Corporate Governance Issues and Challenges in Microfinance Institution in India A case study of SKS Microfinance This Research paper titled “Corporate Governance Issues and Challenges in Microfinance Institution in India – A case study of SKS Microfinance.” Published in Spurthi –IMSR Journal of Management Thoughts – A Peer Reviewed Biannually Journal ISSN No. 2249-1201.
Mr. Mahesh Bendigeri Senior Lecturer Global Business School Bhairidevarkoppa, Beside Bellad Hyundai Showroom, Hubli-580025 M:9342585290 Email: maheshbendigeri@gmail.com
Abstract: It is said that the growth of the economy lies within the poor and if they are supported and uplifted they make the nation proud. Microfinance is one such mode of finance facility to improve the economic activity of poor and helps in alleviation of poverty. Microfinance with its strong base helps for economic development of a nation. Governance-related issues constitute the biggest challenge to the sustainability of India's microfinance institutions (MFIs). The most progressive MFIs, and a few newly established players with strong private investor support and sound governance practices, are setting industry standards and benchmarks. Over the past decade, the microfinance sector in India has grown in size, prominence, stature, and visibility through the increasing participation of international and domestic banks, private equity investors, donors, and the private sector. Their key objective is to provide small-ticket financing on a sustainable basis while enhancing the economic status of less-advantaged sections of society. Institutional structures and governance practices among Indian MFIs are quite varied and differ significantly from mainstream financial intermediaries. Moreover, many MFIs, particularly those that have evolved from nongovernment organizations (NGOs) into "NGO-MFIs," are still struggling to strike the right balance between their social and business goals, two seemingly conflicting objectives. The end result being failure in internal control system, average performance and lack of accountability. One such case is SKS Microfinance, poor corporate governance practice in termination of CEO and non disclosure of significant event during time of raising funds through IPO, playing with regulator bodies are some of the important aspect which needs immediate attention. In this paper an attempt has been made to highlight the various issues and challenges confronting the microfinance
institutions in general and more particularly on SKS microfinance. The paper concludes stating that strict regulatory norms will enforce better Governance Practices. Keywords: Corporate Governance, Regulatory Bodies, Issues and Challenges, MFI
Introduction:
SKS Microfinance was started in 1998 as nonprofit SKS Society. Mr. Vikram Akula founder and CEO started this venture to offer small loans to very poor borrowers. It was funded by individual and institutional donations and focused on markets within its home state of Andhra Pradesh. In 2005 SKS decided to pursue an aggressive growth plan and transformed into a Non-Banking Financial Company (NBFC) named SKS Microfinance and regulated by the Reserve Bank of India (RBI). Since transformation, SKS has been successful in creating a for-profit model of microfinance using commercial funds that is scalable. Delivering services at the doorsteps of its members and following clear-cut processes. Being the India’s largest and one of the world’s fastest-growing microfinance organizations. Its mission is to empower the poor by providing them collateral-free loans for income generation. SKS Microfinance has 1,627 branches in 19 states across India and total assets worth $897.9 million as on Sep 2009. 3.1 As on March 31, 2010 SKS had 6.78 million women borrowers and total disbursement worth over Rs. 14000 crores. 3.1 SKS charges an annual effective interest rate ranging from 26.7% to 31.4%, with a repayment rate of over 99 % on its loans.3.
Origin of Idea: 4. The idea to start up SKS originated during his childhood days. He was born in India but brought up in the United States. Mr. Vikram Akula used to come to India during school holidays, wherein he saw extreme poverty prevailing in India on one side and extreme wealth on other side. Looking into this scenario he decided to do something to eradicate poverty. Upon graduating from college, he started working with an American NGO in Andra Pradesh as a loan officer doing microfinance activity. During this time he observed the tremendous impact that microfinance has on the lives of the poor and thus thought of doing it in a scalable manner. In one of his experience while working as loan
officer, he was forced to refuse a loan to a poor woman due to lack of funds. The woman asked him “Being a poor is it a crime” Stung by the remark, Akula returned to the US. He left working with the NGO, completed doctorate in microfinance from the University of Chicago and set up Swayam Krishi Sangam in 1997.4.
