GOVERNANCE OF MICROFINANCE INSTITUTIONS (MFIS): A CASE STUDY OF BANGLADESH by S. M. Tariqul Islam M.A., University of Manitoba, 2004 THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF ARTS IN INTERNATIONAL STUDIES THE UNIVERSITY OF NORTHERN BRITISH COLUMBIA August 2010 ©S.M. Tariqul Islam, 2010 1*1 Library and Archives Canada Bibliotheque et Archives Canada Published Heritage Branch Direction du Patrimoine de I'edition 395 Wellington Street Ottawa ON K1A 0N4 Canada 395, rue Wellington Ottawa ON K1A 0N4 Canada Your Trie Voire reference ISBN: 978-0-494-75104-6 Our file Notre reference ISBN: 978-0-494-75104-6 NOTICE: AVIS: The author has granted a nonexclusive license allowing Library and Archives Canada to reproduce, publish, archive, preserve, conserve, communicate to the public by telecommunication or on the Internet, loan, distribute and sell theses worldwide, for commercial or noncommercial purposes, in microform, paper, electronic and/or any other formats. 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Conformement a la loi canadienne sur la protection de la vie privee, quelques formulaires secondaires ont ete enleves de cette these. While these forms may be included in the document page count, their removal does not represent any loss of content from the thesis. Bien que ces formulaires aient inclus dans la pagination, il n'y aura aucun contenu manquant. 1*1 Canada 11 ABSTRACT The microfinance programme initiated by the Grameen Bank has become a model of lending to the poor and is now part of the global antipoverty strategy. The present study examines the corporate governance practices of microfinance institutions (MFIs) in Bangladesh including the Grameen Bank based on a survey of 36 MFIs constituting almost 90 per cent of the borrowers in Bangladesh in 2008. The corporate governance structure of the Grameen Bank is based on stakeholder value maximization model. Majority of the board members (9 out of 13) are from the borrower groups - the biggest stakeholder of the bank. However, most of the representatives of the borrowers (mostly women) possess very little education so as to function effectively and independently in a board setting. The government which regulates and provides capital to the Grameen Bank (indirectly through Bangladesh Bank) controls the appointment of the CEO and the Chairman of the Board of the Grameen Bank although it is a minority shareholder (10 per cent of the equity). Thus, the board of the Grameen Bank is compliant to the government and lacks the independent character which is crucial to the conduct and performance of the bank. The empirical analysis based on the data for 36 MFIs in Bangladesh show that corporate governance variables are significant in explaining the performance of MFI's in Bangladesh. Among the corporate governance variables, the board composition variable reflecting the independence of the board seems to have a positive and significant impact on the performance of MFI's in Bangladesh. The absence of statistical significance of other corporate governance variables like auditor independence can be explained in terms of lack of quality data and the evolving nature of microfinance industry in Bangladesh. JEL classification: G30, G32, J23 Key words: Microfinance, Governance, Boards, Audit. iii TABLE OF CONTENTS Abstract n List of Contents in List of Tables List of Figures VI Abbreviations VII Acknowledgement IX Chapter I Introduction Chapter II Corporate Governance and Microfinance Institutions- A Review of the Literature 7 Goals of Shareholder Wealth Maximization (SWM) Vs. Stakeholder Capitalism Model (SCM) International Corporate Governance Codes Corporate Governance and Microfinance Institutions (MFIs) Corporate Governance Literature and Hypothesis Development Corporate Governance in Bangladesh Conclusion 9 Section 2.1 Section 2.2 Section 2.3 Section 2.4 Section 2.5 Section 2.6 Chapter III Section 3.1 Section 3.2 13 15 16 21 27 Evolution of Microfinance in Bangladesh: 19712008 28 An Overview of Rural Credit Delivery Mechanisms in Bangladesh (Before and After the Independence in 1971) The Role of Moneylender in the Rural Credit The Role of Co-operatives in the Rural Credit The Role of Banks in Rural Credit Evolution of Microfinance in Bangladesh The Role of Grameen Bank in the Evolution of Microfinance in Bangladesh The Role of BRAC and Other MFIs The Role of Government Credit Program Current Position of MFIs 29 29 33 36 39 40 43 44 45 IV 46 50 Section 3.5 Why in Bangladesh Analysis of the Micro finance Programs in Bangladesh Scaling-up of MFIs in Bangladesh The Current Legal and Regulatory Framework of MFIs in Bangladesh The Role of the Micro finance Regulatory Authority (MRA) The Role of the Palli Karma-Sahayak Foundation (PKSF) Conclusion >erIV Database and Research Methodology 61 Section 4.1 Section 4.2 Data Methodology and Description of Primary Data Sample Size Analytical Framework 61 62 63 65 Governance ofGrameen Bank of Bangladesh: A Brief Analysis 66 A Brief History of the Grameen Bank Credit Delivery Model of the Grameen Bank Growth and Performance of the Grameen Bank Grameen Bank's Family Organizations Corporate Governance of the Grameen Bank Corporate Governance Literature and Governance of the Grameen Bank Conclusion 67 74 80 85 87 89 Section 3.3 Section 3.4 Section 4.3 Chapter V Section 5.1 Section 5.2 Section 5.3 Section 5.4 Section 5.5 Chapter VI Section 6.1 Section 6.2 Section 6.3 Chapter VII Bibliography 53 55 58 58 59 96 Corporate Governance and Microfinance Institutions (MFIs) Performance in Bangladesh Empirical Result Summary Statistics Cross-Sectional Results Conclusion 98 102 103 Concluding Observations 105 110 v LIST OF TABLES Table 2.1 Table 2.2 Table 2.3 Table 3.1 Table 3.2 Table 3.3 Table 3.4 Table 3.5 Table 3.6 Table 3.7 Table 3.8 Table 3.9 Table 3.10 Table 4.1 Table 5.1 Table 5.2 Table 5.3 Table 5.4 Table 5.5 Table 6.1 Table 6.2 Indicators of Good Corporate Governance Some Recent Codes of Governance Present Reporting System of MFIs in Bangladesh Informal Credit in Bangladesh (Before and After the Independence) Distribution Patterns of Rural Credit by landownership Group-1982 Microcredit Portfolios of the Big three MFIs and the Grameen Bank in Bangladesh (as of endDecember 2006) Share of Micro finance Credit as a Proportion of Total Private Sector Credit Sources of Funds for Microfinance Lending MFIs in Bangladesh—Key Indicators Indicators of Financial Self-Sufficiency and Profitability of MFIs in Bangladesh—2001 - 2004 Microfinance Outreach Indicators of MFIs in Bangladesh—2001-2004 Present Reporting System of MFIs Regulatory Environment of Microfinance Operation in Bangladesh Organizational Profiles: Basic Information of Studied MFIs The Progress of the Grameen Bank The Grameen Bank—Indicators of Outreach2002-2007 The Grameen Bank—Growth in Assets and Loan Portfolio- 2002-2007 The Grameen Bank— Financial Performance2002-2007 The Grameen Bank—Operating Performance2002-2007 Basic Descriptive Statistics Determinants of Performance of MFIs in Bangladesh- Dependent Variables— ROA-2008 13 14 25 31 32 46 48 49 52 53 54 56 57 64 82 84 84 88 89 99 102 vi LIST OF FIGURES Chart 2.1 The Structure of Corporate Governance 12 Graph 3.1 Rate of Growth of MFIs in Bangladesh—1971 - 50 2006 Graph 3.2 Growth of Borrowers of MFIs—1996 - 2006 51 Chart 5.1 Number of Borrowers of Grameen Bank (19762007) Box Plot of Return on Assets of MFIs in Bangladesh-2008 83 Chart 6.1 Chart 6.2 Box Plot of Total Assets and Borrowers of MFIs in Bangladesh-2008 100 101 Vll ABBREVIATIONS ACLAB - Alliance for Cooperation and Legal Aid Bangladesh ADESH - Association of Development for Economic & Social Help ASA - Association of Social Advancement ASOD - Assistance for Social Organization & Development BB - Bangladesh Bank BEES - Bangladesh Extension Education Services BRAC — Bangladesh Rural Advancement Committee BRDB - Bangladesh Rural Development Board CDF - Credit Development Forum CDS - Centre for Development Services CEO - Chief Executive Officer CGAP - Consultative Group to Assist the Poor CSS - Christian Service Society DISA - Development Initiative for Social Advancement DSK - Duhshtha Shasthya Kendra GB - Grameen Bank GDS - Generation Development Society GGS - Grameen Generalized System GOB - Government of Bangladesh KSS - Krishak Samabaya S amity ICAB - Institute of Chartered Accounts Bangladesh IFDC - International Fertilizer Development Centre LGRD - Local Government and Rural Development MD - Managing Director IRDP - Integrated Rural Development Program MC - Micro Credit MDG - Millennium Development Goals MFI - Microfmance Institution MRA - Micro finance Regulatory Authority NGO - Non-Governmental Organization NHG - Neighborhood Group PARD - Pakistan Academy for Rural Development PBK - Palli Bikash Kendra PKSF - Palli Karma-Sahayak Foundation PMUK - Padakhep Manabik Unnayan Kendra PO - Partner Organization POPI - Peoples Oriented Program Implementation RASDO - Rural Agricultural Social Development Organization RD - Rural Development RDRS - Rangpur Dinajpur Rural Service RIC - Resource Integration Centre RHDS - Rural Health & Development Society ROA - Return on Assets ROE - Return on Equity viii ROSCA - Rotating Savings and Credit Association RR - Repayment Rate SATU - Social Advancement Through Unity SCM - Stakeholder Capitalism Model SEC - Security Exchange Commission SJA - Sylhet Jubo Academy SSS - Society for Social Service SWM - Shareholder Wealth Maximization TCCA - Thana Central Cooperative Association TMSS - Thengamara Mohila Sabuj Sangha TSUS - Tangail Samaj Unnayan Sangstha V-AID - Village Agriculture and Industrial Development UDPS - Uttara Development Program Society UN - United Nations VERC - Village Education Resource Centre IX ACKNOWLEDGEMENT This work could not have been completed without the support of many friends and my family. Moreover, for the Research Project Award made possible for my field work in Bangladesh I would like to acknowledge the University of Northern British Columbia for its support. I would like to thank my supervisor, Dr. Ajit Dayanandan, from whom I learned academic material. Dr. Ajit Dayanandan has been a source of constant support. I am indebted for his encouragement, advice, and especially for his patience. His sincere help, insightful assistance and guidance have been extremely helpful to me. I would also like to thank my committee members Dr. Balbinder Deo and Dr. Baotai Wang, for their valuable academic support and advice. I would like to thank Professor Atiur Rahman (Now the Governor of Bangladesh Central Bank), Professor M. A. Baqui Khalily, Dr. Sajjad Zahir for their valuable suggestions and support. I would also like to thank Sharif Ahmed, Rawnaq Zahan and Tariqul Alam (Bipul) for their help in collecting data in Bangladesh. I am also thankful to the MFIs in Bangladesh for providing necessary data for this study. Last but not the least, I would like to thank my daughter Rafiah and my wife, Nurunnahar Kakon, for not only providing support and encouragement, but also for putting up with me throughout this whole process. 1 Chapter I : Introduction The concept of micro-credit— the extension of small loans without any collateral, based on joint liability— was pioneered by Dr. Muhammad Yunus in 1976 in Bangladesh. The remarkable outreach of this movement in Bangladesh (which presently covers not only credit but also a number of financial and non-financial services) has shown that extending credit and financial services to the poor is feasible and profitable. The access of the poor to credit is recognized as an important strategy in achieving the Millennium Development Goals (MDGs) of promoting gender equality, women's empowerment and poverty reduction. The World Development Report of 2000/2001 widely recommended the microcredit for poverty reduction and as a social safety net for the poor of the developing countries (World Development Report 2001). As of end of December 2006, it had served more than 465 million poorest family members (mostly by providing savings accounts) and extended credit to more than 133 million borrowers (Microcredit Summit Report 2007). Micro finance is high on the public agenda after the UN Year of Microcredit in 2005 and the awarding of the Nobel Peace Prize to Dr. Yunus and the Grameen Bank' in 2006. 1 Grameen Bank was a project under Bangladesh Bank from 1976 to 1983. A government ordinance in September 1983 transformed the project into an independent bank. In 1983 Government of Bangladesh owned 60% of the equity capital of Grameen Bank and 40% 2 In Bangladesh, the growth of microfinance has been under, broadly, two institutional structures—as a bank (like Grameen Bank) or as a microfinance institution (MFI). The Grameen Bank is a specialized microfinance bank originated exclusively for providing credit and related services to the poor. It provides credit and other financial services to the poor, encourages them to save so that they can buy a share of the bank, and provides institutional support (training and counseling) for efficient use of loans. In addition, the microfinance institution (MFI), also like Grameen Bank but under a different institutional framework, provides financial and non-financial services to the poor.2 Among the MFIs, three institutions identified as very large are the Association for Social Advancement (ASA), Bangladesh Rural Advancement Committee (BRAC), and Proshika. Each has more than one million borrowers. The Association for Social Advancement's (ASA) total borrowers as of June 2006 was 4.6 million and its outstanding loan disbursement was US$293 million; the BRAC's borrowers was US$4.6 million and outstanding loan disbursements were US$350 million; and the Proshika Manbik Unnayan Kendro's borrowers were 1.6 million and its outstanding loan disbursement was US$54 million (Microcredit Regulatory Authority were owned by borrowers. Now borrowers/shareholders subscribe to 90% of equity capital and the share of Government of Bangladesh is only 10%, see www.grameen.com. 2 For an overview of microfinance movement in Bangladesh, see Khandker 1998; Rahman 1993, 1996, 2004; Yunus 1999; Zaman et al. 2007. 3 Report 2006). At the end of December 2006, in Bangladesh, the overall cumulative borrowers of MFIs were 31 million and their cumulative loan disbursement was US$8,053 million (Credit and Development Forum Report 2006). At the same time, Grameen Bank's members were 6.9 million and cumulative loan disbursement was US$5,751 million (Grameen Bank at www.grameen-info.com). Although the Grameen Bank and the MFIs were initially dependent on external resources (grants and soft loans), they are now large profit-making institutions. The Grameen Bank made US$20 million profit in 2006 (Grameen Bank at www.grameen-info.com). Moreover, in recent years the MFIs have increasingly accessed commercial sources of finance to scale up their operations and used the poor (at the bottom of the pyramid) to enhance their profits (Zaman et al. 2007; Prahalad 2008). The main challenge of micro finance is to create social benefits and promote financial inclusion by providing financial services to low-income households. This is often referred to as the "double-bottom line" of MFIs (Tulchin 2003). The increasing emphasis in recent years on financial sustainability rather than on social mission has led to allegations of "mission drift" among MFIs (Armendariz and Szafarz 2009). It is in this context that the issue of governance of MFIs becomes increasingly relevant. The term "governance" has a wide connotation: it broadly refers 4 to the functioning of the legal and social institutions that support economic activity (Williamson 2005; Dixit 2009). However, in the context of Grameen Bank and MFIs, we are more concerned with corporate governance issues than economic governance issues. In the corporate governance literature, under the 'shareholder approach,' the emphasis is on value creation for the shareholder only. Corporate governance theorizing is dominated by the agency theory approach3. Under the 'stakeholder approach,' however, the interests of all partners (including borrowers) are given equal importance4. In the microfinance industry, the practice has superseded the theoretical developments and the industry has reached a cross-road where one cannot ignore the other. Given these developments, a study of the corporate governance of Grameen Bank and MFIs is important for the following reasons: (1) the microfinance community has experienced some major failures because of inadequacies in its operation, including corporate governance (Labie 2001). (2) Given its tremendous outreach in recent years, its future growth and sustainability depends on how it is governed— the institutional framework (board), legal framework, transparency, etc. (3) To attract further fresh capital into this industry requires a thorough understanding of the corporate governance practices 3 For a review of literature on the topic, see, Fama and Jensen 1983; Shleifer and Vishny 1997. 4 The coipoiate governance models embedded in these two broader approaches include managenal, labour and state-oriented models. 5 of MFIs. This is especially relevant in the case of the recent trends to attract investment funds by MFIs. The investment funds demand involvement in governance of the MFIs in which they invest equity capital. (4) Microfinance institutions have certain objectives like "double bottom-line" which require considerable trade-offs between profitability and social mission. The main objective of the present study is to understand the governance of microfinance institutions (MFIs) and Grameen Bank of Bangladesh for long-term institutional sustainability from the perspective of best practices in corporate governance. For this study, the primary data of corporate governance indicators of MFIs and Grameen Bank has been collected through a primary survey. The closer examination of governance includes an outline of the roles of the board members, board composition, and an explanation of the important issues of trust and conflicts of interest. The thesis is organized as follows: chapter 2 reviews the literature on corporate governance structures and formulates the hypothesis for the study, while chapter 3 traces the evolution of the MFI in Bangladesh and its proposed microfinance regulations, and provides a current overview of the sector in Bangladesh. In chapter 4, the data sample for the study is discussed; it also explains the methodology used in the empirical investigation. Chapter 5 analyses the corporate governance structure of Grameen Bank, the composition of its board, and the effectiveness of its 6 governance structure. An analysis of the corporate governance and empirical result of MFI occurs in chapter 6, and in chapter 7 the concluding chapter, concluding observations on the corporate governance of MFIs in Bangladesh are available. 