Bananas Over Corporate Governance: The 2011 Banana Skins Survey
Corporate governance just isn’t a very sexy topic. The phrase conjures up stereotypes of wealthy old men sitting in tall leather-backed chairs at long conference tables. Not very exciting. But when it comes to finance, the least exciting topics are usually the most important.
Published for the third year in a row by Center for the Study of Financial Innovation, the Microfinance Banana Skins survey polls microfinance practitioners, investors, analysts, regulators, and other microfinance experts on the top risks facing the microfinance industry worldwide. In the 2011 Banana Skins, corporate governance is ranked the fourth-highest risk by itself, up from seventh a year ago, yet it is also deeply embedded in each of the top three: client credit risk, industry reputation, and competition.
Even with a credit bureau system in place, an internal culture of lending discipline is crucial – just ask mortgage lenders in the United States. Pressure to extend loans out of kindness or to meet quarterly portfolio targets are tremendous temptations to circumvent internal controls in the loan approval process – assuming internal controls exist at all. Over-indebtedness is the result of succumbing to those temptations. Internal controls based on an established risk profile are a key concern for board members, as is establishing an internal culture of the highest respect for them.
Reputation risk revolves around the great debate between advocates of nonprofit, mission-driven MFIs versus for-profit, commercial MFIs. The events in Andhra Pradesh are the most recent and perhaps the most heated chapter in the story so far. The commitment to corporate governance among MFIs has been taken up in letter but not enough in spirit, leaving microfinance open to criticism for managing capital irresponsibly and exposing the poor to new-age moneylenders backed by global investors.
Banana Skins respondents cited competitive pressure as one of the prime causes of irresponsible lending and over-indebtedness. The difficulty of finding new clients and managing larger client loads nudges loan officers toward circulating more and more loans among established clients rather than growing clientele. Respondents also cited the need to repay their own creditors as a prime reason why collection agents resort to intimidation and public shame tactics. Competition just isn’t going to go away. Setting an appropriate strategy for competing to reach new clients or merging with another MFI or a bank are decisions that board members must be able to discuss with managers and staff.
As any deposit-taking MFI can tell you, it can take years to build up trust in the community for people to begin leaving their hard-earned cash with an MFI agent. Whether an MFI exhibits fairness, accountability, responsibility, and transparency – the core values of strong corporate governance – in its management and governance will be crucial to its future ability to attract and retain depositors as well as investors. As MFIs continue to expand savings and also insurance products, strongly governed MFIs will stand out as more trustworthy and resilient in the face of rapidly changing environments.
Of course the policy environment, consumer education, new models like correspondent banking and new innovations using mobile and online technology will all have a role to play in reaching the three billion ’unbanked.’ Financial innovation at the base of the pyramid is much sexier than corporate governance, but financial innovation of any kind without effective corporate governance has led to financial ruin again and again and again and again.