Concept of Microfinance: Microfinance refers to the provision of financial services to the low income, the poor and marginalized, including the self employed- financial intermediation. In other words, microfinance is all about assisting the underprivileged families with the necessary financial support by way of small loans, so as to keep them actively working in some productive activities or expand their existing business. Overtime microfinance has come to include broader financial services such as insurance, money transfers and savings
Characteristics of Microfinance Clients: Typically low income people with no access to formal financial services Self-employed and household-based entrepreneurs In rural areas clients includes farmers and small businesses which are into food processing, agriculture In urban areas may clients include artisans, shopkeepers, vendors, manufacturers. Small Businesses, usually owned and operated by one person, with little capital investment, employing less then 10 employees of which maximum will be women. It is not simply banking but a extension of banking in the form of a developmental tool Small loans are lend typically for working capital requirement Informal appraisal of borrowers and investments Collateral substitutes- group or relationships Access to repeat loans depends on repayment performance
Business Model of SKS Microfinance: 5.Since Inception the SKS Microfinance focused heavily on a model that could scale rapidly. One of the key measure of its success was accounted towards the rate at which the number of poor people were reached and the number of loans granted. This was achieved by constantly overcoming constraints to scaling that are present in microfinance. To ensure a sufficient supply of capital, it was the first Indian MFI to raise purely commercial equity; to build capacity, it has adapted scalable processes from the business world and applied them in the microfinance context; and to reduce costs, it has extensively invested in technology. Being the high technology oriented organization. The growth rate of employees confronted with many challenges. One of the difficulty that SKS faces was employees attrition rate. It is said that on an average 25% of its employees leave the job and hence only 75% of the staff would be with the SKS for less then 12 months. Each of its loan officers is responsible for an average of some 450 active borrowers (or 550 clients) thus keeping the productivity level high. SKS has also invested heavily in standardizing its operations, it has developed an automated management information system to bring down the transaction cost and scale rapidly. It is first MFI to have invested such a huge amount in technology to increase the productivity and foster rapid growth.
Products and Services of SKS Microfinance: SKS mainly focus on traditional group-based microcredit loans, accounting for 98.5% of SKS portfolio. At the same time, the company has engaged in tie-ups with insurance companies, most successfully with Bajaj Allianz with which it sold 2.4 million life insurance policies. It has also partnered with Nokia, Airtel and Metro to enhance its revenue. It is said that 89% of revenue generates from Microcredit Operation, 5% from Insurance commission and fees and the balance through interest on bank deposits.
Financing Operation of SKS Microfinance: SKS is constantly engaged in financing its operation for rapid growth. It has been one of the first MFIs to actively engage the commercial finance market, especially in the private equity space. One of the limiting option that forced SKS to opt for IPO was the frequency of raising capital since 2006, with each time the amount of issue being the larger one compare the previous deal. This route of raising capital was no more easy option, thus forcing SKS to chose IPO to fund its operation.
Transition from SKS Society or SKS NGO to SKS Microfinance (Public Limited Company) Journey of SKS started a a public society in 1997 taking the form of NGO named as Swayam Krishi Sangam popularly known as SKS society. Having started up as an NGO SKS found the hardship in achieving the objectives of not-for-profit model. Owing to the great demand for Microfinance, SKS formed a private company named as SKS Microfinance Private Limited in 2003. Later it become a Non Banking Financial Company in 2005. To achieve high growth rate and expand the business operation it decided to go for public by converting from Private limited to Public Limited in May 2009. Today SKS is one of the largest and fastest growing MFI in India. Formation of public limited company has helped SKS to achieve a sustainable level of growth in the entire history of microfinance both in domestic and global market, as witnessed by some of the Equity investors of SKS Microfinance include Quantum Hedge Fund, Sequoia Capital, Vinod Khosla, Small Industries Development Bank of India, Bajaj Allianz, Yatish Trading, Kismet Capital, Sandstone Capital, Silicon Valley Bank and Unitus. In the 3½ year period from March 2006 to September 2009, SKS recorded cumulative annual growth of around 250% across multiple categories.
Meanwhile, its
Source: http://www.microfinancefocus.com/news/2010/05/17/e xclusive-sks-microfinance-journey-to-ipo-an-inside-story/
profit margins continued to increase, with return on equity growing from 5.1% in FY2007 to 18.3% in FY2009.
