6th International Conference on Public Policy & Management at IIM, Bangalore Strengthening Institutions, Enhancing Governance: The Microfinance

Perspective
30th December 2011 Abhijit Ray, Co-Founder & Director aray@unituscapital.com

What is Corporate Governance?

Corporate Governance is a system of
several processes, customs, policies and

laws which try to:

Protect interests of all stakeholders Increase accountability Reduce moral hazard issues Achieve fairness and justice
Board of Directors

Executives & Employees Equity & Debt Investors

Government Central, State & Municipal

Corporate Governance Customers

Society & Environment

Suppliers

Various stakeholders impacted by governance

Factors Impacting Governance

EXTERNAL
Media

Organization

External audit

Industry associations

INTERNAL
Board of Directors Internal Controls/Audit Decentralization of Power

Regulator - Reporting & Compliance

Investors

Competition

Rewarding Merit Employee Unions

Community

Government

Bad Governance Examples: International & National

International
Government Numerous dictatorships/tyrannical regimes overthrown by revolutions in MENA Putin managing democracy in Russia Government 2G Spectrum Scam

National

Unaccounted Wealth Stashed Abroad

Bellary Mines Scam Commonwealth Games Scam

Corporate Enron Institutionalized, systematic accounting fraud Resulted in the creation of the SarbanesOxley Act02 Corporate Harshad Mehta Scam (1992) & Ketan Parekh Scam (2001) Large scale market manipulation

MCI Worldcom A massive quantum ($3.8 bn) of accounting fraud to prop up the stock price

UTI Scam (2001) Small investors funds used to fund big business houses/junk bonds for huge commissions

Satyam Scam (2008)

Raj Rajaratnam Galleon Group Inflated revenues; Rs 6,000+ crore of cash missing Resulted in m-cap erosion of 90%+ & later acquisition by the Mahindra Group

Insider trading in connivance with one of the worlds

most eminent strategy consultant - Rajat Gupta

Criticality of Governance in MFIs

Corporate governance is even more critical in MFIs due to political, financial and customer sensitivities Customer Sensitivities Poor people Women Several sections/castes/religions of society Instances of suicides when caught in debt traps Product push strategy Political Sensitivities Huge vote banks Financial inclusion - a key focus area for the Govt. Interest rate debate

Financial Sensitivities Unsecured lending High financial leverage

High standards of corporate governance needed

Governance Challenges in MFIs

Stressful expansion targets for staff leading to adverse selection & over-lending ESOPs/Incentives to employees for aggressive expansion/collection resulting in misreporting by the staff Lack of proper IT infrastructure contributing to inaccurate & delayed reporting Employees & other internal factors

Lenders/ Investors

Misreporting information to lenders/investors - inflating portfolio, misreporting default cases Choice of external auditors

Microfinance Institutions

Customers

Ghost loans fictitious loans/borrowers Taking security deposits from borrowers Political Nexus makes MFIs susceptible to being used as a and using it to enhance equity base exposes the customer to equity risk and MFI Government & Politics

political tool
Insufficient regulations

to potential liquidity risk

Incentivizing group leaders/agents to do collection in order to enhance efficiency, thus losing touch with borrowers

Board Effectiveness a Major Hurdle

Segregation of roles of CEO & Chairman often not present in MFIs

Strong and often complete influence of promoter on the Board Absence of rotation policy of Board members

Less emphasis on incorporation and staffing of sub committees of the Board Absence of well defined roles & responsibilities for Board members Few high profile Board members participating in Boards of 15-20 firms leading to unavailability Lack of strong independent directors

Corporate governance issues in MFIs

Microfinance Crises in India

Krishna Crisis (2006) First big crisis in Indian MF sector Caused by push led growth, multiple borrowings & unlawful recovery Worsened by clashes with the staterun Velugu program Resulted in government clamp-down on MFIs, arrest of staff and subsequent losses of banking assets

Kolar Crisis (2009) MFI practices (e.g. women meeting with unrelated men staff, going out of town for training) & changing gender equations sparked religious sentiments in a local community Resulted in the communication gap b/w clients and MFIs which in turn adversely affected payments

Andhra Pradesh Crisis (2010) Biggest crisis in the microfinance sector of India Triggered by a variety of factors political, financial and social Attributed to higher interest rates, unlawful collection mechanism, continued misery of the rural population & competitive politics Threatened microfinance sector nationwide & resulted in a state ordinance

Aggressive Competition in UP (2007-08)

Hubli Crisis (2011) Started by political leaders instigating people to default for political mileage Aggravated by the failure of local administration in containing the situation and taking appropriate actions

First big crisis in Indian microfinance sector

Caused by multiple borrowing and coercive recovery practices Worsened by clashes with the staterun Velugu program Resulted in government clamp-down on MFIs and arrest of staff

Examples of Good Corporate Governance

Janalakshmi
Leader in transparency Not-for-profit holds the entire promoter stake Multi product focus to enlist clientele who dont have credit needs CBS/ CRM platform/ biometric smart cards form the

Mann Deshi Mahila Bank

One of the first rural financial institutions to receive a cooperative banking license from RBI Largest microfinance bank in Maharashtra Offers a variety of non-financial services financial and business mgmt. training, community radio, womens health and

technological backbone
Strongest management team in the MFI sector Eminent Board consisting of independent Directors of

farming workshops

ESAF Microfinance
One of the leading microfinance NBFCs in India

the like of S B Mathur, Rama Bijapurkar & Uday Chitale Multi-faceted development focus on education, retail, housing,

No ESOPs to employees

healthcare, water, sanitation and lighting

Examples of Good Corporate Governance (Contd.)

Ujjivan
Lowered interest rates to borrowers even before the AP crisis; Strong focus on improving operational efficiency Ujjivan declared as the winner of the Microfinance India Organization of the year 2011 award Mainly focuses on poor working women in urban and

Equitas
Boasts of fully Integrated ERP System Several steps taken to revolutionize corporate transparency Only MFI to print its all-inclusive interest rate - APR An internal ombudsman to enable members to directly reach out to the management team

semi-urban areas

Sanghamitra/ MYRADA
One of the early innovators of the concept of SHGs; Cumulative repayment record (98.9%) significantly better than priority sector portfolio & overall banks portfolio Use of participatory appraisal techniques in client identification, simplicity of procedures/products/repayment

SKDRDP
Sixth largest micro finance institution in India Awarded the prestigious Microfinance India Award 2010

Recognized for its low operational costs,

efficient administration, rapid scaling up, multifarious development activities & social commitment

Regulations & Policies in Microfinance : India vs. Asia

Strong regulatory framework is the backbone of a sound corporate governance system
Bangladesh
Very low cost borrowing provided by apex Govt. agency (PKSF) with strings attached to it

Nepal
Banking regulations were extended to MFIs during very early phase of microfinance sectors evolution China Strong support from local & national governments initially in promoting microfinance; supplying financial, human and organizational resources

Pakistan Well defined system of regulations and policies contributing to good corporate governance

Crises in Indian microfinance sector could have been avoided by: Creating strong regulatory framework Providing govt. support for funding Proactively disseminating information to public about achievements Encouraging infusion of equity capital by domestic investors Setting up domestic seed capital funds for MFIs Involving all critical stakeholders Managing better public relations Nurturing strong governance & transparency

Thank you! Questions?