Chair an Executive Chair (does he or she work as a full-time, salaried executive for your institution?) Yes No B.11. Which committees does the institution have? Executive Audit (please specify number of executive directors: and number of non-executive directors:) Compensation Risk Management Credit Corporate Governance and Nominating Social Performance Other (please specify) B.12. Indicate the number of board members who have formal qualifications in Banking Finance and Accounting Law Risk and Control 42 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS B.13. Indicate the number of board members who have professional experience in Public Service Finance Sector Marketing Consulting Finance and Accounting Law Risk, Audit and/or Control Social Sector IT Academia Microfinance Other (please specify) B.14. Has your institution formalized board self-evaluation processes? Yes No B.15. On average How many times does the board meet per year? B.16. On average What is the percentage of board members that usually attend a board meeting? B.17. Does the Board meet by teleconference? Yes No B.18. If YES: How frequently? B.19. Do committees have their written charters? Yes No B.20. How often do committees meet in person (on average)? B.21. How often do committees meet by teleconference (on average)? B.22. What is the length of board member term? Please indicate the number of years ANNEX II n n 43 B.23. How are decisions made by the Board? By the Board Chair By the CEO Through Board consensus (after which there is a formal vote) By formal vote By Executive Committee B.24. Does the institution have a formalized strategic plan? Yes No B.25. Is Board approval required for the formalized strategic plan? Yes No B.26. How does the board measure performance of the institution? Financial performance compared to budget Performance compared to strategic plan Social impact Return on equity Return on assets PAR30 Loan Loss Ratio Profitability of each line of business Profitability by branch Growth of revenues Growth of assets Expense control Growth of clients Other B.27. What are the key policy issues and other matters that require Board involvement/approval Borrowing Equity investment Hiring management Succession 44 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Adoption of a new Strategy? Yes No Adoption of annual goals and objectives? If yes, are these documented? Succession of the CEO Is there a formal succession plan? Raising debt and/or equity? Approval of consulting and other contracts above a certain amount? Branch expansion? Other expansion plans Transformation from an NGO to a licensed/regulated non-institution financial institution or microfinance institution? Product Diversification? Hiring/firing of senior executives? On a decision to restructure/re-organize the MFI? Dividend Policy B28. Please indicate which risk related policies your institution has formalized: (Please tick all that apply): Credit Policies Asset/Liability Management Policies Trading Policies Market Risk Interest Rate Risk (Profit Rate Risk) Liquidity Management Policies Accounting and Financial Control Policy Business Continuity IT Risk Policies and Contingency Planning Compliance Policies Anti Money-Laundering Policies Disclosure Policies Related Party Policy Client Protection principles (SMART Campaign principles or other) Other (please specify) ANNEX II n n 45 B29. How frequently are the risk policies above reviewed and updated? Once a year Once every two years Other (please specify) B30. Who in your institution is responsible for the following activities? Operational and financial soundness of the institution Board CEO Other (please specify) Defining the institution’s strategy Board CEO Other (please specify) Evaluating the success of business strategies Board CEO Other (please specify) Evaluating institution performance Board CEO Other (please specify) Managerial oversight Board CEO Other (please specify) Hiring and firing the CEO Board CEO Other (please specify) Hiring and firing senior management Board CEO Other (please specify) 46 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Establishing and reviewing, on a periodic basis, the institutions’ policies for qualitative and quantitative thresholds for credit transactions Board CEO Other (please specify) Monitoring the institution’s operations for compliance Board CEO Other (please specify) Evaluating risk profile Board CEO Other (please specify) Evaluating return on risk Board CEO Other (please specify) Evaluating return on capital Board CEO Other (please specify) B.31. Does the board review and approve compensation policies and incentive structures related to management, loan officers, and overall staff of the institution? Yes No B.32. Do the CEO and top executives have a formal contract? Yes No B.33. Do managers of the institution have shares and/or share incentives in the institution? If yes, how much of the institution do they own? (Please tick one answer and give percentage ownership) Yes (please give percentage %) No ANNEX II n n 47 Do Board members of the institution have shares and/or share incentives in the institution? If yes, what % of the institution do they own? Yes (please give percentage %) No Do employees (non-management) of the institution own shares and/or share incentives in the institution? If yes, what % of the institution do they own? Yes (please give percentage %) No B.34. Does senior management, including the CEO, have formal job descriptions that outline their main roles, responsibilities, and reporting lines? Yes No B.35. Do the CEO and other senior managers have performance benchmarks they are required to meet that are tied to compensation? Yes No B.36. Does Board approve CEO compensation? Yes No B.37. What is the proportion of the CEO’s income from the following sources (please indicate percentage) Fixed Salary ( %) Bonus ( %) Stock Options ( %) Indirect, non-monetary form of remuneration (eg. company car, expense account) ( %) Other (please specify percentage) ( %) B.38. Does the board get compensated? Yes No B.39. If yes, how? Annual Per Meeting Both 48 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS Reporting and Information B.40. In general, how far in advance are board members notified for meetings? At least 2 weeks before 2-3 weeks before All meetings dates for a year are provided at the beginning of the year Other (please specify) B.41. How far in advance do board members receive board information materials for board meetings? 