“What was going on in those board rooms?” Recent crises and institutional failures have exposed important governance weaknesses. They have also underscored how strong boards help MFIs survive tough times. Efforts to improve MFI governance are central to making the microfinance industry’s responsible finance movement robust in its practices and ensuring that it offers meaningful benefits to clients. Fortunately, awareness of the need for good governance seems to be growing: the recent Banana Skins report found that governance now ranks as the second greatest perceived risk to the microfinance industry.

A new CGAP Focus Note takes stock of MFI governance and assesses in particular the performance of microfinance investors in doing their part to govern actively and effectively. The study, which draws on in-depth interviews with more than 100 industry insiders, concludes that the microfinance industry is lagging in applying accepted good governance practices and that equity investors need to step up and do more.

The main role of governance in any organization is to help owners or other key stakeholders ensure that their interests are still advanced and protected once they have delegated responsibility for day-to-day operations to the management. Shareholders rely on legal agreements, policies, and particularly the board of directors to chart mission and strategy, oversee operations and management, and ensure a company’s long-term survival. But MFI governance is a bit more complicated than that of mainstream financial institutions. First, they must account for the fact that most microfinance clients are lower-income, less familiar with formal finance, and thus more vulnerable than conventional banking customers. Second, MFIs generally have both social and financial bottom lines and rely on governance to identify and navigate trade-offs that arise between them.

Several “hot-button” issues commonly arise in MFI board rooms. CGAP’s recent governance study found that the most commonly reported decision that generated heated debate was the pace and quality of the MFI’s growth. In second place were decisions around the MFI’s product line that have significant financial and mission consequences, including how much to invest in serving rural segments and small savers. Next came responsible pricing and other client protection issues. The interviews also revealed a new generation of hot-button issues that are cropping up in MFI board rooms, including appropriate levels of profit and how profits should be allocated, executive remuneration, and how to handle the interest of more commercial players entering into MFI financing and ownership structures.

Social governance—that is, building consideration of the social bottom line into strategy-setting, performance monitoring and decision-making—needs more work. Although many in the field have concluded that “the financial bottom line will always win,” there are quite a few promising new initiatives in the MFI governance space by individual providers, networks, investors, raters and social auditors, and others. This includes tools developed by the Social Performance Task Force through its recently-published universal standards, the Governance Working Group at the Center for Financial Inclusion, and initiatives from the BBVA Microfinance Foundation and CERISE.

Effective MFI governance is also challenged by the reality that the sector is relatively young and many institutions are still led by founders. Managers are often reluctant to accept the need to give up some control in the interest of achieving more balanced governance. In principle, the owners could and should insist on this, but those interviewed for the study reported that too few investors have the intention or focus to take on cases of “management capture,” where the CEO or senior management dominates the board and as a result oversight of the MFI is weak.

Social and development investors that provide equity to MFIs, funds, and other microfinance investment vehicles (MIVs) have ample opportunities to contribute to improved governance. For one thing, the research shows that they nominate and appoint well over 300 people to represent them on MFI boards. For another, they can shape and strengthen MFI governance at every step of the investment process—by the way they do due diligence, the provisions they put in shareholder agreements, how they monitor their investments, and how they exit.

So how well do investors perform their roles in the MFI governance process, as reported by their peers, their partners, and themselves? Many equity investors are not fully capitalizing on the opportunity for active governance. One experienced microfinance professional spoke for many when she observed, “Foreign investors must be engaged owners, not just sleeping partners.” Some investors insist on board seats but do not fill them, or have difficulties in finding nominees with the right qualifications, time to serve, and willingness to ask tough questions.

With all of this said, we can’t just assume that improving governance capacities and processes will pay off in better outcomes. Well-designed research can tell us whether and how governance reforms pay off, based on deeper analysis of the trade-offs between mission and financial goals that need to be anticipated, managed, and when possible, avoided. Recent MIX research is exploring current MFI governance practices and how they relate to performance. Initiatives such as that led by Promifin in Latin America seek to assess governance weaknesses, fix them, and see if MFI partners perform better as a result.

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