> Posted by Bob Bragar, Principal, Strategies for Impact Investors

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

The following is the first of two posts in which Bob Bragar discusses some of the unique governance challenges faced by microfinance institutions. The posts examine governance through the guidance of three experienced board members. This post shares the experience of Tamar Lebanidze as Constanta Foundation, an NGO she founded, underwent the change to become Constanta Bank, a regulated bank. To access the second post, click here.

“I don’t see why we have to reinvent the wheel. Good governance practices for microfinance institutions are just the same as for any other business. Why should we spend so much time talking about ‘MFI governance’ when there is so much information already available about good governance?”

This question was raised during a recent meeting of the Center for Financial Inclusion’s Governance Working Group, of which I am a member. The question really surprised me. I had always assumed that governance for microfinance institutions was special. It is not exactly the same as good governance practices in other businesses because microfinance is not the same as other businesses. Even so, it’s a good question. It got me thinking.

Of course, many good governance practices are the same from sector to sector. Running an enterprise well involves challenges that are not specific to the product or service the enterprise produces. Any institution can suffer if the board functions badly, risks are not managed, or management lacks transparency. And there is a lot of good work that is already out there on the role of key stakeholders to maintain good governance in financial services and other industries.

So why do we bother to re-think these issues for microfinance? Because microfinance is a more complex business than most. Going beyond just earning profits, the double or triple bottom line that we ask MFIs to achieve makes success, and therefore governance, very complex. Moreover, microfinance’s particular history of migration from NGOs to semi-regulated financial institutions to formal banks adds challenges to achieving good governance. The stew thickens when we bring multicultural perspectives to MFI boards through the presence of international investors from various countries.

The best illustration of this came up in a governance workshop that I chaired at European Microfinance Week in Luxembourg in November 2013, which included a representative of a major MFI (Constanta Bank of Georgia), a representative of a major European investor (KfW of Germany), and a very independent board member from India.

Tamar Lebanidze represented the voice of MFIs on the panel. Her institution, Constanta Bank, has had a voyage that tracks the history of microfinance generally. The predecessor Constanta Foundation was an NGO that Ms. Lebanidze founded. As its Executive Director, she was familiar with the special challenges that management faces in running a microfinance NGO. When Constanta Foundation grew larger (it is now one of the largest MFIs in Georgia) it transformed into a regulated bank. At that point Ms. Lebanidze moved to the position of Chairwoman of the Board of Constanta Bank and left management altogether.

The board chair holds a key role to ensure that all needed skills are present, that the board remains engaged, understands its role, and is operating correctly. The chair is also essential to maintaining good relations between board and management. This vital role requires special skills.

In her presentation, Ms. Lebanidze talked about the very different governance challenges between NGOs and regulated entities. For instance, NGO boards generally tend to be close to and place much more faith in management than bank boards do. NGO board members often tend to be high-profile people who may not be able to actively engage as much in oversight, but, because of their high profiles, are able to attract the financial support and government trust that the NGO needs. At the same time, sometimes essential skills are missing. In those cases, outside help can be very valuable to bolster skills and heighten supervisory engagement. International investors can play an essential role to achieve this.

The governance challenges change when an MFI moves from being an NGO to being a regulated bank. Generally, bank boards are more likely to have necessary skills and actively supervise management. Banks are subject to regulatory oversight and their board members must have professional qualifications. They have legal obligations and even potential liabilities if they don’t do their jobs correctly.

But bank boards might be farther from the original social mission of the MFI and more subject to pressure to produce profits for the commercial investors that they might represent. The burden then falls on management to keep an eye on the social mission of the MFI, if they can. In those cases, board training on social mission might be valuable.

MFIs that transform to banks also face special governance challenges because, often, key people from the NGO stay involved on the board of the MFI bank. This raises new issues. In the case of Constanta Foundation in Georgia, the foundation’s CEO became the chairwoman of the board. Naturally, there would be questions about how her role would be perceived so it was important for her to avoid management functions and to become truly supervisory. Yet, this transition from management to the board can be a difficult one to make in terms of adequately delegating responsibilities and directly supervising previous staff members.

As MFI banks get bigger, scale requires a professional and independent board. In the case of Constanta Bank, the board completely replaced its members from those of the NGO. In the end, this was very successful.

To access the second post in this series, click here.

Bob Bragar is the Principal of Strategies for Impact Investors. He is also a member of the Governance Working Group. You can contact him here.

Image credit: University of Maine

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