1 week 2 weeks Other (please specify) B.42. Does the board package contain the following? Financial information such as balance and income statement Updates on performance against budget Updates on performance against the strategic plan Key operating and performance statistics Results and issues from the internal audit review Results and issues from the compliance review Information regarding composition, size and quality of banking exposures Material exceptions to policy, procedure, and limits Performance by product Information on risk exposure Other Board agenda Minutes of prior meeting for approval Information on each of the policy issues to be addressed during the meeting Information on the MFI’s activities and performance Other (please specify) ANNEX II n n 49 Related Party Transactions B.43. Does the institution have a formalized policy on related party transactions and conflict of interest? Yes No B.44. Does the institution allow related party transactions? Yes No B.45. Is it prohibited for Board Members to borrow from the MFI? Yes No B.46. Is it prohibited for Board members to do consulting, accounting or legal services for a fee for the MFI? Yes No B.47. Is there a conflict committee to review potential business conflicts between Board members? Yes No B.48. Does the institution have identification, monitoring, and compliance systems specifically dedicated to related party transactions? Yes No B.49. Are board members who have a conflict of interest required to abstain from voting on the relevant issue during the board meeting? Yes No 50 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS C. Internal Review and Risk Monitoring Functions C.1. Which internal review functions exist in the institution? Internal Audit Compliance Officer or Department Risk Management Internal Control Other (please specify) C.2. To whom is each of the above internal review functions report to? Board Chairman Audit Committee Other Committee (please specify) CEO Senior Management Other (please specify) C.3. If a separate risk management function exists, to whom it report? Board Chairman Audit Committee Other Committee (please specify) CEO Senior Management Other (please specify) C.4. Who is responsible for taking actions based on the findings of each of the review functions? Board Chairman Audit Committee Other Committee (please specify) CEO Senior Management Other (please specify) ANNEX II n n 51 C.5. By whom is the performance of each of the heads of the review functions evaluated? Board Chairman Audit Committee Other Committee (please specify) CEO Senior Management Other (please specify) C.6. What is the scope of risk addressed by the risk management function? Credit Liquidity Interest Rate Exchange Rate Market Operational Other (please specify) C.7. Does a separate credit risk function exist? Yes No C.8. Does the institution employ an internal credit risk rating system? Yes No C.9. Is an overall credit portfolio analysis periodically performed? Yes No C.10. Who manages the day-to-day liquidity function of the institution? CEO CFO Treasury department Other (please specify) C.11. Is liquidity risk management guided by institution policy, procedures and limits? Yes No 52 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS C.12. Is there a written document on management’s responsibilities for liquidity management? Yes No C.13. What are the functions of the Internal Audit department? Verification of internal control Compliance with laws and regulations Compliance with the institution’s policies and regulations Verification of internal accounting records Verification of financial information and MIS provided to Board Identify, review and assess conflicts of interest Ensure asset protection Verify segregation of duties Evaluate related party transactions Review limit monitoring, position and reporting process Review new products Other (please specify) C.14. Does internal audit review the risk management and compliance functions? Yes No ANNEX II n n 53 D. External Audit D1. Does the institution have an external audit? Yes No D2. Who is responsible for approving the external auditor? Board Audit Committee CEO CFO Other (please specify) D3. Who is responsible for reacting to the external auditor recommendations for action? Board Audit Committee CEO CFO Other (please specify) D4. Who is required to approve the institution’s financial statements? Board Chairman Senior Management CEO CFO No formal approval required Other (please specify) D5. Does the external auditor provide non-audit services? Yes No Board Chairman 54 n n CORPORATE GOVERNANCE IN MICROFINANCE INSTITUTIONS E. Commitment to CG E1. What measures have been taken in your institution to improve corporate governance (past 3 years)? (Please tick all that apply) Establishment of Board Establishment of Board committees Changes to Board memberships Formalization of functions and responsibilities or Board and senior management Improvements to MIS package Other (please specify) E2. Why were these measures taken? (Please tick all that apply) Legal or regulatory requirements Change of legal status Change of ownership or shareholder base Need to attract external investments Need to improve efficiency of internal operations Need to improve coordination between stakeholders Other (please specify) E3. What hampers the development of Corporate Governance in the institution today? (Please tick all that apply) Lack of experience and knowledge Insufficient motivation Lack of support from shareholders Lack of support from Board Lack of accountability by management Over-exertion of control by managers Conflicts of interests Internal resistance Other (please specify) ANNEX II n n 55 E4. Which goals should Corporate Governance in the institution achieve? (Please tick all that apply) To enhance public image To improve strategic decision-making To attract external investments To improve efficiency of internal operations To improve efficiency of coordination between shareholders, Board and senior management To improve capitalization To contribute to overall risk management practices To improve the internal control system To comply with laws and regulations Other (please specify) The objective of good governance is to create well-managed, efficient, and sustainable MFIs that also meet their social responsibilities to their clients. The World Bank 1818 H Street, N.W. Washington, DC 20433, USA