7 Chapter II: Corporate Governance and Microfinance Institutions- A Review of the Literature The study of corporate governance has assumed greater importance in recent years with issues such as 'transparency,' 'managerial accountability,' 'corporate governance failures,' 'weak board of directors,' 'protection of minority shareholders,' 'investor activism,' 'executive compensation.' These phrases have become household phrases and have attracted considerable attention in the current debate on corporate failures and reforms. In recent times, it has been increasingly recognized that some companies in certain sectors (including microfinance institutions) have violated their social contract with consumers, shareholders, regulators and the community at large. In a March 2009, a McKinsey Quarterly survey of senior executives around the world found that 85 percent of them believed that public trust is the main issue and that the commitment to free markets had deteriorated (Bonini et al. 2009). According to another survey in 2009 by Edelman Trust, 62 percent of respondents across 20 countries feel that they "trust corporations less now than they did a year ago" (Bonini et al. 2009). Similarly, the failure of big corporations like Enron, WorldCom, and Lehman Brothers, among others, has brought into focus the role of corporate governance in company performance. 8 The question foremost in the minds of practitioners is what constitutes good corporate governance. The dominant view is that corporate governance relates to the ways in which the suppliers of finance to corporations assure themselves of getting a return on their investment (Shleifer and Vishny 1997; Becht et al. 2002). This is a narrow view of corporate governance and many commentators believe that stakeholders, such as employees, communities, suppliers or customers also have a significant role in how value (profit) is internalized in a firm. The classic work by Berle and Means (1932) and Jensen and Meckling (1976) discuss the issue of separation of ownership and control and its consequences. The initial debate occurred with regard to a firm's objective under Shareholder Wealth Maximization (SWM) and the Stakeholder Capitalism Model (SCM) and how the various incentive mechanisms could be used to align the interests of various constituents in a firm (Shleifer and Vishney 1997). The microfinance institutions (MFIs) which have evolved in Bangladesh and various countries face unique challenges because they must achieve a 'double bottom line'- provide financial services to the poor (financial inclusion) as well as create social benefits. This brings into focus how effective governance is critical to the success of MFIs (Champion 1998; Rock et al. 1998; Hartarska 2005). This chapter reviews the literature on corporate governance and in particular its relevance for MFIs. The chapter is organized into seven sections. Section 9 2.1 briefly summarizes the theoretical debate on Shareholder Wealth Maximization (SWM) vs. Stakeholder Capitalism Model (SCM) and the corporate governance issue in SWM and SCM, with section 2.2 briefly discussing the international codes on corporate governance. Section 2.3 addresses the debate on corporate governance with regard to MFIs, and section 2.4 discusses the corporate governance literature and hypothesis development. A summary of corporate governance in Bangladesh is summarized in section 2.5. Finally section 2.6 summarizes the conclusions of this chapter. 2.1: Goals of Shareholder Wealth Maximization Stakeholder Capitalism Model (SCM). (SWM) Vs. Creating value or franchise value has always been the goal of corporate policy. The Anglo-American markets have a philosophy that a firm's objective should follow Shareholder Wealth Maximization (SWM) while the non-Anglo-American markets emphasize the Stakeholder Capitalism Model (SCM). This model requires multiple goals and involves a number of trade-offs. Firms under SWM emphasize maximizing return to shareholders, as measured by the sum of capital gains and dividends for a given level of risk. This model assumes that the stock market is efficient and that stock price reflects the shareholder value. The classical dilemma involved in the 10 SWM model is the separation of ownership and control and its consequences. The agency theory casts this problem in terms of the principal-agent problem- a principal must delegate a task to an agent whose incentives are not perfectly aligned with those of the principal. The solution of the agency theory makes its case in terms of how shareholders can motivate management through incentive mechanisms like bonus; stock options, etc., to think like shareholders. However, the high-profile scandals involving Enron, WorldCom, Parmalat and so on, and the recent failure of investment banks like Lehman Brothers and Bear Sterns has brought into focus the importance of corporate governance in a wellfunctioning market economy. The dissatisfaction with SWM led to the view that a corporation should serve a larger social purpose and be responsible. In some markets (for example, the developing world), the shareholders also strive to maximize long-term returns to equity and takes into consideration the constraint imposed by other stakeholders like labor unions, local communities, creditors, environment, and so on. This model has been labeled the stakeholder capitalism model (SCM). In other words, it advocates reaching out to other stakeholders and not only to shareholders. It argues that 'stakeholding' makes commercial sense. The SCM does not assume that stock markets are either efficient or inefficient, but assumes that long-term 'loyal' shareholders (typically controlling shareholders) 11 should influence corporate strategy rather than the transient portfolio investor. The traditional question of corporate governance relates to the question of goal of corporate management. In the SWM, the overriding objective is the maximization over time of the returns to shareholders. In order to achieve this, good governance practices should focus on internal and external forces which affect the functioning of a firm. Chart 2.1 provides an overview of the various parties and their responsibilities associated with the governance of a firm. 12 Chart 2.1: The Structure of Corporate Governance The Marketplace The Corporation (External) (Internal) Equity Market Board of Directors Debt Markets Management Auditors and Legal Advisers Regulators Corporate governance represents the relationship among stakeholdeis that is used to determine and contiol the stiategic duection and perfoiTnance of the organization Source Moffett, Stonehill and Eiteman 2009 37 The question of what constitutes a good governance structure is strongly debated One of the widely-accepted statements of good corporate governance practices is that established by the Organization for Economic Cooperation and Development (2004) Table 2 1 lists some of the commonly listed indicators of good corporate governance, and section 2 2 13 discusses some of the widely used corporate governance codes around the world. Table 2.1: Indicators of Good Corporate Governance Accountability Transparent Ownership Board Size (5 to 9) Board Accountability Ownership Neutrality Independence Dispersed Ownership Independent Audits and Oversights Independent Directors Disclosure and Transparency Shareholder Equality Board, timely, and Accurate Disclosure Internationally Recognized Accounting Standard One Share, One Vote Source: Newell and Wilson 2002: 21. 2.2: International Corporate Governance Codes Although there is no universal model of corporate governance, with the collapse of corporations, changing patterns of ownership, and varying cultural and societal values, the corporate governance codes have varied widely (Reaz and Hossain 2007). Sixty-two countries currently have a corporate governance code (Hunt 2008). Table 2.2 reports some of the recent codes of corporate governance, also showing that independent 14 directors are recommended in almost all of the countries' corporate codes. In addition, separation of chairman-CEO roles occurs and reporting to the board is required semi-annually. Table 2.2: Some Recent Codes of Governance Country/Code Independent Directors Brazil(CVM Code-2002) France (Bouton Report-2002) As many as possible At least one half of board Russia (CG Code2002) Separation of Chairman-CEO roles Clear preference for split No recommendation At least one Split required quarter of the bylaw board. Singapore (CG At least one- Recommended. Committee-2001) third of the board. United Kingdom Majority of Recommended (Cadbury Codenon1992) executive directors At least one United Kingdom Clear preference half of the (Combined Code for split. board. - 2003) Substantial Separation is United States Majority of one of the three (Conference Board acceptable Board - 2003) options Source: Coombes and Wong 2004: 52. Rotation of External Auditors? Not covered Frequency Financial Reporting Quarterly Regularly, for lead auditors No recommendation given. Quarterly. Not covered of Periodically for lead auditors Periodically, for lead auditors Semi-annually. Not covered. Semi-annually, per listing rules Recommended for audit firm Quarterly, as required by law. Semi-annually. 15 2.3: Corporate Governance and Microfinance Institutions (MFIs) The term of corporate governance in the context of microfinance first appeared in the literature in 1997 (Lapenu and Pierret 2006) and usually refers to the relationship between the board of directors and the management of MFIs. The main challenge of microfinance is to create social benefits and promote financial inclusion by providing financial services to low-income households. It is in this context that the issue of corporate governance of MFIs becomes increasingly relevant. Under the SWM approach, the emphasis is on value creation for the shareholder only. However, in the SCM approach, the interests of all partners (including borrowers) are given equal importance. In the microfinance industry, it is SCM that has close proximity to the practice. However, in the microfinance industry, the practice has superseded the theoretical developments and the industry has reached the point where one cannot ignore the other. Given these developments, a study of corporate governance of microfinance institutions is important. Very few studies on the impact of governance mechanisms of MFIs on the dual missions of financial sustainability and social benefits exist (Hartarska 2005; Mersland and Strom 2009). Hartarska (2005) investigates the relationship between governance mechanisms and financial and outreach performance, using three surveys of rated and 16 unrated East European MFIs between 1998 and 2002. Governance mechanism includes board characteristics, CEO compensation and ownership type (shareholder-owned firms, cooperatives, etc.). Hartarska (2005) finds that a more independent board gives a better return on the assets (ROA) of MFI's in Eastern Europe. The study also finds that a board with employee directors results in lower financial performance and outreach. The study by Mersland and Strom (2009) based on a global dataset of 278 MFIs from 60 countries collected from rating agencies found that financial performance improves with local rather than international directors, an internal board auditor and a female CEO. Given the debate on the impact on corporate governance of MFI's on its performance, the following section broadly sets the hypothesis for empirical investigation. 2.4: Corporate Governance Literature and Hypothesis Development Considering the agency problem and double bottom line of MFIs, an effective board of directors is an important component of their corporate governance. As well, the microfinance governance literature also recognizes the need of the internal governance (board) mechanism for good governance (Rock et al. 1998; Otero and Chu 2002; Helms 2006; 17 Labie 2001). The board effectiveness is determined by its monitoring function, independence, size, and composition, gender composition, CEO experience, internal board auditor, external auditor, ownership; external mechanisms such as product market competition and regulation are also important (John and Senbet 1998; Mersland and Storm 2009; Hartarska 2005; Rock et al. 1998; Labie 2001; Kim and Nofsinger 2007). Given that the size of the board does have some bearing on performance, the first hypothesis is stated as follows: HI: There is a significant relationship between board size and corporate performance. The literature suggests that a small board would be better for effective monitoring of the management and CEO (Fama and Jensen 1983; Kim and Nofsinger 2007; John and Senbet 1998). Empirical evidence from the study of Monks and Minow (1995) suggests that the size of board does matter (cited in Haniffa and Hudaib 2006) and Lipton and Lorsch (1992) have also argued that a small board is more effective. They recommended a board with eight or nine members (cited in Haniffa and Hudaib 2006). An empirical study of a sample of 792 companies by Yermack (1996), as well, suggests that a smaller board brings better performance than a larger one. Eisenberg et al. (1998) found similar patterns using sample of small and midsize Finnish firms. 18 In contrast, Holthausen and Larcker's (1993) study did not find any relationship between the board size and performance (cited in Haniffa and Hudaib 2006). Moreover, Bohren and Storm (2005) report that larger boards are associated with lower firm performance. However, Pfeffer (1987), Pearce and Zahra (1992), and Goodstein et al. (1994) reported that a bigger board may be effective because it might be able to provide the board with diverse opinions and resources (cited in Haniffa and Hudaib 2006). H2: There is a significant relationship between board composition and performance The board effectiveness in its monitoring function is determined by its independence, size and composition. If a board has more outsiders (other than managers), it is considered to be more independent. Corporate governance in America has increasingly shifted towards independent boards with a majority outside board members (John and Senbet 1998). Bhagat and Black (1997) have reported that 50 percent of the 100 American public corporations surveyed in 1996 had only one or two inside directors (cited in John and Senbet 1998). It has also been suggested that boards dominated by outsider (independent) or non-executive directors may help to reduce the agency problem (Berle and Means 1932; Wiliamson 1985; and Jensen and Meckling 1976). Such boards may help in reducing management consumption and removing non-performing 19 CEOs and other personnel (Haniffa and Hudaib 2006). Pearce and Zahra (1992) have argued that if the majority of board members are outsiders, then their deliberations and decisions provide better strategic directions which ultimately improve performance (cited in Haniffa and Hudaib 2006). The empirical evidence of board composition on corporate governance is mixed. Millstein and MacAvoy (1998) study found that corporations in America with a majority of active independent boards perform much better than those of passive, non-independent boards (cited in Haniffa and Hudaib 2006). In contrast, Agrawal and Knoeber (1996) found a significant negative relationship between board outsiders and performance (cited in Haniffa and Hudaib 2006). An independent board is very important for the governance of MFIs. There is considerable consensus in the literature that when a board has a higher fraction of non-insiders/independent directors it becomes more effective at monitoring management (Kim and Nofsinger 2007). Moreover, in MFIs, if the CEO and the chairman are different person then the board can be more effective (Mersland and Storm 2007). Oxelheim and Randoy (2003) also found that firm performance was improved when the directors were independent. 20 The gender of CEO and gender composition of the Board (especially with regard to MFI) could have considerable impact on the performance of the firm (Mersland and Storm 2009). Almost 90 percent members of MFIs are women. Having a female CEO or a good number of board members as women can help the MFIs to understand their customers better. This better understanding of customers would influence its performance positively (Mersland and Storm 2009). H3: There is a significant relationship independence and performance between auditor's Another important variable crucial to the governance mechanism is the internal board auditor. The internal auditor oversee the firm's financial and operating procedures, checks the accuracy of the financial record keeping, and ensures compliance with accounting regulations (Kim and Nofsinger 2007). The internal board auditor provides an independent, objective assessment of the organization's internal governance structure and the operating effectiveness of the management of MFIs (Mersland and Storm 2009). Policy papers regarding MFIs stress the importance of the internal auditor and its direct reporting to the MFI board (Steinwand 2000). A study by Mersland and Storm (2009) shows that when auditor's report directly to the board, a higher financial performance can be expected. 21 A number of other hypotheses are embedded in the corporate governance literature. Given the fact that these hypotheses are less relevant at the present time to the performance of MFIs, they are left to future research. The above-mentioned hypotheses will be examined in the empirical chapter in the context of MFI's in Bangladesh. 2.5: Corporate Governance in Bangladesh Corporate sector development in Bangladesh is still in its rudimentary stage. Most of the companies depend on the banks as financing sources. Bangladesh still follows the hybrid legal system inherited from the British administration. Corporate governance practices in Bangladesh started occupying attention only after its independence in 1972. The legal framework for the conduct of firms in Bangladesh was based on the Companies Act of 1913 and the Securities and Exchange Ordinance of 1969. After independence, the Bangladesh Bank Order of 1972, the Bank Companies Act of 1991, the Financial Institutions Act of 1993, the Securities and Exchange Commission Act of 1993, and the Bankruptcy Act of 1997 were enacted. Currently, the Companies Act of 1994 provides the legal framework for the conduct of the incorporated Domestic Corporation and institutions in Bangladesh. 