Corporate Governance @ SKS Microfinance:
Corporate Governance at SKS Microfinance stems from the termination of services of its CEO and Managing Director Suresh Gurumani and resignation by Ashish Lakhanapal as a Director from the SKS Board. Mr. Gurumani appointment as a CEO of SKS in Nov 2008 was basically the choice of SKS investors, like Mr.George Soros, Narayana Murthy and Vinod Khosla. His appointment came after SKS raised Rs. 366 crore from private equity investors in Nov 2008 in it’s forth round of funding. Mr. Gurumani had a five year contract from April 1,2009 to March 31, 2014. So Questions are raised as to what caused this abrupt decision of terminating the services of Mr. Gurumani as a CEO? Is it; •
A tiff between the owners and the management
•
Is it a corporate governance issue?
•
Financial irregularity being covered up
Two possible theories can be quoted behind the sudden exit. One theory states tussle for “Power & Control” between the Founder Vikram Akula and CEO Suresh Gurumani has given rise for immediate termination of CEO. An article that appeared in CNN-IBN last year titled “SKS founder Vikram Akula battles dilemma” highlighted the power struggles that took place in the top management of SKS Microfinance. Extracts from the article states that “It’s like the story of the boiling frog. You put it in really hot water and it will jump right out. But if you put it in warm water it won’t realize what’s happening till it’s too late.” The situation at SKS was some what similar once Gurumani had officially taken over as CEO and Akula became chairman. On various occasion like staff appraisal, hiring of work force for job related activity there would be difference of views between Mr. Gurumani and Akula. On the other side gaining popularity of Mr. Gurumani for his professional approach and expertise, made Mr. Gurumani feel insecure, his recent appointment as an Executive Chairman gave him a much stronger grip and enough power to plan the unceremonious exit of Suresh Gurumani.
Second Theory speculates that there was some bungling up of ESOP allotments and since the buck stops at the CEO, the board decided to cut short the tenure of the CEO. In early 2010 Mr. Gurumani was allotted 225,000 shares of SKS Microfinance at Rs 300 per share as per the options allotted under SKS Microfinance’s ESOP Plan 2008. All these shares were sold at Rs. 636 per shares before the IPO making himself Rs. 14.32 crores. In addition to this he also hold unexercised options for about 6,75,000 shares of SKS amounting to Rs. 80 crores. It is unclear whether he will be continuing with these shares or it be forced to be forfeited by SKS. Even the Director Lakhanpal resignation was justified on the ground stating that in order to comply with the requirement of listing agreement in connection with the prescribed ratio for independent and non-independent directors he had tendered his resignation. So the Corporate Governance issue with respect to SKS is not of financial irregularities, but it is related to Board of Directors feeling that Performance of CEO is not up to the mark and he is not equipped to handle team related issues. The Board felt that Mr. Gurumani was not the right person to take SKS to the next level”. There is a need for new person to handle the post of CEO in the era of changes in the Micro finance industry. A Good Corporate Governance practice speaks of giving a notice period to its employee along with severance pay package, before terminating, rather then abruptly termination of services. On another front India’s Insurance Regulatory and Development Authority (IRDA) is reported to be investigating SKS Microfinance, for violating norms in its insurance practices. It has found that SKS had collected commission more then the permitted limit of 10% for agents selling policies. Moreover it has also found that it has violated the norms for death claim cheques. Instead of getting the cheques issued in the name of beneficiaries it was found that SKS was receiving cheques of death claims on its name . This shows the poor governance practice of SKS in ‘overlooking' the norms in premium collections in group insurance policies of its clientele and other modalities. Looking into the Corporate Governance practice of SKS, it is evident that some amount of gap is existing in the operation of MFI in the areas of: •
The role of Director and Independent Directors
•
The role of regulatory body like SEBI, RBI and Government
Role of Director and Independent Directors of SKS Microfinance:
The main reasons for failure of independent directors in India are that most of the public listed companies’ shareholding is structured differently. The family or founders bring in their relatives and friends as board of directors and control the organization. The independent directors do not receive insider information of the organization, as senior management is loyal to the founder / family. Hence, all effort is made to protect the family/ founders authority and control, rather than interest of the public shareholders. Therefore, though the qualifications of the directors are good and relevant they have little impact. The directors are appointed more to add prestige to the board and company, a men’s club is formed and nobody bothers to ask the right questions. For the directors it is a status symbol to be on the board, along with the director’s fee, free travel and various indirect privileges. In such a scenario, the board’s independence is lost and there is hardly any focus on