managing risk.pdf

20 Chapter 2 - Good Governance: Managing Internal RiskAn institution’s legal form also determines many aspects of its governance. Good governance is a challenge forall types of organization—from small nongovernmental organizations (NGOs) to large corporations. MFIsface most of the governance challenges of banks and financial institutions and some that are particular tosocially oriented businesses. First, many MFIs are nonprofit entities or are owned by nonprofit entities andoften have an unclear ownership structure. Second, the growth in assets and clients frequently leads to a changein an MFI’s legal form or status requiring an evolution of its governance: from an NGO to a shareholderownedinstitution, from a nonregulated to a regulated MFI. Finally, the legal and regulatory framework inwhich MFIs operate is dynamic and often either inadequate or excessively complicated. As a result, no onegovernance structure is universally applicable to all MFIs at all times. Good governance must be relevant for anMFI’s particular situation and stage of development. It should also anticipate the next stage of development.NGOsIn Latin America, NGOs continue to play a significant role as MFI owners and as operators. In most cases,donors—private foundations, governments, international aid agencies, or individuals—provide the bulk ofcapital to start and sustain the NGO. Because NGOs are nonprofit organizations with no real owners, thefounders cannot lay claim to the organization’s financial and physical assets.This lack of specific owners makes it difficult to identify the person or institution to whom the board isaccountable or for whom it acts as a fiduciary. In this case, the board is accountable first and foremost to theinstitutional mission as it is defined, approved, and understood by the various stakeholders, including thosedonors and agencies that have funded the NGO.A common governance risk associated with NGO ownership (particularly where the NGO is the sole or majorityshareholder) is the concentration of power in the hands of one person or a few people, usually the founders. Atthe same time, management may depend on the MFI for its livelihood. Those who provide financial supportmay lack the time, interest, or ability to adequately oversee the MFI. This may lead to management operatingthe MFI for the primary benefit of management. This risk is avoidable. Numerous MFIs have diligent andcapable NGO board members who value their reputation and have strongly identified with and protected theinstitutional mission. The key is to understand the motivation and what is at stake for the MFI’s leaders.Private InvestorsThe challenge with private investors is to ensure that their concerns are adequately addressed andevenly balanced with the interests of other investors and stakeholders. Because they have somethingto lose (or gain), private investors tend to be active board members (see box 2.1). Private investors inmicrofinance may be divided between two types of owners: profit seekers and patient capitalists. Profitseekers are primarily interested in making a high return on their investment, attracted by the impressivefinancial results that some MFIs have achieved. Institutional mission is not an overriding concern forthis group of investors, and there is a temptation to forgo longer-term objectives and sustainability forshort-term profits. They require an exit strategy to ensure that they can take out profits in the near tomedium term. Patient investors are motivated by long-term return on their investment and a sense of their ownsocial responsibility. They generally support the institutional mission and are motivated to protect the financialhealth of the organization as the basis for future returns.