22 The Companies Act of 1994 provides framework for the audit, preparation and publication of financial statements and disclosure. This act provides certain supervisory functions of the shareholders, such as attending meetings, appointment and removal of directors, and dissemination of financial information and balance sheet (Bhuiyan and Biswas 2007). The Security and Exchange Commission (SEC) has promulgated different guidelines and notifications to ensure good corporate governance in the listed public companies. However, the compliance with these guidelines and notifications leaves much to be desired (Bhuiyan and Biswas 2007). Most of the regulatory agencies (like SEC) suffer from a shortage of qualified staff/expertise. For example, there is only one full-time corporate accountant working at the agency (Reaz and Arun 2006). The Bangladesh Bank (central bank of Bangladesh) is the primary regulator for the financial system (including MFIs). The Bangladesh Bank is fully owned by the central government. It lacks trained quality staff in terms of prudent monitoring and supervision of the financial system (Reaz and Arun 2006). In addition, political interventions, lack of quality and corruption undermine the capacity of regulators to play an effective role in corporate governance (Reaz and Arun 2006). 23 According to the Institute of Chartered Accountants of Bangladesh's (ICAB) mandate, it is the supreme authority for affiliation and regulation of accountants in Bangladesh. It has published a report on Corporate Governance in Bangladesh in 2003, which provides guidelines to improve the corporate governance in Bangladesh. However, ICAB has failed to design effective regulations and train professional accountants to achieve international accounting standards in Bangladesh (Reaz and Arun 2006). Although there are limited regulatory frameworks, in many cases the current system does not provide sufficient legal, institutional or economic motivation for stakeholders to encourage and enforce good corporate governance practice. A study by the Bangladesh Enterprise Institute (2003) has reported that there is no reward or penalties for practicing good governance or not following good corporate governance practices (Bhuiyan and Biswas 2007). A study by Mazumder (2006) also reported that most of the businesses are owned by family and there are lack a of delegation of power to other officials, a lack of independent internal audit and a lack of professionalism, which may have contributed to the poor corporate governance in Bangladesh (cited in Bhuiyan and Biswas 2007). As the literature suggests, the corporate governance in Bangladesh is in its nascent stage and evolving. 24 As regards the framework for the conduct of non-government organizations to which most of the MFIs belong, there are virtually no guidelines. The NGOs operating MFIs (NGO-MFIs) in Bangladesh do not have to fulfill any extra terms and conditions or regulations for operating microcredit programs in Bangladesh (Khaled 2001). The MFIs carry out financial intermediation by mobilizing savings and extending microfinance to their members. They are like quasi-banks, but not controlled by banking laws and regulations of the country. In recent years the government's concerns have grown significantly with the increasing size, outreach and savings deposits of MFIs operations. In 1997 active members of MFIs were 6.74 million; this increased to 20.51millions in 2006, in less than a decade. In 1997, whereas outstanding borrowers were only 4.26 million, it increased rapidly and in 2006 it was 16 million. The cumulative disbursement of the MFIs in 1997 was US$968 million which increased to US$7948 million in 2006. These facts indicate the tremendous growth of the sector in Bangladesh, which emphasizes the need for better corporate governance practices among these institutions. However, in the early stages of the development of MFIs, they depended on low-cost funds from donors. During the 1980s, the donors began to fund on a large scale to the organizations, such as BRAC, the Grameen Bank, RDRS, ASA, and Proshika. Now these are the largest MFIs in Bangladesh. Foreign grants to the MFIs averaged $ 160 million 25 annually in the first half of the 1990s and have grown to US$ 255 million annually since then (Zaman et. al. 2007). These MFIs depended on donors 100 percent. For example, from the beginning, BRAC was 100 percent subsidized by donors and its expenditure from the beginning to 1985 was 100 percent contributed by the donors; even in 2006 it was almost 30 percent (BRAC Annual Report 2006). In the case of Grameen Bank, in 1992 more than 99 percent of its funding came from foreign donors. AT present these low-cost funds have diminished. Therefore, the big MFIs, like BRAC, ASA, and Grameen Bank are increasingly accessing international capital. That is why corporate governance aspects are increasingly relevant today for the conduct and performance of MFIs in Bangladesh. Table 2.3: Present Reporting System of MFIs in Bangladesh Law Dealing Authority Societies Registration Act of 1860, Companies Act 1913/1994 as a nonprofit Companies Voluntary Social Welfare Ordinance of 1961 Foreign Contribution Ordinance of 1962, Foreign Donations Regulation Ordinance of 1978 Trust Act of 1882 Joint Stock Companies Source: Rashid 2005:11. Social Welfare Ministry NGO Affairs Bureau (Under this law no organization can be formed, it gives the permission for foreign fund) Ministry of Law Some are enlisted under Dept. of Family Planning, Youth Development and others 26 Presently, in the NGO-MFIs sectors, there are no specific regulatory or corporate governance guidelines in Bangladesh. Twelve different laws for MFIs registration in Bangladesh exists (discussed in chapter 3). These laws do not require submitting robust reporting, auditing or disclosure. For example, the Societies Registration Act of 1860 requires an annual meeting but does not require submission of annual accounts or audits. The Trust Act of 1882 requires maintenance of accounts but not external audits (Zaman et al. 2007). The Company Acts (1913, 1994) require book keeping, audit and report-filing, but the Registrar of Joint Stock Companies is unable to enforce these requirements (Zaman et al. 2007). In addition, the Bangladesh NGO Affairs Bureau is the primary regulator, because most of the NGO-MFIs who are getting foreign donations or aid must register with the bureau. However, the NGO Affairs Bureau does not actively use its power against non-compliance (Zaman et al. 2007). Therefore, the financial management practice of MFIs in Bangladesh is shaped by donor requirements and the absence of coherent and uniform accounting standards within regulations. As a result, there is no specific governance structure. It is in this context that the corporate governance of MFIs becomes important as it is vital for their sustainability and poverty alleviation in Bangladesh. 27 2.6: Conclusion Considering the importance of the fulfillment of the dual missions of MFIs, there are limited studies on MFIs governance of Bangladesh. This chapter has reviewed the broad contours of theoretical and empirical literature on the various facets of corporate governance and highlighted some important hypotheses for empirical investigation in Bangladesh. The literature on MFI governance suggests that the microfinance governance depends on the interaction between the board, managers and borrowers of the MFIs. From that perspective, three dimensions of governance (horizontal, vertical and external dimensions) are suggested in the literature. The literature suggests that governance is important for the financial performance of microfinance institutions and the hypotheses earmarked for empirical verification are: (i) that there is a significant relationship between board size and corporate performance of MFIs; (ii) that there is a significant relationship between board composition and performance of MFIs; and (iii) that there is a significant relationship between the auditor's independence and the performance of MFIs. These hypotheses will be tested in the empirical chapter. 28 Chapter III: Evolution of Microfinance in Bangladesh: 1971 - 2008. Bangladesh has had a colorful political history. Part of the undivided Bengal province during the colonial period, during the partition (1947) it became the part of Pakistan called East Pakistan. It attained political independence in 1971 after a prolonged and disruptive liberation struggle. After independence in 1971, the country had to confront a massive displacement of population and faced the challenges of providing relief and rehabilitation to the vast majority of the population. Along with governmental efforts, there were efforts by a number of non-government agencies (like Bangladesh Rural Advancement Committee) to provide relief and rehabilitation of the displaced and improve their livelihood. The Grameen Bank, which won the Nobel peace prize in 2006 and was the model of lending to the poor and, as an anti-poverty strategy, emulated in many parts of the world, was created and nurtured in Bangladesh. The chapter traces the evolution of the microfinance industry in Bangladesh since its independence in 1971. The chapter is divided into five sections: section 3.1 provides an overview of the rural credit delivery mechanism in Bangladesh; section 3.2 traces the evolution of microfinance in Bangladesh; section 3.3 offers an analysis of the program 29 of micro finance in Bangladesh; section 3.4 discusses the current legal and regulatory framework of micro finance institutions (MFIs); and section 3.5 provides the conclusion. 3.1: An Overview of Rural Credit Delivery Mechanisms Bangladesh (Before and After the Independence in 1971) in 3.1.1: The Role of Moneylender in the Rural Credit The undivided Bengal province was dominated by informal credit, especially by the money lenders. The people of ancient Bengal had experienced exploitation from moneylenders even before 400 BC; reference to this phenomenon is found in Koutilya's Artha Shastra. The credit system in the Indian sub-continent (undivided Bengal province) gained substantial strength during the Mughal period (1526-1858) when gold coins were in use which facilitated money-lending activities (Azad 1993). The rural credit system in Bengal is closely linked with agriculture. In the early eighteenth century, mahajans (moneylenders) advanced money to the rural peasants before the season for grains production. They accepted grain as repayment and stored it until a profitable market period. The interest rate was embedded in the grain and repayment was very high. In the middle of the nineteenth century, the peasants were provided loans by merchants and landlords (Azad 1993). Thus, the credit market, 30 especially the informal credit market, was interwoven with the agriculture tenure system. The then British government, considering the repression of peasants by local lenders (money lenders) established the Indian Central Banking Enquiry Committee to investigate, among other things, the agrarian lending practices in agriculture. The committee found malpractice in money lending. Money lenders took unfair advantage of the rural peasants who were illiterate, ignorant and helpless (Amaravati District Gazetteers; Borooah 1980). On the basis of the Committee's report, the finance department of the government made some suggestions to prevent the practice throughout India. The Bengal Money-Lenders Act of 1940 was adopted to regulate the activities of the moneylenders. This was an important addition to other laws such as the Usurious Loans Act of 1918 or the Bengal Moneylenders Act of 1933. According to the latter, interest in excess of 15 percent on secured loans and in excess of 20 percent on unsecured loans was declared illegal. --» Following independence from the British in 1947, Pakistan inherited a banking and credit structure from the British regime consisting of a host of formal and informal institutions. The formal-informal system constituted of 631 local and foreign bank offices. However, the presence of informal sources of credit was also noticeable in both provinces of 31 Pakistan (East & West). The share of the formal and informal credit markets in rural areas was 4.53 percent and 95.47 percent respectively in 1956; 13.89 percent and 86.11 percent in 1966; 14 percent and 86 percent in 1974; and 25 percent and 75 percent in 1989. The average rate of interest on informal credit during the periods varied from 60 percent to 110 percent per annum (Azad 1993) Table 3.1: Informal Credit in Bangladesh (Before and after the Independence) Informal credit of total market share (%) Formal credit of total market share (%) Source: Azad 1993. 1956 95.5 4.5 1966 86.1 13.9 1974 86.0 14.0 After independence in 1971, Bangladesh inherited a very weak credit and banking system. The informal segment was comprised of local moneylenders and merchants, shopkeepers, and other types of lenders, who were almost non-functional during the early years of independence due to the scarcity of loanable funds. Despite the increases in institutional components of the rural credit market in Bangladesh, non-institutional sources continued to remain as the major sources of rural credit (see Table 3.2). 32 Table 3.2: Distribution Pattern of Rural Credit, by Landownership Group-1982 Landownership Households Group (in receiving acres) loans from Institutional Sources (%) Households receiving loans from Informal Sources Functionally 6.8 91.6 landless (upto0.49) 55.9 Small Owner 15.0 (0.50-1.99) 46.9 Medium owner 20.0 (2.00-4.99) 29.0 Large Owner 21.0 (5.00 or more) 14.3 61.7 All Households Note: Exchange rate $US 1= 20 (BDTK.) Source: Hossain 1988: 22 Loans obtained (households) from Institutional Sources ($US) 4.05 Loans obtained (households) from Institutional Sources ($US) 46.8 Share of total loans obtained from institutional sources (%) 11.30 42.05 21.2 25.2 48.15 34.4 46.45 74.65 38.4 16.15 48.2 25.0 As is evident from Table 3.2, 62 percent of the rural households obtained loan in 1982 from moneylenders or the informal credit market. Nearly 92 percent of the functionally landless households were dependent on the informal market/moneylenders. In addition, in many cases the average rate of interest charged was estimated at 125 percent a year (Hossain 1988: 22). 8.0 33 3.1.2: The Role of Co-operatives in the Rural Credit In the middle of the nineteenth century, the dadan (advance) loans to weavers, local farmers, and industrial producers were provided by merchants (foreign and domestic), landlords and companies for supplying a particular amount of goods within a particular period. The interest rate embedded in production-system agreements such as share-cropping was extraordinarily high (more than 100 percent). This was a source of concern to public authority. The Nobel laureate Rabidranath Tagore (1861-1941) came up with the idea of collateral free credit to rural peasants and established the Kalligram Krishi Bank in 1905 in the village of Patishar in the district of Naogaon in north-eastern Bengal province (now in Bangladesh). It was modeled on the basis of co-operative societies of England and other European countries. His rural co-operatives were started in 1914 and were community based and; they functioned until the 1920s (Mondal 2002). Before that there was the Agricultural Loans Act of 1885 set up by the British Government for 'Taccavi' loans in Bengal— loans for peasants affected by natural disasters. This system lasted until the 1970s. The loan was considered as a debt relief and repayment was not enforced by the government (Rutherford 1995). In 1904, undivided India's first Cooperative Societies Act was passed to provide a legal framework for the establishment of village-level, self-help, user-managed co-operative societies which mobilized the 34 society's personal savings. Moreover, the Agricultural Debtor's Act of 1935 and the Money Lenders Act of 1939 were enacted to restrict the money lenders activity in the most credit system. The British government also amended the Cooperative Societies Act of 1940 and increased the number of loan mortgage banks to facilitate the availability of credit to the rural peasant (Nath 2004). Nevertheless, in thel930s, the cooperatives did not work well for a number of reasons. The illiteracy of the rural poor and peasant made it difficult to manage their schemes. The official character of the cooperative movement distanced it from the rural users. These users were controlled by wealthy and influential people in society and many members were engaged only for personal profit. The Money-Lenders Act of 1939 also gave a jolt to the societies because it defined co-operatives as money-lending agencies and imposed restrictions on them. Although the professional money lenders could evade the restrictions, the societies as an institution could not do that. In addition, the great depression of the 1930s put the agricultural sector in a position that resulted in the closure of many co-operatives (Rutherford 1995). Furthermore, the Second World War, the great famine in 1943 and the political and social upheaval of partition of the country in 1947 were further blows for the co-operatives. At the time of partition, there were 26,664 agricultural credit societies in East Pakistan and many of them 35 were on the brink of liquidation because of large overdue. By 1956-57 over 24,000 of these societies were under liquidation (Rutherford 1995). As the co-operative movement declined, the government tried to revive the co-operative movement from the Union (smallest elected administrative unit in the rural area) level in the early 1960s. The Pakistan government introduced the "Multipurpose Societies" at the Union level. Again, the members of these co-operatives were close to centers of influence and they became the influential's source of outside money in favorable conditions. The Annual Reports of the Co-operative Directorate stated that in the year 1962-63, only one percent of the societies were closed or 'thoroughly good' and 86 percent were classified 'unsatisfactory' (Rutherford 1995). The Village Agriculture and Industrial Development (V-AID) programme was introduced to facilitate the self-help group in the rural areas in the 1960s. It was followed by the "Comilla Model" developed by the Pakistan Academy for Rural Development (PARD) in 1960. The Comilla Model had four components: the establishment of the Thana (subdistrict) training and development centre; a rural works program for construction of road and drainage; a Thana-based irrigation program; and a two-tier cooperative system under the Thana Central Co-operative 36 Association. Although these initiatives institutionalized the rural cooperative system, they also had a number of problems: (a) the cooperatives have been taken over by large farmers; (b) discipline of the cooperative never occurred and the recovery rate was very low; (c) the two-tier co-operatives lacked inner strength and have become totally dependent on the government for survival; (d) the system ignored the poor and women; (e) the co-operatives were not large enough to respond to individual needs and aspirations; and (f) too-fast expansion of the model made it vulnerable (Rahman 1996). The Comilla Model was expanded throughout the country in 1970 as the Integrated Rural Development Programmes (IRDP). This model was based on a group approach and provided credit to the co-operators. Under IRDP, farmers were organized into two-tier cooperative groups: credit and agricultural output were mobilized through these cooperatives (Nath 2004). In 1982, the IRDP was reconstituted as the Bangladesh Rural Development Board (BRDB) which is working to strengthen the credit programme to the rural poor in Bangladesh. 