curtailing fraudulent activities. SKS Board composed of Independent Director with rich experience in the field of industry and academic they are CEO of Genpact Mr.Pramod Bhasin. CEO of National Commodities & Derivatives Exchange and former managing director and now the head of Invent Assets Securitization & Reconstruction Mr. PH Ravikumar; and Tarun Khanna, a professor at Harvard Business School. Considering the fact that the board had hiked pay package of Mr. Gurumani to the extent of 50% jump with additional cash bonus of Rs. 80 lakh. But after the listing of SKS the same board decided to terminate his service without any explaination. This shows that the board of directors have failed in their duty for not exercising objectivity, independence in announcing the termination of CEO. It also proves that the founder chairman Mr. Vikram Akula has made undue use of his supremacy on the board to decide the termination of Mr. Gurumani without any reason. Another aspect to be looked into the case is, as Vikram Akula was busily involved in resolving legal dispute case, was not able to devote time for the SKS development. The board felt that the company needs a professional hand to hold the position of CEO and thus had appointed Mr. Gurumani. Later when Mr. Akula was through with all the legal cases, forced the board to reappoint him as a full time executive chairman. The proposal to appoint Mr. Akula as Executive Chairman was kept pending till the IPO was successfully completed. Mr. Akula appointment as Executive Chairman came only after the IPO thus leading to role conflict and power conflict between the CEO and Executive Chairman. Thus a question arises is the conflict between the founder and the professional CEO is all about the failure on the part of Board in managing the relationship.
Role of Regulatory Body in SKS Case:
Role of SEBI: Termination of CEO without any reasons was one of the shocking news in the stock market, hearing this news capital market regulator SEBI has asked SKS Microfinance to spell out the reasons behind its decision to sack CEO Suresh Gurumani. It also raised a question on the resignation of one of its independent director Mr. Ashish Lakhanpal. If the company indeed had a hint of any such event, it would amount to suppression of key information which as per SEBI norms leads to violation of code of conduct, resulting into loss of shareholder interest and confidence. It has also led to staggering of confidence and hopes of other MFI to raise money from the capital market.
Role of Andra Pradesh Government & its impact on MFI’s: Taking the stock of situation, Government of Andra Pradesh took a bold set in promulgating AP Microfinance Ordinance which came into effect from Oct 15, 2010. The ordinance was built on the basis of four premises: a) MFIs charge usurious interest rates; b) If clients fail to pay on time, MFIs use coercive methods to collect the interest; c) These practices are forcing the poor to commit suicide; d) MFIs make huge profits and have no social mission to help the poor. Basic intention of issuing the ordinance was to protect the Self Help Groups Women, who are easy prey for most of the private microfinance institutions, through lending the loan at higher rate of interest and use coercive means to recovery the loans resulting in their impoverishment and in some cases leading to suicides.� The Ordinance makes it mandatory for all private institutions engaged in micro-lending to register with the district Registering Authority, the Project Director (PD) of District Rural Development Agency (DRDA) for rural areas, and the PD of MEMPA for urban areas by November 15, 2010 (one month from the issuance of the ordinance). MFIs have to specify their areas of operations, the rate of interest, and their system of operation and recovery. Further, they cannot seek security from a borrower by way of pawn or any other means. If a SHGs or the any other general public complains to the registering authority either in writing or verbal. The authority has every power to terminate the registration of firm by providing sufficient reason for the same. MFI will ensure that all the repayment of loans will be routed through Village Panchayat Office.
Conclusion:
Based on the study undertaken it is observed that MFI helps to improve the economic stability of the poor and empower them to make the living by providing small ticket loans, but in the process of achieving this objectives they are confronting with other issues which needs serious attention. More over the entire microfinance sector need to put relook into their dual objectives and should make know to public quite frequently. This may not be as simple as it sounds, but it is an entirely necessary exercise, in order to give clarity to all stakeholders about the objectives of microfinance. MFI are prone for many wrong acts in term of business practices, relationship with stakeholders internal and external, playing with regulatory bodies. Hence it is said that for every evil act done in India there is a punishment. The Andra Pradesh ordinance made a great impact on the MFI and was eye opener for existing MFI and also the up coming MFIs in India. Hence it is proved that when a system is allowed to function independently there will be a scope for exploitation, so Government Intervention is a must to ensure protect the interest of stakeholder and also to maintain its own status quo and thus ensuring smooth and good governance practices.
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