The term ‘governance’, while relatively new to the development sector, became in the early 1990s an unavoidable concept when discussing on economic and social development issues. The governance issue has been placed in the development field since the outbreak of the Asian crisis in 1997, as one of the underlying causes of the crisis. Different aspects were supposed to be the reasons of the financial crisis. Among them, one element in which too little attention was paid until that period, emerged as one of the reasons as to the extent to which financial crises resulted. This was failure in “governance”─ broadly defined to include the efficient and effective management of public institutions and private firms. When countries and firms borrow excessively and mismanage their financial affairs, then almost by definition, they are not being governed well (Litan, Pomerliano, and Sudararajan, 2002).

Several international organizations have defined governance in different way. Among them, the World Bank (1992) first discussed the issues relating governance in the early 1990s. The World Bank defines

The term ‘governance’, while relatively new to the development sector, became in the early 1990s an unavoidable concept when discussing on economic and social development issues. The governance issue has been placed in the development field since the outbreak of the Asian crisis in 1997, as one of the underlying causes of the crisis. Different aspects were supposed to be the reasons of the financial crisis. Among them, one element in which too little attention was paid until that period, emerged as one of the reasons as to the extent to which financial crises resulted. This was failure in “governance”─ broadly defined to include the efficient and effective management of public institutions and private firms. When governance as “the manner in which power is exercised in the management of a country’s social and economic resources for development”.

Governance fosters strong, but sharply delimited, state capable of sustained socio-economic development and institutional growth. The World Bank (1994) has identified three distinct aspects of governance: (i) the form of political regime; (ii) the process by which authority is exercised in the management of a country’s economic and social resources for development; and (iii) the capacity of governments to design, formulate, and implement policies and discharge functions. The Asian Development Bank (ADB) defines governance exactly in the same way as the World Bank does (ADB, 1999).

United Nations Development Program (UNDP) defines governance as “the exercise of political, economic and administrative authority in the management of a country’s affairs at all levels. It is the complex mechanisms, processes, relationships and institutions throughout which citizens and groups articulate their interests, exercise their rights, obligations and mediate their differences” (UNDP, 1997).

Considering the several interpretations from the scholars and international organizations, it is noted that governance indicates the mechanism by which powers and responsibilities are exercised by the involved parties in managing the organization for the achievement of its goals and objectives. It has become an essential aspect to keep the discipline of general institutions as well as financial institutions.

In microfinance literature, the term governance first appeared in 1997 (CGAP, 1997) and referred to the relationships between the board of directors and the management of an MFI.

“Governance is the process by which a board of directors, through management, guides an institution in fulfilling its corporate mission and protects the institution’s assets over time.” (Guidelines for the Effective Governance of Microfinance Institutions, ACCION)

“Governance is defined broadly as the system of people and processes that keep an organization on track and guides major decisions.” (CGAP, 2010).

“A board of directors is established to provide oversight and give direction to the managers of an institution. The board carries out this function on behalf of a third party, referred to as shareholders in

countries and firms borrow excessively and mismanage their financial affairs, then almost by definition, they are not being governed well (Litan, Pomerliano, and Sudararajan, 2002).

Several international organizations have defined governance in different way. Among them, the World Bank (1992) first discussed the issues relating governance in the early 1990s. The World Bank defines

the case of for-profit corporations. Because there are no owners in nonprofit corporations, that third party is not as easily identified and has been defined to include the corporation’s clients, staff, board, and donors.” (Principles and Practices of Microfinance Governance, ACCION)

There are three elements of this definition worth emphasizing. First, governance is a process. It is a system of checks and balances between owners and other stakeholders who set the standards and objectives of accountability for a given institution. It is fluid; involves many players; and evolves over time according to the institution’s legal structure and external context. Second, governance is a process that requires leadership and commitment. It is the process used by an institution to ensure that it fulfills its mission and protects its assets over time. Third, governance is a process guided by the board of directors. Although the MFI may have many stakeholders, the governance process is under the direction of the board.

Therefore, the board needs to be aware of what effective governance requires, in terms of board characteristics, responsibilities and oversight mechanisms.