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Rediff.com  » Business » MFI governance issues under lenders' lens

MFI governance issues under lenders' lens

October 15, 2010 04:04 IST

Call it the SKS effect. Stung by the controversy over the sudden sacking of the Managing Director at India's largest microfinance institution, SKS Microfinance, lenders have decided to raise corporate governance issues at board meetings of other MFIs.

An official at the Small Industries Development Bank of India (Sidbi), which coordinates the work of lenders to MFIs, confirmed the move. The SKS board recently terminated the services of managing director and CEO Suresh Gurumani without assigning any reason.

The SKS controversy is, however, just one contributing factor to lenders' decision. Banks have jointly floated a lenders' forum and its coordination is tasked to Sidbi under the terms of a $300-million World Bank loan. The objective of the credit line to Sidbi is to scale up access to sustainable microfinance services, introduce innovative financial products and foster transparency.

The forum is also concerned about interest rates charged to small borrowers and wants uniform reporting systems and disclosures. Ethical field-level practices will receive equal attention, a senior public sector bank official said.

The forum intends to simplify reporting formats, so that a single report from each MFI meets the norms of all lenders. Lenders have begun auditing their loan portfolios to check the end use of funds and improve transparency in MFIs' operations. Audit agencies have been appointed to examine the loan books of larger MFIs and more institutions would be covered in phases.

Meanwhile, leading private equity players said recent developments in the industry could affect the flow of funds. MFIs receive a large part of their funding through PEs.

Leading PEs are also concerned about the finance ministry's decision to ask banks to cap the interest rates charged by MFIs. Bank finance is major source of leveraged funds for MFIs. The ministry wants banks to ensure that MFIs don't charge more than 24 per cent interest from borrowers if they have taken bank financing.

Vikram Utamsingh, executive director & head of the private equity group at KPMG India, said private equity investors would be very wary about putting money in an industry where business ethics have been questioned. They had issues with the land bank valuations of real estate companies and now MFIs face similar questions.

MFIs operate mainly through middlemen. While they charge borrowers on average 24-28 per cent interest, they pay these middlemen 3-4 per cent commission. This commission ensures that middlemen recover — often through unacceptable means — loans, which are unsecured or extended without collateral.

Middlemen are also believed to extort a 3-4 per cent cut from borrowers to get them MFI loans.

In many cases, this is shared with MFI loan-sanctioning officials, said an insider. These issues make the whole business of microfinancing increasingly murky, giving high returns in the name of financial inclusion. It is estimated that only one out of seven MFIs follow proper corporate governance practices and ethics.

Many felt that the sector needs handholding. Ashvin Parekh, a partner and national leader of global financial services at Ernst & Young, said microfinancing has been a noble way of reaching out to people at the lowest levels of society and cater to their financing needs while saving them from loan sharks. The trouble, however, is that some bad apples are giving the whole industry a bad name. He wanted agencies like RBI to step in.

Rajesh Bhayani & Abhijit Lele in Mumbai
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