“Governance is defined broadly as the system of people and processes that keep an organization on track and guides major decisions.”
Since the 1980s, microfinance has been labeled as one of the most effective policy tool and has become an important component of development, poverty reduction and economic regeneration strategies around the world. By the early twenty-first century, tens of millions of people in more than 100 countries have been accessing services from formal and semi-formal microfinance institutions (MFIs). It has become global industry involving large numbers of governments, banks, aid agencies, NGOs, cooperatives and consultancy firms and directly employs hundreds of thousands of branch-level staffs (Hulme and Arun, 2009). Microfinance, which is understood as the means and institutions created in order to provide financial services to people excluded from traditional banking system, has a long history.
From an international development perspective, microfinance has attracted increasing interest due to a wide variety of new institutions. There are several MFIs with various backgrounds. Some of these have directly emerged from the credit unions movement (such as the major credit and saving cooperatives networks in Africa); some have their roots in NGOs (such as the seminal cases of the BRAC, in Bangladesh, Prodem-Bancosol in Bolivia and the K-Rep Bank in Kenya); while others have emerged from public bank restructurings (such as the emblematic case of Bank Rakyat in Indonesia) (Labie and Mersland, 2011).
These initiatives, along more than hundreds of others, have received a great deal of attention from national authorities, as well as from international donor and development communities. Moreover, during the last decade, there is increased interest from the international banking and investment communities.
The current wave of management thinking places considerable emphasis on the use of private-sector market-based arrangements to address developmental goals on a global scale. The effectiveness of governments and nongovernmental actors is limited by constraints on resources and reach. The power of capitalism, it is said, can be harnessed to combat problems such as poverty and the lack of basic education and healthcare by delivering products and services on a commercial scale to communities that have been traditionally isolated from mainstream markets. Concepts such as “creative capitalism,” “shared values,” and “bottom of the pyramid (BoP)” have gained rapid ascendancy in management and developmental discourses.
While these ideas continue to evoke conceptual debates, they have already found acceptance in practice in the field of microfinance. Microfinance evolved as an instrument to reduce poverty and bring about sustainable economic development. As an alternative to traditional means of finance, which failed to meet the needs of poorer sections of society, microfinance was pioneered by self-help groups, non-governmental organizations, and other nonprofit institutions. While this form of finance has attained a fair amount of popularity in the developing world, a key shortcoming was identified: the lack of a wider reach to generate a more meaningful impact on society.
With a view to building a scalable model that engenders overall sustainable economic development, the microfinance sector has recently witnessed operational dynamism of MFIs, diversifying their asset base and broadening sources of finance.
Besides, emergence of for-profit institutions that are structured along the lines of the modern business corporation are also in existence. This commercial MFI adopts market-based mechanisms to raise capital that is employed in financing the poor and less-privileged. While these MFIs raise debt from banks, they also raise risk-capital by issuing shares and other securities to private equity and venture capital investors, and even through initial public offerings that make their securities available for trading on stock exchanges.
Such efforts at raising finances impose demands on MFIs to service their lenders and investors. Arguably, the pressures to service their financial stakeholders and the consequential need to generate
profits create incentives for MFIs to lend on commercial terms that cause a tight squeeze on underprivileged borrowers (who may be left with no option but to borrow on those terms). Recent anecdotal evidence from India (MFIs namely, SKS Microfinance, Spandana, SHARE Microfin) reinforces the issue—wherein MFIs are alleged to have charged exorbitant interest rates on microloans, resulting in a major backlash against the sector with the state of Andhra Pradesh speedily enacting legislation that leaves the survivability of the industry in that state in doubt. (Varottil 2014)
On other way round instances are there that, MFIs have not succeeded to deliver the financial services efficiently and some failed. Most MFIs face the challenge of institutionalization and achieving sustainability. The sustainability of an MFI demands not only financial viability and the ability to adapt to existing legal frameworks, it also requires a clear strategic vision and an organization that is transparent, efficient and accepted by all the stakeholders involved. These issues are often grouped together under the concept of “Governance.”
Governance of microfinance institutions has recently surfaced as an essential component of long-term institutional success. Its importance is highlighted by the juncture at which we find microfinance – a field poised to become part of national financial systems with links to international financial markets. The lack of suitable governance policies is one of the main obstacles for the sector’s growth. Microfinance Banana Skins, a benchmark publication to measure opinions and risks affecting the growth and viability of MFIs, ranked the lack of effective governance policies as the second major risk for MFIs. (CSFI, “Microfinance Banana Skins 2008”) At no other time has the competence and commitment of governance bodies of microfinance institutions appeared more pressing.
Conventional governance framework, corporate governance in particular, relies on the lure of financial returns to induce investors and financiers to provide capital to corporations. Such a framework places excessive dependence on the financial sustainability of MFIs. This framework also pays less heed to the social goals and outreach of MFIs, even though the evidence of better financial performance through commercialization is open to debate. By adopting market-based mechanisms such as public offering of shares—where there is anonymity of shareholding and possible short-termism —and securitization of portfolios, there is a fear that MFI activity carries several features of the subprime crisis that may result in the creation of a “microfinance bubble.” Viewed through the conventional framework, the
microfinance industry has also generated a perception of profiteering from the poor that has seriously impacted its credibility.
One of the most important challenges that any MFI must face when designing its governance policy is how to strike this balance between social and financial goals. Just as it is important to measure financial performance indicators, the same amount of effort must be put into measuring the fulfillment of social goals.
Although the existing discourse on governance does recognize broader stakeholder interests (beyond just shareholders), it has yet to receive the necessary impetus due to the heterogeneity of the interests of stakeholders such as creditors, employees, customers, and the community in general.
There is therefore a need for a paradigm shift that necessitates an understanding of governance for microfinance institutes through an altogether different lens that provides equal importance to the social performance of MFIs and their impact on external stakeholders.
Measurement of social goals poses a particular challenge, as reliable indicators are still in development. These days more initiatives are being developed to evaluate the success of institutions in turning their social mission into evident and measurable results. (See the following table-1) “Social scorecards” or “balanced scorecards” are often used, but there is limitation about the value, consistency, and reliability of available indicators. Nevertheless, social outreach indicators, benchmarks, or scorecards should be reported and discussed as part of a board’s information package, just as financial statements are.
A different set of parameters are required to judge the financial and social performance of MFIs such that they are able to maintain their “double bottom lines” by achieving their social goals along with sustainable financial performance.