Governing Banks, Governing MFIs

> Posted by Beth Rhyne
If you’ve read any of the dozens of books analyzing the recent meltdown of some of the world’s most famous financial institutions, you already know that corporate governance failures enabled the collapse.  The World Microfinance Forum Geneva has just released a paper aimed at helping the microfinance industry to learn from the missteps of the mainstream. The paper, “Same Game, Different League” by Maria Giovanna Pugliesi, lines up key lessons from the mainstream literally side by side with their implications for microfinance.
I want to give a shout-out to five of these governance lessons because the Center for Financial Inclusion has been advocating them in its work on Investing in Inclusive Finance and support to the Council of Microfinance Equity Funds (CMEF).

1. Duty of Care.  The European Commission is floating the idea that for financial institutions, board member duties extend beyond the standard “maximize shareholder value” to a range of stakeholders including depositors and borrowers.  They want to create a formal “duty of care.”  Given that the stakeholders of MFIs include many of the world’s vulnerable people, this is an excellent principle to enshrine in MFI governance.

2.  Avoiding Management Capture.  There’s nothing new in the idea that accountability demands that CEOs and Board Chairs be different people.  So why has this dictum been neglected so often?  For MFIs, strengthening the board with people who are both knowledgeable and independent is necessary to counterbalance the dominance of management, as CMEF’s governance guidelines emphasize.

3.  Active Risk Management. Apparently, many banks created risk management departments and promptly ignored them because the risk managers lacked the stature of the “real” decision makers. For MFIs, whose risk environment is rapidly getting more complex, risk management needs to appear at the board level.  Providing guidance on how to do this is the goal of the CFI’s Running with Risk project, now getting underway.

4. Compensation.  Enormous pay packets for CEOs at leading banks outraged the public. Recommendations emerging from the crisis advise linking bonuses more explicitly to long term performance and increasing transparency about executive compensation and the process for setting it.  The microfinance industry is only beginning to contemplate such steps, as CFI discovered through its “Aligning Interests” project.  The industry needs to hurry up, because rumblings over executive compensation at MFIs, once very muffled, are getting louder.

5. External Auditors and Rating Agencies.  Shoring up the third party observers of banks is a good and probably necessary idea, but increasingly complex.  This is true as well in microfinance: external auditors may soon be asked to do more in depth portfolio quality analyses, and rating agencies seem to get a new mandate – social performance, governance, client protection, environmental practices – every month.

As I think about all of this, I just can’t get over how hard governance is.  And it’s getting harder and harder. I sometimes worry that all the steps we take to improve governance may make it more complicated without making it better.  Ultimately, along with improved practices, what makes governance better is some brisk fresh air (disclosure?) that wakes everyone up and forces them to pay attention to the important things that are right before their eyes.

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