In the microfinance literature, governance first appeared in 1997 in the CGAP report under the topic of “Effective Governance for Microfinance Institutions”, emphasising the relationship between boards of directors and the management of MFIs (Lapenu & Pierret, 2006). The literature contributes to emphasise the importance of corporate governance for the microfinance sector because it is a significant factor for enhancing the viability of the industry (Hartarska, 2005; Labie, 2001; Mersland, 2011; Mersland & Strøm, 2009; Varottil, 2012). MFI principals hire agents to manage their MFI’s operation and in many instances there is ultimately a negligible return achieved. Principals, it is suggested, expect to gain assurances on the funds/donations made by them for MFI activities (Sinclair, 2012). It is very difficult for principals to monitor the actual flow of money with information independent of the MFIs (Sinclair, 2012). When corporate governance incorporates a high level of continuous disclosure market forces respond to the information and impose pressure on the firm to shape up (Varma, 2005). These pressures tend to be absent from the MFI sector.
In addition to the high growth rate of microfinance around the world and an increasing number of heterogeneous institutions in the microfinance sector, there have been some serious complaints of unfair practices and low transparency in MFI affairs. Potentially, these have arisen due to increasing competition between MFIs and the evidence available suggests that the lack of corporate governance practices contributes to problems relating to firm sustainability and loss of clients. Malpractice by some MFIs in Andhra Pradesh and Karnataka, India, ultimately increased the debt liability of poor borrowers and was even attributed to causing the suicide of some clients (Galema et al., 2012; Rooyen et al., 2012). MFIs need good financial and management practices to operate their micro-financing activities more transparently and sustainably (Barry & Tacneng, 2014; Caudill et al., 2009). Sound corporate governance practices are viewed as a way of helping MFIs to operate
66 more effectively and efficiently (Hartarska, 2005). It has become a hot issue among policy makers ruminating over which model of corporate governance practices should be recommended for MFIs to enable them to perform well (Milana & Ashta, 2012).
There is a substantial body of consultancy reports and general guidelines on governance. Some reports relate to all industries and some are more focussed, promulgating guidelines for specific industries. However, general guidelines on corporate governance have not been put into practice by MFIs (Arthur et al., 1993; Mersland, 2009). General guidelines for corporate governance are deemed adequate for MFIs as there are cultural and regional differences that require the development of a specific framework for corporate governance (Gant et al., 2002). Varottil (2012) states that MFIs need a specific corporate governance framework even when they are examined from a theoretical perspective. A view of corporate governance, which suggests that the corporate governance is an area where market discipline is more valuable than regulation (Varma, 2005), is important and may be reflected in the pursuit of higher returns by MFIs and by concentrating their work in urban areas. Similar to the early savings banks, many MFIs struggle to identify board members with an appropriate background who are able and willing to dedicate the time to effective monitoring (Armendariz & Labie, 2011). Mersland (2009) identifies corporate governance factors that affect the performance of MFIs; CEO/chairman duality, international directors, internal board auditor, board size, shareholder ownership, female CEO. Furthermore, Mersland and Strøm (2010) examine the relationship between firm performance and corporate governance in MFIs by using secondary data of third-party rating agencies. They find that the local directors, internal auditors and female CEOs can help to improve the financial performance of MFIs. Also the number of credit clients of the organisation increases if there is CEO/chairman duality. They suggest an industry-specific approach to MFI governance.
As stated by Labie (2001), an agency cost framework can be applied to the microfinance sector, and emphasising outreach performance rather than financial performance should be a priority for MFIs. This is highly important for MFIs compared with traditional firms in terms of assessing their corporate governance.
67 However, Mersland and Strøm (2009) state that an agency cost framework cannot be applied to MFIs to deal with the relationship between financial performance and outreach. In the microfinance sector, corporate governance issues are subjected to a different set of factors that successfully target the core of the relationship between financial performance and outreach.
