> 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 second of two posts in which Bob Bragar discusses some of the unique governance challenges faced by microfinance institutions, as explored through a governance workshop that Bob chaired at European Microfinance Week in November 2013. In this post, workshop panelists Matthias Adler, Principal Economist, KfW and N. Srinivasan, an independent director at Equitas Bank in India, discuss the importance of their positions for effective microfinance governance. To access the first post, click here.

Institutional microfinance investors have a special role to play in maintaining good governance in an MFI, and this can take unexpected turns.

Matthias Adler from KfW spoke about the special concerns that his institution has. KfW is a major German public sector investor that is required by law to have board representation in the institutions in which it invests. As a result, KfW has developed special practices to strengthen the quality of their widespread board participation.

In particular, KfW has developed rules to create strict “Chinese walls” (information barriers) between their board members and the investment staff at KfW. Why? Because they are very aware of the potential for conflicts of interests between a board member’s duty to look (only and foremost) after the interests of the MFI, and the interests of individual investors. They make sure that a KfW board member will not return to headquarters and report on an MFI board meeting to his colleagues. In KfW’s view, this practice increases transparency and reduces the potential for distrust on the part of the MFI’s management. Management may need to obtain guidance from its board without always speaking directly to the investors. And if management is less forthcoming, the board cannot do its job.

Numbers And Finance

While this concern is not exclusive to MFI investors, in the small world of microfinance, with its limited number of players, the concerns are all the greater.

KfW, as a leading microfinance investor, also wants to ensure that boards of directors have all of the skills they need. So KfW helps boards with needed training.

In the final presentation, N. Srinivasan, an independent board member of Equitas Bank in India, spoke persuasively about the value of truly independent directors who balance the needs of all MFI stakeholders.

According to Mr. Srinivasan, the board should ensure that the institution is mission-driven and balances shareholders’ interests with those of the other stakeholders, especially the clients. Given the special protection that many MFI customers need, MFI boards cannot just stop at compliance with regulatory minimums on governance, but should go beyond to ensure that vulnerable customers are well served. The board should give robust oversight to the MFI’s audit and customer grievance mechanisms, as well as to the appropriateness of interest rates the MFI is charging. The role of independent board members in overseeing these areas and others is critical, given the unique perspective afforded by their impartiality. Having at least one independent board member can provide boards with a good reality check, and can often be a voice of reason, caution, and prudence when other board members might represent investors that stand to profit from excessive growth or other risky behavior.

Mr. Srinivasan also called attention to things that can weaken the board and reduce its oversight capacity. In particular, transfer of certain board oversight functions to select shareholders by means of shareholder agreements can fragment and weaken board oversight. Typically, such shareholder agreements can affect the board’s authority to decide such key items as corporate budgets, selection of senior executives, opening or closing branches, or other important strategic decisions. This lack of board oversight could create problems and raise conflicts of interest. A well-functioning board is an empowered board.

The particular history, structures, and mixed missions of the microfinance industry bring new and special challenges to achieving good governance. I’ve tried to summarize a few of these here and in my previous blog post, but this is a subject that deserves much more thought.

To access the first 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: SeniorLiving.org

Have you read?

Microfinance Corporate Governance: Is It Special? (Part One)

12 Practices to Improve Governance

Peer Pressure for Good: Applying Peer Learning to Governance Leadership