3.1.3: The Role of Banks in Rural Credit The banking system in the territory of Bangladesh grew slowly during the British and Pakistan periods. There were only 25 bank branches in 1901, but the number had grown to 668 in 1946. The creation of Pakistan was a deterrent in the sector, as was evidenced by the closure of 37 bank branches, which was only 148 in 1950 (Azad 1993). After independence from the British, the then-Pakistan government tried a 'new' approach to rural credit and established the Agricultural Development Finance Corporation in 1952 and the Agricultural Bank of Pakistan in 1956. These two banks had similar loan conditions, but each had only a few branches in East Pakistan (now Bangladesh) cities. The loans were given to the wealthier farmers and the recovery rates were low. A commission in 1959 concluded that the banks had failed to make any significant contribution to the rural credit (Rutherford 1995). In 1961, the Agricultural Development Bank of Pakistan was established. In addition, the State Bank of Pakistan created a program for jute retailers, named, Farias and Beparis, a financing scheme for small loans. The loans were collateral free, but trading licenses were deposited as collateral (Khaled 2001; Islam 2005). Moreover, as advised by the Central Bank, the scheduled banks developed their own small-loan schemes for small-scale economic activities: the National Bank of Pakistan opened the People's Credit Scheme; Habib Bank Ltd. opened the Shop-keepers Loan Scheme; and the United Bank Ltd. opened the Small Loan Scheme. These loans were given to the big dealers; banking institutions and the legal environment were not suitable for rural credit programs. In addition, mass discontent grew up and the political leaders' imagination of mass banking made the people confused. As a result, the 38 Faria-Bepari scheme and the small loan schemes imposed by the central bank failed to fill the gap in the rural credit system (Khaled 2001). After independence in 1971, the new government of Bangladesh nationalized all the scheduled banks to fulfill its social commitment to introduce people-oriented 'mass banking' to meet people's aspirations. Branches were opened in rural areas and started micro-lending to small farmers. Rural institutional credit was dispensed mainly through (i) the agricultural development bank (Bangladesh Krishi Bank: BKB); (ii) the nationalized commercial banks- Sonali, Janata, Agrani, Rupali and all private commercial banks; and (iii) the Bangladesh Samabaya Bank Ltd., the apex bank for co-operatives. The number of rural branches increased rapidly, from 854 in 1975-76 to 3225 in 1983 - 84; and in 1986 there were 5114 bank branches operating in Bangladesh; of these, 67.4 percent branches were serving rural areas (Hossain 1988; Chowdhury and Garcia 1993). Unfortunately, most of the opportunities for the loans were received by a few medium and large landowners and influential person. A survey conducted by the International Fertilizer Development Centre (IFDC) in 1982 showed that in a paddy-growing season only 4.6 percent farmers received credit from institutional sources (Hossain 1988). In addition, the World Bank calculated that 50 percent of urban and 75 39 percent of rural borrowers did not have access to institutional credit (Chowdhury and Garcia 1993). The reasons for this lack of adequate institutional credit to the rural small borrowers are as follows: complicated and lengthy loan procedures, delay and higher transaction cost; restrictive features which also narrowed coverage of the traditional credit scope, and the security requirements unaffordable to most rural borrowers, who have neither the assets nor income to support their loan liability; and the lack of banking and facilities in the remote rural areas (Chowdhury and Garcia 1993). Furthermore, the credit that is available goes to the rich, who basically do not require it (Khandker and Chowdhury 1996). In short, it is evident that the formal credit delivery mechanisms were not only inadequate in the rural areas but also carried high transaction costs, low efficiency, low coverage, and control and manipulation by the rich farmers and local influential people (Khandker and Chowdhury 1996). 3.2: Evolution of Microfinance in Bangladesh In response to the failure of the formal rural credit delivery system to reach the rural poor, alternative credit dealing mechanisms were 40 contemplated in the early 1970s and mid-1980s. The setting up of Grameen Bank, the Bangladesh Rural Advancement Committee (BRAC), Proshika and other government and non-government microfinance institution programs were attempts to increase flow of credit/assistance to rural areas especially the poor. These targeted credit programs were directed towards the rural poor who did not have access to the formal credit system and especially to the poor women who were discriminated in the labour and credit markets. Moreover, these targeted credit programs were group-based (based on joint-liability), peer monitored/mentored in contrast to the directed credit delivery system in Bangladesh (Khandker and Chowdhury 1996). These non-governmental organization (NGOs) credit programs emerged as microfinance institutions (MFIs) in Bangladesh. 3.2:1: The Role of Grameen Bank in the Evolution of Microfinance in Bangladesh The origin of the microfinance industry can be traced to the pioneering effort of Professor Muhammad Yunus's Grameen Bank (GB). Microcredit was invented as a strategy for survival of the poor. Professor Muhammad Yunus gave collateral-free microcredit to the rural poor females of Bangladesh with nearly 100 percent repayment rates. The success of Grameen Bank in lending to the poor on a group basis has become a livelihood and development strategy not only in Bangladesh but 41 also in other parts of the world. Professor Yunus began his experiment by distributing small loans to the poor of the village of Jobra from his own pocket and then with the help of Bangladesh Bank, he later expanded the project in 1976 as the Grameen Bank Prakalpa (project). Professor Yunus's aim was to test the hypothesis that if credit is provided to the poor without collateral and at reasonable terms, it could provide selfemployment for them (Wahid 1993). Professor Yunus, with the help of Bangladesh Bank (the Central Bank), started to provide small credit to the poorest of the poor as a project and later, in 1983, a government ordinance transformed the project into Grameen Bank, an independent specialized microfinance financial institution for the rural poor. Collateral-free financial services were brought to the doorstep of the targeted rural poor and exclusively to rural women. From the mid 1980s and the early 1990s, there was rapid expansion of Grameen-style microfinance programs all over the country and abroad as well. The decisive factor in the rapid growth of the sector has undoubtedly been the availability of foreign aid. In the beginning, donor agencies provided funding on a large scale to organizations such as the Grameen Bank. In the 1990s, the Grameen Bank began rapid expansion with the help of subsidized donor funds. For example, between 1985 and 1996 Grameen Bank's membership expanded 12 times and at the same time the bank got US$175 million subsidized funds from donors (Morduch 42 1999). In 1992, more than 99 percent funding came from foreign donors, although by 1994, the figure had fallen to just 4 percent (Khandker 1998). In the mid 1990s, the Grameen Bank received most of its funding from Bangladesh Bank. The remaining funds came from the International Fund for Agricultural Development (IFAD), Norway, Sweden, the Netherlands, and the Ford Foundation (Morduch 1999) In the 1990s, the Grameen Bank became able to present itself as a second generation microcredit institution and it appeared to be much better equipped than it was in its earlier version. This new Grameen Bank II is now a real and functioning institution. There was a call for change and it got better equipped after the crisis of 1995, namely the withdrawal of "Group Fund". In addition, in the flood of 1998, the borrowers lost their houses and businesses; they felt the burden of accumulated loans and started to stay away from weekly centre meetings. As a result, the repayment rate declined. These external factors reinforced the internal weaknesses in the system. To overcome this situation, the Grameen Bank introduced the new system, "the Grameen Generalized System (GSS)," by the beginning of 2001. By April 2002, the Grameen Bank II had emerged. In GGS, the "Group Fund" was eliminated and the bank introduced three obligatory savings accounts: personal saving account, special saving account, and pension deposit account. 43 To make the loan system more flexible, the bank also introduced one prime-loan product; called "basic loan." In addition, there are two other loan products: housing loans, and higher education loans. In the case of failure to pay the basic loan, GGS introduced "Flexible Loan" as an alternative way to repay a basic loan. In these ways, the GGS removed the tensions from microcredit permanently for both sides, both lenders and borrowers. The Grameen II introduced flexible and sustainable 1971, external donor agencies other initiatives micro finance institution. 3.2.2: The Role of BRAC and Other MFIs Following supported the independence government in and private for relief/rehabilitation of displaced population due to war. The NGOs were also working for relief and rehabilitation with the support of foreign aid/donors support. However, the main focus of the NGOs was basically to mobilize masses for empowerment. They believed that without credit or access to the credit any development or mobilization of these poor would not be effective. For example, the Bangladesh Rural Advancement Committee (BRAC), started as an NGO in 1972, was in the forefront of settlement of displaced families/households due to the liberation war in 1971. The BRAC believed that the poor need skills development and other organizational inputs such as skills promotion and consciousness-raising 44 (Khandker 1998). The NGOs like BRAC identified three problems of development: lack of resources including finance; unemployment; and lack of social cohesion (Rutherford 1995). The NGOs responded quickly to these development failures with credit programs. Over time, NGOs like the BRAC and the Grameen Bank have learned from each another. The BRAC learned that credit must be provided along with skills development training and awareness building. The Grameen Bank also realized that credit alone would not be able to solve the problems, because their borrowers needed social development and organizational inputs for their discipline and poverty reduction (Khandker 1998). Moreover, the Grameen Bank model has taken note of the major limitations of the Comilla Model of rural development, which has been struggling to provide credit to the poor through cooperatives (Rahman 1996). 3.2.3: The Role of Government Credit Program Following the examples of BRAC and the Grameen Bank, the government of Bangladesh introduced a group-based, targeted-credit approach based on the Comilla Model of two-tier cooperatives. Under Integrated Rural Development Programs (IRDP), farmers were organized into two-tier cooperative groups: credit and agricultural output were 45 mobilized through these cooperatives (Nath 2004). In 1982, the IRDP was reconstituted as the Bangladesh Rural Development Board (BRDB) which is working to strengthen the credit programme to the rural poor. In 1988, with the funds from the Canadian International Development Agency, the progammes of BRDB was strengthened and renamed the Rural Development Project-12 (RD-12). It was based on the two-tier cooperative structure with the group-lending model of the Grameen-style delivery model (Khandker 1998). In addition to these, the government's various ministries and divisions are also providing credit to the poor. 3.2.4: Current Position of MFIs The history of microfinance in Bangladesh spans more than 35 years. Among the pioneers, the BRAC and the Grameen Bank launched their operations inl974 and 1976 respectively. One third of the MFIs were established between 1995 and 2000 (Credit and Development Forum 2006). About 47 percent of the MFIs are relatively late entrants (Graph 3.1). They joined the industry from 2001 onwards. As of February 2007, 4236 MFIs have applied to Microfinance Regulatory Authority (MRA) for license (MRA Report 2006). Although the number is very big, the industry is dominated by Grameen Bank and three other MFIs (BRAC, ASA, and Proshika). Table 3.3 illustrates the scale of these institutions. These four institutions combined have over $1189 million in outstanding loans and 46 around US$594 million in savings. The differences between the borrowers and members reflect a variety of services provided by these MFIs. Table 3.3: Microcredit Portfolios of the Big three MFIs and the Grameen Bank in Bangladesh (As of end- December 2006) Organization Active Outstanding Savings Cumulative Outstanding Members Borrowers Million Disbursement Loan Million Million US$ Million US$ Million US$ 471.19 6.9 390.48 5750.57 6.9 Grameen Bank BRAC 5.3 4.6 151.55 ASA 6.5 5.2 48.75 Proshika 2.64 2.8 1.7 Total 21.5 18.4 593.42 Source: Credit and Development Forum 2006. 2981.10 2521.44 501.13 11754.24 After the big four, there are only twelve MFIs who have more than 100,000 borrowers. Around 30 MFIs are categorized as medium, large and very large and can be considered as the major players of the sector (Credit and Development Forum 2006; Microcredit Regulatory Authority 2006). 3.2.5: Why in Bangladesh After the fierce liberation struggle of 1971, Bangladesh was facing multiple challenges to rebuild the nation, with the challenges of the reconstruction and rehabilitation of the displaced. In addition, the nation frequently faced natural disasters. A survey found that over 80 percent of the population was living in poverty in 1973-1974 (cited in Aghion and 345.53 300.42 71.50 1188.64 47 Morduch 2005). After independence in 1971, the donors supported the government and private initiatives for relief and rehabilitation of the displaced during the war. The NGOs were also working for relief and rehabilitation with the support of foreign aid/donors. However, the main focuses of the NGOs were mobilizing mass people and building awareness, neither of which worked well (Rutherford 1995). The new government tried to develop programs for the rural poor; one program was a credit program for the rural poor through mass banking. This had a limited impact on the livelihood of the rural poor. As a result of the grave situation in the rural area, some visionary leaders came forward with their long-term vision to rebuild the country. During the liberation war volunteer groups were helping freedom fighters and refugees. The driving forces behind these self-motivated volunteer groups were moral, ethical, humanitarian and patriotic. Some of them were also ideologically motivated. After independence, these volunteer groups continued to work with the people to rehabilitate them in a new country. In a short time, they founded organizations for social welfare and development and NGOs for development. Some of these organizations became today's BRAC, Gono Sasthya and Rangpur Dinajpur Rural Service (RDRS) (Khaled 2001). Moreover, some of them were revolutionary such as the ASA's founder 48 who wanted to set off a process of rural change which would eventually become a big driving force of the nation and come into state power within a decade (Rutherford 1995). The visionary leaders were born out of necessity and gradually expanded their activities from community development to income generation activities for the rural poor. These nongovernmental organizations started to provide credit to the rural poor gradually and established themselves as microfinance institutions. A number of NGOs also replicated their credit program and transformed themselves as microfinance institutions (MFIs). These MFIs in 2004 accounted for 5.3 percent of the total private sector credit in Bangladesh (Table 3.4). Table 3.4: Share of Microfinance Credit as a Proportion of Total Private Sector Credit (in million- US$) 2002 2003 Banks 1167.0 1328.7 54.1 42.5 Non-banks 62.7 73.7 Microfinance institutions Total 1272.2 1456.5 5.1% Microfinance as % of private sector credit 4.9% Source: Zaman et al. 2007. Note: a Includes PKSF, Grameen Bank, BRAC, ASA, and Proshika The main source of funding of MFIs came from donors and government which were instrumental in the homogeneity of the growth and development of the MFI sector (Table 3.5). One decisive factor in the rapid growth of the sector has undoubtedly been the availability of foreign 2004 1495.9 66.6 87.9 1650.4 5.3% 49 aid. During the 1980s, the donors began funding on a large scale to organization such as BRAC, the Grameen Bank, RDRS, ASA, and Proshika, now the largest MFIs in Bangladesh. Foreign grants to the MFIs averaged US$160 million annually in first half of the 1990s and have grown US$255 million annually since then (Zaman et. al. 2007). For example, from the beginning BRAC was 100 percent subsidized and its expenditure from the beginning to 1985 was 100 percent covered by the donors; even in 2006 it was almost 30 percent (BRAC Annual Report 2006). In the case of Grameen Bank, in 1992 more than 99 percent of its funding came from foreign donors, although by 1994 the figure had fallen to just 4 percent (Khandker 1998). Table 3.5: Sources of Funds for Microfinance Lending (%) Sources 1996 1998 2000 2002 2004 A. External Sources: Donors 18.6 15.3 10.6 48.5 28.0 81.4 B. Internal Sources 84.7 89.3 Bl. MFIs own sources 45 50.6 56.6 39.6 36.0 i) Members savings 20.4 22.6 25.5 26.9 28.5 16 17.8 ii) Service charge 19.2 13.4 23.7 3.6 4.4 iii) Own fund 5.9 B2: Other sources 36.4 34.1 11.8 36.0 32.7 23.0 21.9 i) PKSF 2.4 23.2 17.0 ii) Local Banks 9.5 12.8 9.8 12.7 9.1 iii) Others 3.7 3.1 3.0 100 100 100 100 100 Total (A + B) Source: Credit and Development Forum 1996, 2003,:2006. At the same time, public policy directed at the MFIs played an important role in the growth of the sector, giving the MFIs the necessary functional autonomy to operate and innovate. In addition, the successive 2006 6.0 94.0 59.8 28.8 26.5 4.5 34.2 13.9 17.6 2.7 100 50 government's favorable policies to the MFIs were instrumental to the sector's growth (Zaman et al. 2007). 