Bassem (2009) uses a self-conducted survey, annual reports and MIX market data for a study on governance and performance of MFIs in Euro-Mediterranean countries. He highlights how governance mechanisms can improve the performance of Euro-Mediterranean MFIs in relation to outreach and sustainability. Lapenu and Pierret (2006, p. 10) state that the “good functioning” of the board of directors is not enough to guarantee the success of MFIs. Other governance mechanisms probably play a more important role. It is necessary to broaden the scope of a study to include all stakeholders involved (employees, managers, elected officials, clients, donors, bank partners, shareholders, the government, etc.) as well as any organisational form with a “governing” role that may have been set up at the inception of the institution. Mersland (2011) recommends in his study that stakeholders such as donors, depositors, local communities and bank associations can provide a monitoring system to boost the existence of MFIs.
Mersland (2009) states that in order to identify the various relationship dimensions within MFIs through a corporate governance viewpoint, it is necessary to develop a three dimensional approach which comprises the relationships between MFIs and their equity investors, debt financiers, employees, borrowers, community, competitors and government regulations. Figure 3.9-1 demonstrates the diagrammatic representation of the three dimensional approach. Further, Mersland emphasises the importance of having more studies in this sector to better understand the governance system for MFIs. He also recommends further research should be conducted to identify how the combination of organisational types enhances competition in the microfinance industry and affects performance of MFIs.
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Figure 3.9-1: Relationship-Dimensions of MFIs
However, the increasing popularity of microfinance as a development and anti- poverty tool has pushed the industry towards financial self-sufficiency and created a tension between the MFI’s dual mission of financial self-sufficiency and social orientation (Sinclair, 2012). Furthermore, Varottil (2012) and Sinclair (2012) point out that the commercialisation of MFIs from non-profit institutions to for-profit institutions has created several issues in the industry. Even if the commercialisation of MFIs has assisted in scalability and outreach by broadening the scope of financial support for poor people, it has caused MFIs to turn back their social goals. According to Arena (2012), microfinance providers are drifting away from their mission and corporate governance is being blamed. This is because the existing corporate governance practices available to MFIs are only influencing their ability to raise capital and that has created a perception that private interests are benefiting from the vulnerability of the poor.
It is important to investigate the extent to which corporate governance pays attention to the interests of the poorer sections of society as stakeholders (Mersland & Strøm, 2010). Through the application of social corporate governance, MFIs can give more attention to the poor stakeholders and mitigate the problem of getting away from the mission. As Arena (2012, p. 269) states:
“Unlike traditional corporate governance mechanisms, the social corporate governance is designed to vindicate the organisation's social and development goals. This note argues that social corporate governance
69 mechanisms, when properly balanced against traditional corporate governance structures, alleviate the tension between financial and social development goals and provide a solution to mission drift in microfinance”. Consideration of both financial performance and outreach encompasses a generally overlooked consideration that these concepts are not necessarily compatible (Hermes et al., 2011). While the mission might be outreach to the rural poor, the practice may focus on financial performance which is more ready achieved through consumer loans to clients in urban areas (Hermes et al., 2011; Montgomery & Weiss, 2011; Rooyen et al., 2012). This has been confirmed by the New York Times in a front page article, “Banks making big profits from tiny loans,” which criticised the microfinance sector in general (Sinclair, 2012). By shifting from financial aspects of governance, it is timely and important to focus on social aspects of governance to identify the appropriate corporate governance mechanisms for MFIs. The financial feasibility of MFIs can develop by having a rational approach toward financial objectives (Mersland, 2011). Accordingly, among policy makers there is a hefty debate on the compatibility or trade-off between financial sustainability and outreach of the microfinance sector (Hermes et al., 2011). Lapenu, Foose, Bédécarrats, and Verhagen. (2009) state that the integration of social mission with strategic and operational decisions is therefore essential to mitigate the mission drifting of MFIs.