Produced by the United States Agency for International Development (USAID) Nigeria PRISMS Project, for presentation at the International Year of the Microcredit (IYMC) Workshop, 16 December 2005, 8 pages, available here.
This paper examines the concept of institutional governance, exploring governance issues that concern microfinance institutions, both commercial and nonprofit.
OVERVIEW OF GOOD GOVERNANCE
The paper begins by reviewing good governance, defining the concept as the process by which the organization’s Board of Directors guides an institution in fulfilling its mission and protecting the institution’s assets. The paper asserts that good governance is contingent upon directors being guided the highest standard of ethical behavior, and identifies three aspects of ethical behavior:
“Duty of loyalty”: placing the interest of the institution above self
“Duty of care”: being fully informed and participating in decisions prudently, and taking responsibility for actions
“Duty of obedience”: being faithful to the institution’s mission by being transparent with shareholders and clients
GOVERNANCE ISSUES SPECIFIC TO MICROFINANCE INSTITUTIONS
The paper stresses that boards of organizations providing financial services must assume a higher level of fiduciary responsibility than those boards of organizations providing non-financial services, since financial institutions are entrusted with the public’s money. Boards of microfinance institutions have two additional responsibilities beyond those of other financial institutions. First, the type of individual that borrows from an MFI often lacks access to alternative sources of financing other than the microlender, which suggests that the MFI’s financial failure might mean of end of an individual’s access to any capital. Second, boards of MFIs also need to consider the fact that the insolvency of a large-scale MFI could have a severe impact on the domestic and international microfinance sector. Following the implosion of a “key player” in microfinance, lenders and investors might question the overall economic viability of microfinance lending. Thus, boards must understand that shirking their fiduciary responsibilities could have ramifications that extend well beyond their own institution.
ACHEIVING BEST PRACTICES
To navigate through the challenges identified above, the paper outlines two best practices that should be employed by MFIs: appropriate criteria in selecting board members and the establishment of a specific governance structure
In selecting directors, the paper stresses that three concerns should be kept in mind. First, the board should collectively boast a diverse set of technical and managerial skills. To this end, the selection criteria for each candidate should include what skills that the particular candidate can contribute to the board’s overall skill-set. Second, potential board members must recognize and be committed to fulfilling the “dual mission” that guides the operation of a microfinance institution. Finally, the board must be the appropriate size; a size that fosters ample ideas and perspectives on issues, but one that does not hamper efficiency.
When establishing a governance structure, three mechanisms must be included to ensure the board operates ethically and efficiently. First, the paper strongly advocates that the role of Chairman and Chief Executive Officer not be assumed by one individual. Separation of these roles ensures that the Chairman can facilitate board meeting discourse without harboring a conflict of interest. If the Chairman were also the CEO, the individual tasked with running daily operations, they could not objectively facilitate a discussion that critically examined the firm’s daily operations. The second essential mechanism in the governance structure is having a detailed definition of the Chairman’s role, particularly in relation to other Directors. Finally, the governance structure must assign specific roles and responsibilities to each committee. The effectiveness and efficiency of a board depends on the clarity of each committee’s responsibilities.
By Ryan Benson, Research Assistant
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