3.3: Analysis of the Microfinance Programs in Bangladesh Both BRAC and the Grameen Bank started microcredit programs in the mid 1970s. However, until thel990s, only a few organizations were delivering credit to the poor. The early 1990s was a period of rapid expansion of the Grameen-style microcredit program (Zaman 2004). Graph 3.1: Rate of Growth of MFIs in Bangladesh- 1971-2006 Source: Credit and Development Forum 2006. A shift from group lending to individual lending also occurred and more professionalism came to the sector. At this time, the Palli Karma Sahayak Foundation (PKSF—the rural employment generating foundation) emerged as the wholesale financing institution to the MFIs. 51 By the 1990s, trial-and-error experimentation in the fields led to a big push that spearheaded a massive expansion of microfinance activities during the 1990s. The PKSF contributed significantly to the expansion of microcredit programs in Bangladesh as an apex body of financing and helped to organize them with proper procedures and regulations. Furthermore, microfinance service was now covering almost the entire country. Graph 3.1 shows that one third of the MFIs were established between 1995 and 2000. About 47 percent of the MFIs are relatively late entrants, joining the industry only from 2001 onwards. Graph 3.2: Growth of Borrowers of MFIs— 1996 - 2006 (in millions) Source: Credit and Development Forum 1996, 2006. The principal microfinance service providers in Bangladesh are usually divided into four major categories: microfinance institutions (MFIs); specialized institutions (Grameen Bank and PKSF); banks (nationalized and private commercial bank); and government ministries 52 /divisions. However, three MFIs (BRAC, ASA and Proshika) and the Grameen Bank share almost eighty percent of the microfinance sector. After the big four, there are only twelve MFIs who have more than 100,000 borrowers. Around 30 MFIs, categorized as medium, large and very large, can be considered as the major players of the sector. Table 3.6 shows the major indicators of MFIs outreach in Bangladesh. In 1997, although total outstanding borrowers were only 4.26 million, this increased rapidly in 2006 to 16 million; and cumulative disbursement of the MFIs in 1997 was US$968 million, increasing to US$7948 million in 2006. These figures indicate the tremendous growth of the sector in Bangladesh (see Table 3.6). Table 3.6: MFIs in Bangladesh— Key Indicators Indicators 1997 (N=380) 1999 (N= 533) 6.74 7.99 Active Members (million) Cumulative Borrowers (million) Cumulative Savings deposit (in US$ million) 74 136 Net Savings (in US$ million) 968 1,812 Cumulative Loan Disbursement (in US$ million) 25,060 32,233 Total credit staff Source: Credit and Development Forum 1998, 1999, 2006. 2002 (N=656) 2004 (N=721) 2006 (N=6U) 12.86 15.84 553 16.62 16.24 883 20.51 30.76 1,165 224 3,603 295 5,615 352 7,948 42,918 59,215 79,464 53 3.3.1: Scaling-up of MFIs in Bangladesh In Bangladesh, the outreach of MFIs has increased substantially; the number of active members increased three fold during 1997-2006 (from 6.7 million in 1996 to 20.5 million in 2006) (Table 3.6). The cumulative loan disbursement increased nearly nine-fold— from US$ 968 million in 1997 to US$ 7,948 million in 2006 (Table 3.6). Table 3.7: Indicators of Financial Self-Sufficiency and Profitability of MFIs in Bangladesh— 2001- 2004 Category Very Small Small Indicators 2001 2002 2003 2004 (%) (%) (%) ™ 168 122 119 121 3.4 n.a 3.8 4.0 128 122 113 127 n.a 3.4 4.8 1.7 144 122 122 119 n.a 3.6 3.5 3.2 113 173 169 269 10.9 10 10.5 15.0 107 118 111 117 3.4 n.a 2.3 3.3 Financial Self-Sufficiency (FSS) Return on Equity (ROE) Financial Self-Sufficiency (FSS) Return on Equity (ROE) Medium Financial Self-Sufficiency (FSS) Return on Equity (ROE) ASA Financial Self-Sufficiency (FSS) Return on Equity (ROE) BRAC Financial Self-Sufficiency (FSS) Return on Equity (ROE) Source: Zaman 2004; Mix Market (web http://www.mixmarket.org). Notes: n.a—not available The increasing outreach of MFIs in Bangladesh has enabled them to enhanced profitability. The return on equity (ROE) of all categories of MFIs (Very small, small, medium, large and very large MFIs like BRAC and ASA) 5 has recorded rapid growths during 2001- 2004 (Table 3.7). MFI's borrowers less than 10,000 is classified as very small, borrowers from 10,000 to less than 50,000 is classified as small, borrowers from 50,000 to less than 100,000 is medium, borrowers from 100,000 to less than 1,000,000 is large and borrowers 1,000,000 to above is called the very large MFIs, such as BRAC, ASA, GB, etc. 54 Table 3.8: Microfinance Outreach Indicators of MFIs in Bangladesh— 2001-2004 2001 Very Small MFIs Borrowers per credit officer Portfolio per credit office Cost ratio Small MFIs Borrowers per credit officer Portfolio per credit office Cost ratio Medium MFIs Borrowers per credit officer Portfolio per credit office Cost ratio ASA Borrowers per credit officer Portfolio per credit office Cost ratio BRAC Borrowers per credit officer Portfolio per credit office Cost ratio Source: Zaman et al. 2007. Notes: n.a—not available 2002 2003 2004 148 161 167 207 570,000 7.6% 573,000 9.9% 630,000 9.9% 811,000 9.2% 190 200 209 207 506,000 10.5% 576,000 10.3% 622,000 9.9% 677,000 9.1% 345 448 461 461 686,000 8.8% 733,000 11.4% 740,000 10.1% 898,000 9.6% 345 4408 461 461 1,310,00 0 4.1% 1,700,00 0 3.4% 298 1,970,00 0 3.3% 364 2,110,00 0 3.1% n.a 881,000 n.a n.a 12.6% 1,160,00 0 11.5% The ROE of very small MFIs in Bangladesh were relatively high (amount 3.8 to 4.0%) as compared with small and medium MFIs in Bangladesh. The financial sustainability indicator reflecting the ratio of financial revenue to financial expenses was relatively high (larger than 100) for all categories of MFI's in Bangladesh (Table 3.7) n.a 55 3.4: The Current Legal and Regulatory Framework of MFIs in Bangladesh The legal framework for MFIs has not undergone any substantial change in recent times. The NGOs in general derive their legal rights from the constitutional guarantee of freedom of association with the country. Although most of the NGO-MFIs are registered with one agency or the other, there are some NGO-MFIs which are not registered with any agency in Bangladesh. One of the most important laws for the registration of MFIs dates back to 1860 and the newest one is in 1982. There are 12 different statutes for MFIs registration in Bangladesh. The most important laws and regulations for the registration and operation of the development NGOs-MFIs the Societies Registration Act of 1860; Trust Act of 1882; Voluntary Social Welfare Agencies (Regulation & Control) Ordinance of 1961; Charitable & Religious Trust Act of 1920; Company Act of 1913; and Foreign Donations (Voluntary Activities) Regulation Ordinance of 1978 (Zaman et al. 2007; Khaled 2001). These laws and regulations are implemented by four government agencies: the Social Welfare Ministry, the NGO Affairs Bureau, the Ministry of Commerce, and the Ministry of Women and Children Affairs (Zaman et al. 2007). 56 Table 3.9: Present Reporting System of MFIs Law Societies Registration Act of 1860, Companies Act 1913/1994 as a non-profit Companies Voluntary Social Welfare Ordinance of 1961 Foreign Contribution Ordinance of 1962, Foreign Donations Regulation Ordinance of 1978 Trust Act of 1882 Other relevant laws Regulatory Authority Joint Stock Companies (Commerce Ministry) Social Welfare Ministry NGO Affairs Bureau (Under this law no organization can be formed, it gives the permission for foreign fund) Ministry of Law Some are enlisted under Dept. of Family Planning, Youth Development and others Source: Rashid 2005:11. Most of the NGO-MFIs in Bangladesh are registered with the Societies Registration Act of 1860. Over 16,000 NGOs/MFIs are registered under this act (Khaled 2001). Registering with this law is very simple and no provision is made for whether or not the society is maintaining any audit or accounts. The Trust Act of 1882 is another law providing the legal basis for MFIs. The Companies Act of 1913, which was amended in 1994, provides a legal basis for not-for-profit companies (Zaman et al. 2007). In addition, a large number of MFIs are registered under the Voluntary Social Welfare Agencies (Regulation and Control) Ordinance of 1961. Other than these, NGOs whose are receiving foreign donations must be registered under the Foreign Donations (Voluntary Activities) Ordinance of 1978 with the NGO Affairs Bureau. About 1200 MFIs are currently receiving foreign funds and almost 1900 MFIs are registered with the NGO Affairs Bureau (Zaman et al. 2007). 57 Table 3.10: Regulatory Environment of Microfinance Operation in Bangladesh Legal statute Banks- Bank- Companies Act of 1991 Grameen BankGrameen Bank Ordinance of 1983 NGOs— Under different Laws /Acts Government Programs Co-operatives—Co-operative Ordinance of 1984 Source: Rashid 2005:10. Regulatory Authority Bangladesh Bank Government Different Ministries/Division Government of GOB Different Ministries Societies LGRD and Cooperatives Ministry The NGOs operating in microfinance do not have to fulfill any extra terms and conditions or regulations for operating credit programs for the poor in Bangladesh (Khaled 2001). They carry out financial intermediation by mobilizing savings and extending microfinance to their members. They are like quasi-banks, but not governed by the banking laws and regulations of the country. In recent years, the government's concerns (from the financial stability point of view) have grown significantly with the increase in size, outreach and savings deposit of MFI operations. Considering the need for a regulatory system, the Government of Bangladesh passed a law in 2006, which led to the creation of the Microcredit Regulatory Authority (MRA), which is endowed with the powers to license, monitor and regulate MFI's in Bangladesh. of 58 3.4.1: The Role of the Microfinance Regulatory Authority (MRA) The main objectives of the MRA are the efficient regulation of microcredit programs and institutions and the ensuring of transparency and accountability in the activities of microcredit organizations operating in Bangladesh. By February 2007, 4,236 MFIs had applied to MRA for license. The MRA has specified that license will issued only to the MIFs with a minimum of 1000 or more borrowers or equal to or more than $58,000 loans outstanding. Accordingly, only applications from 705 MFI's were approved. Up to May 20, 2008, the MRA has issued 250 licenses to different MFIs and the licensing procedure for other selected MFIs is under process (Microcredit Regulatory Authority 2008). The MRA is also working to prepare detailed rules and policies to monitor and supervise licensed MFIs that will cover governance issues, financial transparency, mode of operations and other related issues to ensure transparency and accountability in operation. 3.4.2: The Role of the Palli Karma-Sahayak Foundation (PKSF) The Palli Karma-Sahayak Foundation (PKSF) was established in 1990 by the Government of Bangldesh as an apex body of MFIs, the only apex wholesale financing body in Bangladesh. Its main objective is to build organizations like MFIs for eradicating poverty in the rural areas and subsequently in urban areas as well. The basic operational strategies of PKSF (Rural Employment Support Foundation) are the following: lend 59 money through its Partner Organizations (POs) especially to the NGOMFIs; provide greater thrust to institutional development, both in its own capacity as an apex organization as well as the capacities of partner organizations (MFIs). The PKSF does not support any particular model or approach of microfinance; it advocates for appropriate policies and regulations useful for the microcredit sector in Bangladesh. Therefore, PKSF, as an apex body of microfinance program is helping to develop an appropriate regulatory framework, as well as helping the MFIs in funding their microfinance program for the poor. 3.5: Conclusion In Bangladesh, microfinance developed out of necessity and the environment helped its tremendous growth. In this development, Professor Dr. Yunus' Grameen Bank stands out as a model for all over the world for lending to the poor without collateral. Apart from the Grameen Bank a number of MFIs under various legal statuses exist in Bangladesh and their outreach has grown over the years. The growth of Grameen Bank and MFIs in the earlier years has been facilitated by cheap donor funds. This was supplemented by funds and support from central bank (Bangladesh Bank) and rural development regulator (PKSF). Lately attempt is made under the umbrella of Microfinance Regulatory Authority (MRA) an arm of the Bangladesh Bank to license, monitor and regulate MFIs in 60 Bangladesh. Overall, the most of the MFIs has attained financial selfsufficiency and has recorded good returns on their equity. 61 Chapter IV: Database and Research Methodology This chapter provides a brief description of the database and research methodology used in this study. The chapter is divided into three sections: section 4.1 provides an overview of the secondary data used in the study; section 4.2 explains the sampling methodology and the description of primary data; and section 4.3 provides a brief overview of the analytical framework used in empirical investigation. 4.1: Data In Bangladesh, there are two primary sources of data on MFIs; one is provided by a self-regulatory body called Credit and Development Forum (CDF), which provides statistics on microfinance industry in Bangladesh on a regular basis from 1995. The other source is the official statistics provided by the report of the newly established Microfinance Regulatory Authority of Bangladesh Bank (the central bank of the country). The CDF is a microfinance apex organization that compiles data from its members only. The CDF has been publishing microfinance data from 1995 and its latest issue 2006 (published only in 2008) contains selfreported information of 611 MFIs in Bangladesh. To understand the longterm trend and dynamics of MFI, the CDF data is most appropriate and valuable, although it has coverage limitations. 62 The Microfinance Regulatory Authority was established recently (in 2006) to replace the Microfinance Research and Reference Unit (MRRU) which existed under the Bangladesh Bank- the central bank of the country. The MRRU was in existence from 2000 to bring microfinance industry under a single regulatory framework and started publishing data from 2004. The MRA report summarizes the information provided by the MFIs in their application form for a license. The latest data compiled by MRA, relating to 641 MFIs, are more comprehensive than that of Credit and Development Forum (CDF) database. The data from the CDF and MRA provide information about the MFIs basic characteristics of MFIs in Bangladesh: inception date, branches, number of groups, numbers of members, numbers of borrowers, total savings, total debt, recovery rate, and so on. These data formed the initial database for our primary survey. 4.2: Methodology and Description of Primary Data The primary data of corporate governance indicators of MFIs in Bangladesh are collected through a primary survey (a structured questionnaire). The variables included in the survey relate to board size, board independence, board composition, tenure, gender composition, and 63 other areas and have been selected by scanning the existing literature on corporate governance, in particular literature that relates to MFIs. Sample Size In the selection of the sample, we stratified the population of MFIs according to size and used the random sampling method within the stratified population to generate a sample cohort. The purpose of the sampling method was to attain a high usage (in terms of borrowers). As of June 2006, these 36 MFIs in our sample cover 34 percent of total members (all members are not borrowers), 40 percent of the total borrowers, 46 percent of outstanding loan, and 54 percent of the total saving of MFIs services sector in the country. This study also includes the Grameen Bank, which covers almost 27 percent of the borrowers of microfinance sector in Bangladesh (Credit and Development Forum 2006: 2). Thus, our study covers nearly 67 per cent of the total borrowers in Bangladesh based on information for the year 2008. Table 4.2 reports the basic characteristics of the sample. Since the focus of the study was on corporate governance aspects (especially relating to board characteristics, composition, size and auditor independence), this additional information was collected through a structured questionnaire based on visits to their head office. 64 Table: 4.1: Organizational Profiles: Basic Information of Studied MFIs Name of MFIs Date of Inception Alliance for Cooperation and Legal Aid Bangladesh (ACLAB) Antar Society for Development Annesha Foundation Assistance For Social Organization & Development (ASOD) Association of Development for Economic & Social Help (ADESH) Association for Social Advancement & Rural Rehabilitation Bangladesh Extension Education Services (BEES) BRAC Buro Bangladesh Centre for Development Services (CDS) Chirontoni Christian Service Society (CSS) Development Initiative for Social Advancement (DISA) Duhshtha Shasthya Kendra (DSK) Generation Development Society (GDS) Gharoni Grameen Bank HEED Bangladesh Muslim Aid-UK Padakhep Manabik Unnayan Kendra (PMUK) Palli Bikash Kendra (PBK) Peoples Oriented Program Implementation (POPI) RDRS Resource Integration Centre (RIC) Total Members Total Borrowers Total Savings Outstanding Loan 1994 570 493 658838 1843852 2004 1991 1986 1516 32648 77006 1479 25839 66962 1957783 49768695 70995827 6595037 119741173 230885712 1995 5168 3368 8535901 18107933 2001 2700 2158 1530700 9423850 1988 96328 79551 107687974 341095953 1974 1990 1989 5310317 313350 4340 4550855 243948 3465 10595070000 550560564 5432484 24156690000 1359068888 151571515 2002 1972 1525 33046 458 29488 4935923 36560460 6845170 134014808 1994 6316 4844 9786120 22580209 1985 94310 68736 165517601 315717366 1998 9042 4620 2624294 6525072 2002 1976 1990 1993 1993 6604 6908704 89593 24203 116708 5803 6908704 60884 20575 103087 3396041 43274470000 167530956 27317566 190727703 10075144 33235460000 277855491 69624146 679102668 1993 1986 34938 126610 30090 105689 46908391 128212402 122008893 374208314 1991 1989 348536 48116 338079 34992 255425407 81033109 705835167 230020666 65 Rural Agricultural Social 3419755 2000 696 628 1062767 Development Organization (RASDO) Rural Health & Development 3214 10486235 1997 2829 6903526 Society (RHDS) 261773491 Sajida Foundation 42163 40374 1993 91369727 79431454 SATU 1994 26317 20502 31408020 971540004 Shakti Foundation For 1992 172741 119139 638425800 Disadvantaged Women 232218 184902 1045118573 Society for Social Service 371517009 1990 (SSS) 65179646 Swanirvar Bangladesh 19657 17835 1978 16071490 1456 2048360 Sylhet Jubo Academy (SJA) 1991 1018 737765 9585930 Tangail Samaj Unnayan 1994 2350 1846 4020932 Sangstha (TSUS) Thengamara Mohila Sabuj 499035 1987 437715 962545383 2148307115 Sangha (TMSS) 74274 412665949 UDDIPAN 1991 96249 195466324 47658 187630643 Uttara Development Program 1988 38181 68071283 Society (UDPS) 144164534 27110 Village Education Resource 1982 20899 60777735 Centre (VERC) Total borrowers 14863058 13654309 58235022500 67926248716 Source: Microfinance Regulatory Authority 2006; Credit and Development Forum 2006. 4.3: Analytical Framework For this study, primary data collected from the MFIs in Bangladesh were analyzed using descriptive statistics. We also employed cross- section regression (based on ordinary least squares) to analyze the impact of corporate governance variables on the financial performance of MFIs as given below: ROA = ao + oti log (TA) ,t + a,2 (Auditor Independence Dummy) lt + 013 Board Composition Dummy,, + Board Size Dummy lt+ £,t 66 Chapter V: Governance of Grameen Bank of Bangladesh: A Brief Analysis The concept of micro finance owes its origin to the Grameen Bank in Bangladesh, which was established as a specialized bank for micro finance (similar to an industrial or agricultural bank) in 1983 under a separate charter. Its successful lending model to the poor, based on group joint-liability (association of poor borrowers), is widely emulated worldwide as a model of providing credit to the poor and as an antipoverty strategy. Of its 7 million active borrowers, nearly 97 per cent of them are women. The average loan size is around US$100 and the bank boasts of a repayment record of about 98 per cent which far exceeds the record of other formal financial intermediaries like banks throughout the world. In 2006, the Grameen Bank, along with its founder Dr. Mohammed Yunus, won the Nobel Peace Prize for their efforts "...to create economic and social development from below". The Nobel selection committee said that the peace prize was for developing what "...had appeared to be an impossible idea", namely loans to people who lack collateral. In the initial phases of its development, Grameen bank had 6 littp://nobelprize.org/nobel prizes/peace/laureates/2006/press.html. Accessed on November 29, 2009. 67 to depend on the savings of its members and funds from philanthropic funds. Lately, however, it has become self-sufficient and has expanded beyond its borders. This chapter is devoted to an analysis of corporate governance of Grameen Bank. The chapter is organized as follows: Section 5.1 provides a brief history of Grameen Bank and its roles in rural credit infrastructure in Bangladesh. Section 5.2 the credit delivery model of Grameen Bank is discussed and section 5.3 discusses the growth and economic performance of the bank. Section 5.4 discusses the bank's governance; and section 5.5 provides the conclusion of the chapter. 5.1: A Brief History of Grameen Bank After gaining independence in 1971 from Pakistan, Bangladesh inherited a very weak and fragile economic (including credit and banking) system. The loan or credit market, especially in rural areas, was still dominated by informal lenders - moneylenders who performed these tasks independently or in conjunction with other tasks like petty trading, commission agents, share-cropping, etc. The formal financial institutions like banks had an urban bias and were almost nonexistent in rural areas. The non-institutional sources dominated the rural loan market: in 1992, 62 percent of the rural households obtained loans from the moneylenders or the informal credit market (Hossain 1988). Nearly 92 percent of the functionally landless households were dependent on the informal market/ 68 moneylenders. Moreover, in many cases the average rate of interest charged was estimated at 125 percent a year (Hossain 1988). The new government of Bangladesh sought a solution to the elitist behavior of the formal banking system and came up with a solution of social control of financial intermediaries; in 1972 all scheduled banks in Bangladesh were nationalized and an era of social banking or mass banking was initiated. Through government control, bank branches were opened in the rural areas and started lending to small farmers. Rural institutional credit was dispensed mainly through the nationalized banking system. Consequently, the number of rural branches increased rapidly, from 854 in 1975-76 to 3,225 in 1983- 84. In 1986 there were 5,114 bank branches operating in Bangladesh; of these, 67.4 percent branches were serving the rural areas (Hossain 1988; Chowdhury and Garcia 1993). However, most of the loans were given to medium and large landowners and to people with good social and political connections. A survey conducted by the International Fertilizer Development Centre (IFDC) in 1982 showed that in a paddy growing season only 4.6 percent farmers received credit from institutional sources (Hossain 1988). The World Bank estimated that 50 percent of urban and 75 percent of rural borrowers did not have access to institutional credit (Chowdhury and Garcia 1993). 69 The cooperative system based on the Comilla Model (discussed in chapter III) was expanded throughout the country in 1970 as part of the Integrated Rural Development Programmes (IRDP). This model was based on group an approach and provided credit to the membership of cooperatives. Under IRDP, farmers were organized into two-tier cooperative groups. The two-tier cooperative is a co-operative system comprising village-based primary cooperative societies called Krishak Samabaya Samity (KSS) (Farmers cooperative association) at the local level. Members of KSS accumulate capital through weekly savings. Every KSS formulates joint production of plans, and creates a block of 50 to 100 acres of land in the village in order to facilitate the economic adoption of irrigation, institutional credit and improved farming. The KSS receives credit from the Thana Central Cooperative Association (TCCA), which is a larger administrative unit (Momin 1987). The credit and agricultural outputs are mobilized through these cooperatives. The co-operative movement was controlled by large farmers and the system ignored the poor and women (Rahman 1996). In response to the failure of the formal rural credit delivery system, the informal moneylenders patron-client relations, and their high interest rate (sometimes more than 125 percent), targeted credit programs were developed in the late 1970s into the mid-1980s. The Grameen Bank 70 is one of the pioneer microfinance banks that was created to make credit directly available to the rural poor who do not have access to a formal credit system and to focus exclusively on women. Moreover, this targeted credit program used group-based peer monitoring, a closely supervised credit approach which is different from the formal credit institutions; this makes a significant difference in the rural credit market in Bangladesh (Khandker and Chowdhury 1996). The origin of the microfinance industry can be traced to the pioneering efforts of Professor Muhammad Yunus' Grameen Bank. The bank's origin goes back to a chance meeting of the founder, Mohammad Yunus, with a bamboo stool maker, Sufia Khatoon, in the village of Jobra in the southern part of rural Bangladesh. Sufia was making bamboo stools with raw materials supplied on credit by a moneylender, who then bought the finished product. The money lender set both the price of raw materials and the price of the finished product. After paying for the raw materials, Sufia had hardly enough left to feed her family of five. Sufia made two cents from each stool which meant that she had to return to the money lender for credit. Seeing this exploitative situation, Professor Yunus tried to find out how many other people were in the same situation as Sufia in the village. With the help of his students and through a survey, he found that there 71 were 42 such people. Professor Yunus gave collateral-free microcredit (US$27) to these exploited people out of his own pocket. The initial loan that Professor Yunus made was repaid in full. This strengthened his belief in the poor's ability and willingness to repay and provided the foundation for the creation of Grameen Bank, which was turned into a development philosophy. Subsequently, with the help of the Bangladesh Bank (the central bank in Bangladesh); he later expanded the project in 1976 as Grameen Bank Prakalpa. Later, in 1983, a government ordinance transformed the project into the Grameen Bank—a village bank, an independent specialized microfinance financial institution for the rural poor. The announcement of the Norwegian Nobel Committee to award the Nobel Peace Prize to Professor Yunus and Grameen Bank points out that the Grameen Bank has been a source of ideas and a model for the many institutions in the field of micro-credit that have sprung up around the world (The Nobel Peace Committee 2006). The Grameen Bank was established as a challenge to the existing collateral-based banking system and the exploitative moneylenders (Khandker et al. 1995). Professor Yunus argues, "....the money-lending business has served as an expensive alternative to official institutions, but it often undermines individual efforts to alleviate situations of poverty. 72 Money lenders can charge exorbitant interest rates that initiate an endless cycle of poverty and debt..." (Yunus 2007b: 21). Collateral-free financial services were brought to the doorstep of the rural poor, especially to the rural women. Professor Yunus also notes that "...the new system should target the detrimental effects of money lending by freeing borrowers from high interest rates and any pressures or legal requirements to repay loans " (Yunus 2007b: 21). Therefore, Grameen Bank wants to save the poor from the clutches of the exploitative moneylender whose role impoverishes the poor. The moneylenders charge exorbitant interest rates (in the range of 60 to 300 per cent) an action that creates indebtedness and perpetuates the vicious circle of poverty. On the other hand, the traditional banking system neglected the poor because of the lack of collateral and high transaction costs. The Grameen Bank differs from traditional banks in the "....value of the principal amounts and types of the loans it offers, the terms of its loans, the repayment conditions of its loans, its lending procedures and in the overall social consciousness and guidance that it incorporates in its loan policies.." (Hassan 2002: 240). The Grameen Bank focuses not on profit but on the needs of its borrowers. Professor Yunus notes, "...the objective is to bring financial services to the impoverished, particularly women and the poorest of the poor, to aid them in their fight against poverty and ensure that their business endeavors remain financially sound. It is a 73 composite objective with both social and economic visions...." (Yunus 2007b:21). For this, it provides organizational support to the poor to make effective use of their credit and income. In Yunus words, "...micro-credit is a well trained and well funded method that can bring financial services to the poor. Micro-credit promotes entrepreneurship, and put each individual poor person, especially women in the driving seat, in their own lives..." (cited in Mjos 2006). Lamia Karim (2008) summarizes the declared objectives from Grameen Bank's document as follows: according to Professor Yunus, the GB model of micro credit (MC) is not solely a matter of the extension of credit; it has a unique set of social objectives that it aims to implement through MC policies. These are: • • • • • • • It promotes credit as human right. It is aimed towards the poor, particularly poor women. It is based on "trust", not on legal procedures and system. It is offered to create self-employment, income-generating activities and housing for the poor, as opposed to consumption. It was initiated as a challenge to conventional banking which rejected the poor by classifying them as "not creditworthy." It provides service on the doorstep of the poor based on the principle that the people should not go to the bank, the bank should go to the people. It gives high priority to building social capital (cited in Muhammad 2009: 38-39). Now Grameen Bank is the world's largest bank for the poorest of the poor, and is based on a different philosophy from traditional banking. 74 It is more about people than about money. Professor Yunus says, "...lend the poor money in amounts which suit them, teach them a few sound financial principles, they manage on their own..." (cited by the Chairman of Nobel Peace Prize Committee). Since its formal opening in 1983 it has lent almost eight billion US dollar. Today the bank has almost eight million borrowers; Grameen Bank lends US$800 million dollars per year. The bank is presently self-sufficient and has also generated a return on assets in the range of 0.11 to 2.5 per cent per annum in recent years (20012007) (www.grameen.com). 5.2: The Credit Delivery Model of the Grameen Bank The Grameen Bank has integrated group activity with credit delivery to assist the rural poor in income-generating activities. In the process of the Grameen Bank credit program, households first take the initiative to organizing themselves into a group of five. The Grameen bank officials most often help the households in the formation of the group. Men and women form separate groups, considering the religious and societal values of Bangladesh society. Membership in a group is strictly limited to people who own less than half an acre of land or whose assets do not exceed the value of one acre of land, live in a village and are not members of the same households. Therefore, the members of the group belong to the same socio-economic characteristics. This facilitates 75 bonding, mutual trust and confidence that give them a sense of strong feelings of working together. Each group elects a chairperson, who performs the leadership role in the group, and a secretary, who assists the group in many organizational activities like book-keeping. Members gather once in a week for group meetings where they share their experience and learn and discuss the rules of Grameen Bank's group lending programme. In a village five to eight groups are collated as a centre. A centre is led by an elected chairperson and secretary. Each centre is also assisted by a Grameen Bank employee, who visits several groups on a weekly basis. All transactions are openly conducted at the centre meeting. These peer monitoring and peer mentoring mechanisms work at the level of the group and at the centre levels. The Grameen Bank credit delivery system has the following features: There is an exclusive focus on the poorest of the poor Borrowers are organized into small homogenous groups Special loan conditionalities which are particularly suitable for the poor Simultaneous undertaking of a social development agenda addressing basic needs of the clientele Design and development of organization and management systems capable of delivering programme resources to target clientele Expansion of loan portfolio to meet diverse development needs of the poor 76 The Grameen Bank considers savings mobilization to be an integral part of lending. Each member is required to save at least one taka every week, which is deposited in the weekly meeting. In addition, each borrower is required to contribute 5 percent of their borrowed amount to the group fund. The group fund is self-managed and can be used for mutually agreed purposes. In addition to mandatory savings, each member can purchase a Grameen equity share worth Taka 100 ($US1.50). By the beginning of 2001, the new system, "The Grameen Generalized System" or GGS was launched and by April 2002, the Grameen Bank II emerged on a full-fledged operational basis. The transition was completed on August 7, 2002. The new Grameen Bank II is now a real and functioning institution. This second- generation microcredit institution appears to be much better equipped than it was in its earlier version. In the Grameen Bank II, gone are the general loans, seasonal loans, family loans, and more than a dozen other types of loans; gone is the group fund; gone is the branch and zone loan ceiling; gone is the fixedsize weekly installment; gone is the rule to borrow every time for one whole year, even when the borrower needed the loan only for three months; gone is the high-level tension among the staff and the borrowers trying to steer away from the dreadful event of a borrower turning into a "defaulter," even when she is still repaying; and gone are many other familiar features of the Grameen Classic System. 77 Moreover, the GGS has been built around one prime loan product— the Basic Loan. In addition, there are two other loan products: 1) the housing loan, and 2) the higher education loan which runs parallel to the basic loan. All borrowers start with a basic loan. One most visible change everybody notices in GGS is the disappearance of the Group Fund. The Grameen Bank had had to keep defending the Group Fund ever since it was created twenty-five years earlier. There are no more joint accounts. Each borrower will have three obligatory savings accounts— a) Personal savings account, b) Special savings account, and c) Pension deposit account (obligatory only for borrowers borrowing above Taka 8,000 (US$ 118). The Grameen Bank's microfinance programmes target women with the explicit goal of empowering women. The Grameen Bank believes that money that goes to women brings more benefits to the family. When women borrow, children become immediate beneficiaries. Moreover, women have a longer vision and they want to bring changes to their lives step by step. The women use money more cautiously and they are excellent managers of scares resources. The majority of women receive loans for activities that are considered traditionally female activities— milch cow, cow fattening, poultry rising, paddy husking, vegetable 78 cultivation and trading, clothing shop, plantation, village phone and so on. Therefore, microcredit is working as a liberating force for the poor women in the rural area. Nobel Prize Committee notes that "micro-credit proved to be an important liberating force in societies where women in particular have to struggle against repressive social and economic conditions" (Announcement of Nobel Committee 2006). The Grameen Bank as the pioneering microfinance institution has established the trust in the poor's ability to repay the credit on time, use it for self-development development. and become an agent of socio-economic The Grameen Bank helped to create a norm of credit discipline in the rural poor of Bangladesh. The 98 percent repayment rate of the credit has become the gold seal of approval (Dowla 2006). The Grameen credit gives high priority to building social capital; this promoted through formation of groups and centers, developing leadership quality through annual election of group and centre leaders, and electing board members when the institution is owned by the borrowers. To develop a social agenda owned by the borrowers, something similar to the "sixteen decisions," it undertakes a process of intensive discussion among the borrowers, and encourages them to take these decisions seriously and implement them. Grameen Bank's sixteen decisions have established set of norms. The credit delivery model of the 79 bank- group formation, weekly group discussion, group disbursement, collection, and centre meetings are the basis of accountability and performance (Dowla 2006). The Bank also puts special emphasis on the formation of human capital and concern for protecting the environment. It monitors children's education, and provides scholarships and student loans for higher education. For the formation of human capital it makes efforts to bring technology such as like mobile phones, and solar power, and promotes mechanical power to replace manual power. The microfinance program has provided the message to the people of various walks of life that the poor have every right to get credit and those poor have proved their credit worthiness. The Grameen Bank also established the norm that credit is not charity (Dowla 2006). Basher (2007) suggests that the Grameen Bank credit program helps, (1) to reduce the fertility rate of women in Bangladesh; (2) the Grameen Bank helps its borrowers as an agent of economic and social development; (3) the Grameen credit program helps to empower the women in the rural area of Bangladesh (Basher 2007). The Grameen Bank also provides housing loans, education loan to its members. The bank encourages members to build homes, plant vegetable gardens, and plant trees and install sanitary latrines for a healthy life. In addition, it also train 80 its members in maternal health care, nutrition and child care, family planning and public health as well (Hassan 2002). Moreover, participation in the credit program increases the mobility of the rural women from purchasing power to household decisions and their ownership of property. Grameen Bank micro finance is empowering the rural poor of Bangladesh (Hashemi et al. 1996). Therefore, in addition to economic self-sufficiency, the microfinance encourages control over resources, changes in attitudes and decision making, changing parental preference for male children, self-confidence, decision regarding the child's education; women are in the process of empowering themselves. 5.3: Growth and Performance of the Grameen Bank The growth of the Grameen Bank in Bangladesh has been tremendous; it has now around 7 million borrowers, and the proportion of female clients increased from 20 per cent in 1976 to 98 per cent in 2007. Grameen Bank over the years has made a number of operational changes (Hassan 2002; Zaman 2004). Initially it included both male and females in a group and then separated the male and female groups. The classical Grameen bank model was based on group formation— promotion of thrift and after a certain incubation period, extension of credit to the group. 81 The classical Grameen bank model consisted of a bank unit being set up with a Field Manager and a number of bank workers, covering an area of about 15 to 22 villages. The manager and workers would start by visiting villages to familiarize themselves with the local culture in which they would be operating and identify prospective clients. They also explained the purpose, functions and operations of the bank to the local population. Groups of five members are eligible to receive a loan. In the first stage, only two out of the five group members are eligible for, and receive, a loan. The group is observed for a month to see if the members are conforming to the rules of the bank. Only if the first two borrowers repay the principal plus interest over a period of fifty weeks do other members of the group become eligible for their loan. These restrictions provide for substantial peer monitoring and group pressure. The collective responsibility of the group serves as collateral for the loan. Those borrowers with good repayment records are eligible for higher loan amounts and graduate to seasoned borrower status in which case they become eligible for individual loans. The Grameen Bank's pioneering use of group-lending contracts with joint-liability potentially reduces the problems of moral hazard and adverse selection in the credit market for the poor (Morduch 1999). 82 From the 1980s and the early 1990s, Grameen Bank started to expand its credit all over the country (Table 5.1). Loans were made to individuals but through small groups under joint-liability. The loans were meant for income-generating activity. The collection of the loans was frequent— usually weekly. The interest rates charged did not include any sort of subsidy and the rates were relatively low (around 20 per cent). The fundamental tenet of the Grameen Bank is that the poor are credit worthy and the poor always pay back (Dowla and Barua 2006). Table 5.1: The Progress of the Grameen Bank (Amount in Million US$) Performance indictors 1976 1990 1983 Cumulative .001 194.9 248.0 Disbursement Disbursement during .001 99.3 68.7 the year Total Deposit 18.5 25.9 Total Members (in .06 0.9 millions) Percentage of Female 20 46 91 Members Profit/ Loss (for the -0.0059 0.0027 year) Source: Grameen Bank (www.Grameen-info. org) 1995 1405.9 2000 3060.4 2006 5954.0 2007 6685.5 333.2 268.4 724.9 731.5 117.6 2.1 126.8 2.4 633.3 6.9 758.9 7.4 94 95 97 97 0.4 0.21 20.00 1.56 83 Chart 5.1: Number of Borrowers of Grameen Bank (1976- 2007) Source: Same as in Table 5.1. From the mid 1990s, it significantly expanded its outreach and activities throughout the county (Table 5.1, 5.2 and also discussed in chapter III). The Grameen bank faced significant challenges in the late 1990s when in 1998, the nation faced a devastating flood, putting twothirds of the country under water for eleven weeks. The Grameen bank faced repayment problems during this period; 20 per cent of the loans became irregular (Dowla and Barua 2006). This forced the bank to rethink their business model. Prof. Yunus changed the model in September 2001 (called Grameen II)- switching from group lending and savings to individual lending and savings, merging various loan products into one product called the basic loan, and providing temporary reprieve in the form of a flexible loan for borrowers having repayment problems. The first pronouncement of the change in Grameen II came with the 84 publication of a monograph by Prof. Yunus in April 2002 titled Grameen Bank II: Designed to Open New Possibilities. Table 5.2: The Grameen Bank— Indicators of Outreach— 2002 - 2007 Number of Rate of Active Growth Borrowers (%) (in Year Millions) 2002 2.08 2003 2.87 37.98 2004 3.70 28.92 2005 5.05 36.49 2006 5.96 18.02 2007 6.16 3.36 Source: Same as in Table 5.1. Total Women Borrowers 1.98 2.73 3.54 4.86 5.76 5.97 Rate of Growth (%) 37.88 29.67 37.29 18.52 3.65 Share of women in total borrower s 95.20 95.44 95.66 96.27 96.70 96.85 Number of Deposito rs (in millions) 1.48 3.12 4.06 5.58 6.91 7.41 Rate of Growth (%) 110.8 30.13 37.44 23.84 7.24 At the present level of disbursement and loans outstanding, the GB is operating without a financial subsidy. In addition, the present level of disbursement and outstanding loan has increased its growth in assets and loan portfolio significantly (Table 5.3) Table 5.3: The Grameen Bank—Growth in Assets and Loan Portfolio— 2002-2007 us$ Assets In million Year dollars 2002 315.70 394.03 2003 2004 514.71 2005 633.02 2006 819.79 2007 941.27 Source: Same as in Table 5.1. us$ Rate of Growth (%) Gross Loan Portfolio Rate of Growth (%) 28.81 30.63 22.99 29.50 14.82 213.34 268.03 337.70 424.47 482.08 532.04 25.64 25.99 25.69 13.57 10.36 85 The bank diversified its program from credit to insurance and other types of loans such as educational loans. Moreover, from the mid 1990s, it established eleven sister organizations that range from profit organizations to not-for-profit organizations (discussed in this chapter in 5.3.1). These sister organizations provided support in Grameen's mission of poverty alleviation of the rural poor. The growth of the Grameen Bank started in the 1990s and applies to both borrowers and assets. The Grameen Bank is not taking any subsidy or aid from the donors. This discussion reveals that the Grameen Bank's growth of borrowers, outstanding loan, assets and profitability has confirmed it as a profitable micro finance institution. Given its operational costs and financial performance, the Grameen Bank is a financially viable microfinance institution. 5.3.1: Grameen Bank's Family Organizations The Grameen Bank has twelve family organizations (subsidiaries) which are equally responsible for helping the rural poor of Bangladesh in various ways. The Grameen Bank family organizations are Grameen Communications, Grameen Trust, Grameen Fund, Grameen Telecom, Grameen Cybernet Limited, Grameen Shakti/Energy, Grameen Phone, 86 Grameen Shikkha/Education, Grameen Knitwear Limited, Grameen Solutions, and Grameen Byabosa Bikash (business promotion services). Grameen Communications: Grameen Communication is a not-for-profit Grameen Telecom Company, established in 1997. Its main goal is developing software, hardware, networking, IT services and IT education. Grameen Trust: Grameen Trust was introduced in 1989 to support and promote a GB type program that works for poverty alleviation. It builds networks, publishes materials, and provides technical support to national and international organizations for GB replication initiatives. Grameen Fund: Not-for-profit sister organization of GB was founded in 1994. It provides finance to ventures that are risky, technology-oriented and otherwise deprived of finances from existing formal lending institutions. Grameen Telecom: Grameen Telecom was established in 1995 as a sister organization of GB to provide easy access to telephone services all over rural Bangladesh. Grameen Cybernets Ltd.: Grameen cybernet was established in 1996 to provide internet services in Bangladesh. Grameen Shakti/Energy: Not-for-profit sister organization of GB established in 1996. It is a rural power company to empower the rural people with access to green energy and income. It supplies renewable energy to unelectrified villages in Bangladesh. Grameen Phone: A profit based sister organization of Gameen Bank established in 1997 to provide cellular phone services. Grameen Shikkha/Education: Grameen Education was established in 1997 to promote mass education in rural areas, provide financial support in the form of loans and grants for the purpose of education. Grameen Knitwear Limited: Established in 1997, it is an export oriented knitwear company. Grameen Solutions: A software development company. Moreover, it provides solution services for the businesses, technology fields Grameen Byabosa Bikas (business promotion services): A not-for-profit business promotion services organization established in 2001 as sister organization of GB. Its strategy is to make resources and scope available to the poor (farmers/producers) entrepreneurs through technical, financial, and marketing support. The wide variety of subsidiaries that Grameen set up has provided for a diversified asset base and provided revenue from multiple sources (assets) which then formed as a corpus for many of its charitable activities. 87 Grameen Bank not only expanded its credit programs but also a wide variety of services to the poor. As a result, the poor receive products and services at an affordable price that leads the opportunity to scaling up services as well. 5. 4: Corporate Governance of the Grameen Bank Governance is about achieving corporate goals. In the case of Grameen Bank it has dual missions— called the "double bottom line" (Tulchin 2003). It has to serve the poor through financial inclusion (social benefits) and at the same time be financially sustainable. The social impacts can be assessed in terms of outreach variables such as (a) number of borrowers covered, (b) share of women in total outreach, (c) magnitude of assets and (d) magnitude of loan extended. Similarly, financial sustainability can be assessed in terms of overall profitability through measures such as (a) return on equity (ROE), (b) return on assets (ROA), (c) gross portfolio yield and (d) operational cost (Christen 2001). We present such an analysis in the following paragraphs. As discussed in the preceding paragraphs, the number of borrowers covered by Grameen bank is around 7 million in 2007 of on nearly 97 percent are women (Table 5.2).The rate of increase in outreach (borrowers) averaged between 3 to 38 per cent between 2002 and 2007. There were more than 7 million depositors by 2007. The assets of the 88 Grameen Bank stood at US $ 941 million at the end of 2007; nearly 56 per cent of the assets were in the form of a loan portfolio (Table 5.3). The Grameen Bank has been financially successful. With a repayment record as high as 98 per cent, the return on equity varied between 1 per cent and 22 per cent between 2002 and 2007 (Table 5.4). The return on assets (ROA) has been positive and in some years (2005 and 2006) was as high as 2.5 per cent, which is impressive given the average return of banks internationally of one per cent. The yield on return on its gross portfolio was as high as 20 per cent (Table 5.5). The proportion of default (impaired) assets is very low— around 2 per cent. The operating expenses to loan portfolio has been low (around 9 to 13 per cent). Table 5.4: The Grameen Bank— Financial Performance—2002- 07 Capital/Asset Year 2002 10.81% 2003 9.12% 2004 15.37% 2005 11.25% 2006 10.81% 9.12% 2007 Source: Same as in Table 5.1. Debt to Equity 8.25 9.96 5.51 7.89 8.25 9.96 Return on Assets 0.11% 0.19% 2.41% 2.46% 0.11% Return on Equity 1.07% 1.07% 18.40% 22.37% 1.07% 89 Table 5.5: The Grameen Bank— Operating Performance— 2002-07 Yield on Gross Portfolio Year 2002 2003 20.31% 2004 2005 22.43% 22.94% 2006 2007 20.31% Source: Same as in Table 5.1. Provision for Loan Impairment/ Assets Operating Expense/ Assets 2.23% 1.81% 0.44% 1.50% 2.23% Operating Expense/Loan Portfolio 7.33% 6.19% 8.35% 6.97% 7.33% Considering the good economic performance and outreach, it would be interesting to examine its links with other elements of corporate governance. 5.4.1: Corporate Governance Literature and Governance of the Grameen Bank In terms of analytical framework, we use the stakeholder model of corporate governance as the basis for analytical and empirical analysis (as discussed in chapter II). As outlined in chapter II, the evaluation of corporate governance of Grameen Bank is conducted on (a) board characteristics, size, etc., and (b) Auditor independence. From 1976, the Grameen Bank was a project directed by Prof. Mohammed Yunus and the central bank of Bangladesh (Bangladesh Bank) along with international donors. There was no board or council to oversee its functioning. In 1983, a board was constituted by the government with 12.72% 9.29% 12.57% 11.17% 12.72% 90 only government nominees. In 1996, through an amendment, the board size was expended to 13, of which nine were to be elected from borrowers/shareholders and other four members (two general members, Chairman of the Board and Managing Director-CEO) were appointed by the government. The board of directors is the body that oversees the management of the Grameen Bank (from 1983). As elected representatives of the stakeholders, the directors are obligated to ensure that managers protect the interests of the stakeholders— in the case of the Grameen Bank they could be identified as borrowers (who own 90 per cent of the equity), government (who own the remaining 10 per cent), donors, and regulators (like PKSF and central bank). The independence of the board and its effectiveness are important attributes crucial to the functioning of the Grameen Bank. If a board has more outsiders (other than managers), it is considered to be more independent. Bhagat and Black (1997) reported that 50 percent of the 100 American public corporations surveyed in 1996 had only one or two inside directors (cited in John and Senbet 1998). It has also been suggested that boards dominated by outsider (independent) or non-executive directors may help to reduce agency problems (Berle and Means 1932; Wiliamson 1985; and Jensen & Meckling 1976). Such boards may help in reducing management 91 consumption and removing non-performing CEOs and other personnel (Haniffa and Hudaib 2006). Pearce and Zahra (1992) argue that if the majority of board members are outsiders, then their deliberations and decisions provide better strategic directions which ultimately improve performance (cited in Haniffa and Hudaib 2006). The Grameen Bank is a specialized village bank for lending to the poor. Borrowers of the bank own 90 percent of its share capital and 10 percent of its share capital is owned by the government of Bangladesh. The government, which owns 10 per cent of the share capital of Grameen Bank, appoints the CEO and Chairman of the Board of the Grameen Bank and has a greater voice in the day-to-day functioning of the bank. Thus, a minority shareholder (government) is able to control the appointment of CEO, Chairman of the Board of Grameen Bank and thereby the functioning of the bank. Even though a majority of board members are outsiders (stakeholders), the government in terms of its control over supply of capital (through BB) and regulatory power (through Bangladesh bank) is able to vest itself in control of the Grameen Bank. Hence the board of the Grameen bank is subservient to the government. As long as Dr. Mohammed Yunus is the moving spirit behind the organization, Grameen Bank may be able to minimize the intrusive behavior of the government. 92 The Grameen Bank board is composed of outside board members. Out of 13 board members, the managing director of the bank is the only insider in the board. In the Grameen Bank, 9 out of 13 board members are the borrowers/shareholders on the board. Most of them are hardly literate and have little formal education; they could be overwhelmed by government nominees or managers. On the contrary, most of the government representatives are graduates of from universities and professional institutions and management schools. Almost all the outside board members are women borrowers. Thus in theory, outsiders dominate the board of Grameen Bank; in reality they may not have a 'real voice' as these outside board members (women borrowers) may not have the knowledge, expertise in board conduct. They could easily be influenced or cajoled into submission by powerful insiders. Therefore, they may not be able to follow the proceedings of the board and contribute to a good and effective board. A high fraction of women borrowers on the board could help the Grameen bank to understand their customers better and that could prevent the mission drift. However, most of the office bearers (including the CEO) are men. It is paradoxical that a bank with an almost exclusive focus on women clientele allows them very little influence at the operational level. The second issue related to board performance is the size of the board of the Grameen bank. A board with fewer members could improve 93 the decision-making process and efficiency of the board. Literature suggests that a small board would be better for effective monitoring of the management and CEO (Fama and Jensen 1983; Kim and Nofsinger 2007; John and Senbet 1998). The empirical evidence from the study of Monks and Minow (1995) suggest that the size of board does matter (cited in Haniffa and Hudaib 2006). Lipton and Lorsch (1992) argue that small board may be more effective, recommending a board of eight or nine members (cited in Haniffa and Hudaib 2006). An empirical study of a sample of 792 companies by Yermack (1996) suggests that a smaller board brings better performance. The Grameen Bank has a board size of 13 which is relatively large by corporate board standards. The 1983 Grameen Bank ordinance stipulates a board of governors composed of the chairman, the managing director, and nine other members— five appointed by the government of Bangladesh and four appointed by the borrower-shareholders. The 1983 board was essentially dominated by the government nominees. However, the 1986 amendment of the ordinance provides for 13 members of the board, of which nine are to be elected members from the borrowers/ shareholders and the other four members (two general members, chairman and managing director) are selected by the Bangladesh government. The Grameen Bank board members are elected every year and the board members are eligible for re-election to the board. 94 For electing the board members form the borrowers, the Grameen Bank has divided the whole coverage area into nine electoral areas. From each of the electoral area one board member is elected by the borrowers of the Grameen Bank. The election process starts from the group level and then goes up to the electoral areas through centre, branch, area, and zone. The Grameen Bank board meetings are held four times per year. However, in case of emergency or need, meetings can be held more than four times in a given year. The Board is assisted by various committees of the Board for various aspects of decision making (like human resources, overseas operation, etc.). On the other hand, Pfeffer (1987), Pearce and Zahra (1992), and Goodstein et al. (1994) argue that a bigger board may be effective because members will bring diverse opinion and resources which may eventually reduce environmental uncertainties (cited in Haniffa and Hudaib 2006). It may be appropriate to have a larger board for the Grameen Bank, because almost all of the outside board members are the borrowers/members of Grameen Bank. Therefore, a larger board composed of various experts will bring critical resources for the bank, which will be helpful for good and effective governance. 95 Another important variable crucial to the governance mechanism is the independence of the auditor. The internal auditor oversees the firm's financial and operating procedures, checks the accuracy of the financial record keeping, and ensures compliance with accounting regulations (Kim and Nofsinger 2007). The internal board auditor provides independent, objective assessment of the organization's internal governance structure and the operating effectiveness of management of MFIs (Mersland and Storm 2009). Policy papers regarding the MFIs stress the internal auditor's independence and to report directly to the MFI board (Steinwand, 2000). A study by Mersland and Storm (2009) show that MFIs are reporting directly to the board shows higher financial performance. The Grameen Bank board has several sub-committees that are chaired by members of board; an audit committee, finance committee, budget committee, and planning and evaluation committee. At the same time, the Grameen Bank has an internal auditor who report directly to the board. Corporate governance stresses the importance of internal audit and recommends that the internal auditor reports directly to the board. Thus, an MFI allowing its internal auditors to report directly to the board should show higher financial performance. The present study found that Grameen Bank sent the audit report directly to the board. Moreover, it has external independent auditor and its report is published regularly and posted on its website regularly. In addition, it publishes its financial report regularly. 96 5.5: Conclusion The corporate governance structure along with its business model of the Grameen Bank is widely emulated worldwide and is often cited as a model code for other MFIs. Essentially, the corporate governance structure of the Grameen Bank is based on the stakeholder value maximization model. The majority of the board members (9 out of 13) are from the borrower groups— the biggest stakeholder of the bank. However, most of the representatives of the borrowers (mostly women) possess very little education so as to function effectively and independently in a board setting. The government, which regulates and provides capital to the Grameen Bank (indirectly through nationalized bank and Bangladesh Bank), controls the appointment of the CEO and the Chairman of the Board of the Grameen Bank although it is a minority shareholder (10 per cent of the equity). Thus, the board of the Grameen Bank is compliant with the government and lacks the independent character which is crucial to the conduct and performance of the bank. At present, the Grameen Bank is dependent on the tremendous clout and goodwill of Professor Mohammed Yunus (founder of the bank) in preventing potential abuses by the government and also in attracting capital worldwide (from various governments and NGOs). The question of how the bank will be able to function in the absence of its founder is a serious one. On the positive side, the Grameen Bank possesses 97 independent auditors (internal and external) who report to the board directly. This positive aspect is overshadowed the dominance of the government in the vital decision-making of the bank. 98 Chapter VI: Corporate Governance and Microfinance Institutions (MFIs) Performance in Bangladesh— Empirical Results This chapter presents the results of the empirical investigation and is organized as follows. Section 1 presents basic statistics of the data used in the empirical investigation, while Section 2 presents the results of the empirical investigation. Section 3 summarizes the main conclusions. Section 6.1 Summary Statistics The average asset size of MFIs in Bangladesh used in the study is US$24 million. However, the median size is only US$2.8 million, which indicates that there is considerable variation in the firm size among the MFIs in Bangladesh used in the study (Table 6.1). The lowest size of asset size in the study is US$0.03 million while the largest firm has a total asset size of US$619 million. The standard deviation of total assets of MFI's in Bangladesh is high (US$102 million). In general, the total asset size variable is positively skewed (skewness= 5.63). Similarly, the number of borrowers of MFIs, which is an alternative measure of size, is also highly skewed. The lowest number of borrowers among the MFIs was 458 and 99 the largest one has 4.5 million borrowers; the median number of borrowers was 1.9 million. The average return on assets (ROA) is 2.25 per cent with the median value lower at 2.13. The lowest ROA was -13.84 while for MFIs with the highest ROA it was 11.13. Unlike total assets ROA is negatively skewed (-1.07 per cent). Table 6.1: Basic Descriptive Statistics ROA Basic Statistics No. of Duml Total Assets Borrowers Dum2 Dum3 Mean 2.25 24,558,834 187,378 0.88 0.44 0.19 Median 2.13 2,852,311 27,663 1.00 0.00 0.00 Std. Deviation 4.48 102,644,049 754,323 0.32 0.50 0.40 Skewness -1.07 5.63 32.90 -2.47 0.22 1.54 Range 24.97 619,365,159 1.00 1.00 1.00 Minimum -13.84 34,379 458 0.00 0.00 0.00 Maximum 11.13 619,399,538 4,550,855 1.00 1.00 1.00 Observations 36 36 36 36 36 36 Chart 6.1 and 6.2 reports the box plot (which presents graphical plot of variations in data like quartile 1, quartile 2, quartile 3 and range) of the MFI data used in the empirical investigation. As is evident, the size of the firms (total assets and number of borrowers) show significant variation (Chart 6.2) 100 Chart 6.1: Box Plot of Return on Assets of MFIs in Bangladesh— 2008 Return on Assets of MFI's in Bangladesh - 2008 ** 10- : f-; •}./ ROA s£-" '- -5- * -10- -15- * 101 Chart 6.2: Box Plot of Total Assets and Borrowers of MFI's in Bangladesh—2008 Total Assets of MFI's in Bangladesh-2008 100000000 200000000 300000000 400000000 500000000 600000000 700000000 200000000 300000000 400000000 TA 500000000 600000000 700000000 -* * 0 100000000 No. of Borrowers of MFI's in Bangladesh - 2 0 0 8 1000000 2000000 1000000 2000000 3000000 4000000 5000000 3000000 4000000 5000000 -*** Borr 102 Section 6.2: Cross-Sectional Results Table 6.2 summarizes the results of the cross-section regression results based on ordinary least squares based on the following equation ROA = ao + ailog (TA) „ + 012 (Auditor Independence Dummy) ,t + a 3 Board Composition Dummy lt + Board Size Dummy l t + e l t (6.1) Table 6.2: Determinants of Performance of MFI's in Bangladesh— Dependent Variables— ROA - 2008 ROA Constant Log (Total Assets) ROA 7.01 (1.61) -0.50 (-1.77)* Log(Borrowers) Auditor independence (Dummy 1) Board Composition (Dummy2) Board Size (Dummy3) 5.12 (1.53) -0.71 (-0.39) 6.62 (5.16)* -0.53 (-1.82)*** -0.66 (-0.36) 6.45 (5.21)* 0.55 (0.38) 0.56 (0.38) Number of Observations 36 Diagnostics R Square 0.48 0.48 2.1 2.2 Durbin-Watson Statistic 7.2 F- Value 7.14 Note: 1. Figures in brackets are 't'-values. 2. *, **, *** indicates statistical significance at 1%, 5% and 10% respectively. 103 The ROA equation (equation 6.1) shows that the corporate governance variable- board composition (dummy2) has a positive and statistically significant impact on MFI performance in Bangladesh. The board composition variable captures the impact of the number of independent directors (outsiders) relative to insiders (managers); MFIs with independent board (number of independent directors > insiders) have a positive impact on MFI performance. These results are corroborated with the regression results where the size variable is the number of borrowers as well. Other corporate governance variables like board size and auditor independence are not statistically significant. The overall explanatory power of the equation is relatively good (R = 0.48). Section 6.3 Conclusion The empirical results reported in this chapter show that corporate governance variables are important in explaining the performance of MFI's in Bangladesh. Among the corporate governance variables, the board composition variable reflecting the independence of the board seems to have a positive and significant impact on the performance of MFI's in Bangladesh. The absence of statistical significance for the other corporate governance variables like auditor independence can be attributed to lack of clarity regarding these. For example, almost all of the MFIs 104 report that the auditors are independent. However, a careful scan of these data and checking into other information shows that the auditors may be related to the CEO in one way or another. 105 Chapter VII: Concluding Observations The microfinance programme initiated by the Grameen Bank has become a model of lending to the poor world-wide and is now part of the global anti-poverty strategy. Bangladesh has the highest MFI density and has now become a model of outreach to the poor worldwide. Given the fact that MFIs have to tread a fine path between profits and social outcomes, the future expansion of the microfinance sector hinges on among other things, the integrity and credibility of the industry. In this regard a study of the corporate governance of microfinance institutions (MFIs) in Bangladesh is appropriate. This study is the first step in this direction. The microfinance institutions (MFIs) operate under different institutional frameworks, providing financial and non-financial services to the poor. However, three MFIs (BRAC, ASA and Proshika) and Grameen Bank share almost eighty percent of the micro-credit in this sector. Most of the NGOs-MFIs in Bangladesh are registered with the Societies Registration Act of 1860. Registering with this law is very simple and no distinction is made on whether or not the society is maintaining any audit or accounts. In addition, there are a few other NGO-MFIs reporting laws, not sufficient to provide supervisory and regulatory environment for MFIs 106 in Bangladesh. For this, the Government of Bangladesh passed a law in 2006 that created the Microcredit Regulatory Authority (MRA), which will recommend relevant laws and regulations and provide licenses to all the MFIs. Without the MRA license, MFIs are not allowed to deliver microcredit in Bangladesh. For its part, the Grameen Bank has been financially successful. With a repayment record as high as 98 per cent, the return on equity varied between 1 and 22 per cent between 2002 and 2007 which far exceeds the return of the formal banking system worldwide. The return on assets (ROA) has also been positive and in some years (2005 and 2006) was as high as 2.5 per cent which is impressive given the average return of banks internationally of one per cent. The yield on return on its gross portfolio was as high as 20 per cent. The proportion of default (impaired) assets is very low— around 2 per cent. The operating expenses of the loan portfolio have been low (around 9 to 13 per cent). Considering the good economic performance and outreach, this bank's elements of corporate governance have been studied on the basis of the analytical framework provided in chapter 4. The MFIs in Bangladesh expanded in the 1990s and one-third of MFIs joined the industry from 2000 onward. However, the MFI's product market in Bangladesh is very competitive. At the same time the 107 overlapping of customers is increasing rapidly and there are increasing concerns about borrowers having multiple memberships which could lead to over-indebtedness of borrowers. This situation is aggravated by the fact that the MFIs are not regulated yet, but the process is ongoing. Moreover, the MFIs are following the rules of financial transparency as a process of regulation. Although the NGO-MFIs are broadly following the corporate governance structure, however, the chief executives are said to overpower the boards. Because of the chief executive selects the members of general body, it is possible that like-minded people and friends will become members of the general body of MFIs. If this is the situation, good governance will not occur by just inducting good people in the governing body. Moreover, the essence of governance is to ensure an overall system of structuring accountability and transparency in an organization. The governance problems of NGO-MFIs are mostly due to the inadequacy of the existing laws and regulations, and the lack of reporting, supervision and monitoring in Bangladesh. One of the innovations in microfinance has been the targeting of female customers. In case of the sample of 36 MFIs, more than 90 percent of the members/borrowers are women. Presumably, having a female CEO or a high representation of women in the board could help the MFIs to 108 understand their customers better, and that would eliminate the risks. Our empirical investigation found results to the contrary: most of the board members and CEOs of MFIs are male and men dominate the boards of MFIs where almost all of their clients are women. The Grameen Bank's governance is based on the stakeholder value maximization model. The majority of the board members (9 out of 13) are from the borrower groups - the biggest stakeholder of the bank. The board of Grameen Bank is independent. However, most of the representatives of the borrowers (usually women) possess very little education needed to function effectively and independently in a board setting. The government that regulates and provides capital to the Grameen Bank (indirectly through Bangladesh Bank) controls the appointment of the CEO and the Chairman of the Board of the Grameen Bank although it is a minority shareholder (10 per cent of the equity). Thus, the board of the Grameen Bank may lack the independent character which is crucial to the conduct and performance of the bank. At present, the Grameen Bank is dependent on the tremendous clout and goodwill of Professor Mohammed Yunus (founder of the bank) to prevent potential abuses by the government and also to attracting capital worldwide (from various governments and NGOs). The question of how the bank will be able to function in the absence of its founder is a serious one. On the positive side, the Grameen 109 Bank possesses independent auditors (internal and external) who report to the board directly. The empirical results reported in Chapter 6 clearly show that corporate governance variables are significant in explaining the performance of MFI's in Bangladesh. Among the corporate governance variables, the board composition variable, reflecting the independence of the board, seems to have a positive and significant impact on the performance of MFI's in Bangladesh. The microfinance industry in Bangladesh is in the consolidation phase: big MFIs and the Grameen Bank account for more than two-thirds of the clientele. In recent years, with the entry of commercially-oriented MFIs, there is a need to strengthen the governance and supervision of MFIs in Bangladesh. Although the Grameen Bank is under the direct supervision of the Bangladesh Bank, other MFIs have only recently been brought under the umbrella of supervision. 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