Corporate Governance and Strategic Issues Perspective from the FOMIN

3. Microfinance in Latin America and the Caribbean

5. Bankers Poll: FOMIN-IIC-FELABAN (end 2008)Strong Interest in Microfinance The survey was conducted at the end of 2008 among more than 100 executives from large, medium and small banks from 19 LAC countries.

6. Market Overview

7. En 2007 las instituciones reguladas representaban, en conjunto, 69% de la cartera y 54% del n�mero de clientes del sector de microfinanzas de Am�rica Latina.En 2007 las instituciones reguladas representaban, en conjunto, 69% de la cartera y 54% del n�mero de clientes del sector de microfinanzas de Am�rica Latina.

8. However, despite the important advancements of the industry as just mentioned, only about 15% of microenterprises in the LAC region actually have access to financial services

9. Our Experience

13. FOMIN microfinance portfolio Since 1993, FOMIN approved more than US$280MM with 182 institutions in total. As of December 31st, 2009, FOMIN�s outstanding microfinance portfolio amounted to US$62.0MM. Senior loans: US$28.1MM Subordinated loans: US$4.5MM Equity investments: US$12.1MM Investments in microfinance funds: US$17.4MM

14. FOMIN track record in microfinance Invested in or provided technical assistance to 1/3 of all microfinance institutions (MFIs) in LAC Historical committed amount of US$270 million Drove move to regulated financial institutions from NGOs Structured and/or lead multiple, innovative microfinance investment vehicles (MIVs) ProFund: First ever MIV Lacif: First microfinance debt fund in LAC Emergency Liquidity Facility (ELF) Locfund: First 100% local currency debt fund Sponsor of the largest microfinance conference in LAC (�Foromic�) Major role in creating and working with regulatory authorities and industry associations in LAC Created (with EIU and CAF) only index that tracks country climate for MFIs Supported specialized microfinance rating agencies

15. Corporate Governance and MFIs

16. Corporate Governance for MFIs There is a number of good definitions or corporate governance� �.we don�t need to reinvent the wheel for the case of MFIs It is better and more important to focus on� Design and implement a tailored corporate governance structure at specific point in time according to specific institutional features: NGO, Coops, Banks� Integrate the principles of corporate governance in a MFI culture: Board practices, Senior management, Risk management and internal control, Compensation, Disclosure and transparency, Accountability, Responsibility and Fairness

17. Differentiating Corporate Governance from Other Concepts Corporate governance must not be confused with corporate management. Corporate governance focuses on a company�s structure and processes to ensure fair, responsible, transparent, and accountable corporate behavior. Corporate management on the other hand focuses on the tools required to operate the business. Corporate governance is in fact situated at a higher level of direction that ensures that the company is managed in the interest of its shareholders. One area of overlap is strategy, which is dealt with at the corporate management level and is also a key corporate governance element. The slide above illustrates the difference between corporate governance and corporate management. Corporate Governance must also not be confused with �real� governance, which deals with the governance structures and systems within the public sector. Corporate governance must further be distinguished from good corporate citizenship, corporate social responsibility and business ethics. Good corporate governance will certainly reinforce these important concepts. But while companies that do not pollute, invest in socially responsible projects or run charitable foundations often benefit with superior reputation, public goodwill and even better profitably, corporate governance is and remains distinct from these concepts. Corporate governance must not be confused with corporate management. Corporate governance focuses on a company�s structure and processes to ensure fair, responsible, transparent, and accountable corporate behavior. Corporate management on the other hand focuses on the tools required to operate the business. Corporate governance is in fact situated at a higher level of direction that ensures that the company is managed in the interest of its shareholders. One area of overlap is strategy, which is dealt with at the corporate management level and is also a key corporate governance element. The slide above illustrates the difference between corporate governance and corporate management. Corporate Governance must also not be confused with �real� governance, which deals with the governance structures and systems within the public sector. Corporate governance must further be distinguished from good corporate citizenship, corporate social responsibility and business ethics. Good corporate governance will certainly reinforce these important concepts. But while companies that do not pollute, invest in socially responsible projects or run charitable foundations often benefit with superior reputation, public goodwill and even better profitably, corporate governance is and remains distinct from these concepts.

18. Transforming MFIs � An Interesting Option This is usually where the investment opportunity is and where the corporate governance challenges arise Often, an NGO, governed as an NGO, has been operating for 10-15 years, very entrenched culture Governance may be sound but not associated in any way with shareholder protection or diverse interests Introduction of new investors can result in shocks to the corporate culture and individual managers

19. The Overall Challenge of Aligning (Conflicting) Interests

20. Transformation � Aligning Interests Transformation is not easy. This topic is explored at length in a publication - Aligning Interests: Addressing Management and Stakeholder Incentives during Microfinance Institution Transformations. Why transform? Specific objectives may include: access to finance, regulatory recognition, wider product range, among others� �but the process is not easy. Some common roadblocks NGOs and foundations status usually establish that profits should not benefit private parties Senior managers rarely work under performance-based compensation schemes Directors serve as custodians of the social purpose and sometimes they do not even receive compensation Staff esprit d�corps is built around viewing banks as a problem Once an MFI transforms regulation dictates ownership structure (e.g. In India, NGO cannot own shares in financial institutions)

21. Transformation � Growing Pains How to recognize founders and manager�s �sweat equity�? How to value severance packages? This type of valuation has not been a norm in the industry (donors are not accustomed to this) and may benefit from looking at practices from other industries (e.g venture capital) How to share benefits (once intangible) with employees? Equity ownership seems farfetched but there are some good experiences in profit sharing (end-of-year) that seem to work We should also recognize that compensation schemes are undergoing changing in the mainstream financial sector�nonetheless, that should not prevent the microfinance industry to seek ways to address this issue that may be hampering growth.

22. When Bad Things Happen to Good Institutions Capture of the institution by unethical management Use of political influence to take actions that benefit specific groups over others Weaknesses of certain shareholders (usually NGOs) can spillover to the MFI and result in disputes over control that can paralyze decision-making Exits � manipulation of process to ensure the new buyer is �favored shareholder.� Human capital � the most scarce resource available

23. Some Issues to Consider from FOMIN�s Experience as an Investor Aligning interests among shareholders � DFIs, NGOs, private investors, networks as shareholders, each has different perspective and expectation (dividends, pricing, technical assistance providers, exit) Agreements should have consequences It�s not just about the corporate governance policies, it�s about individual behavior Cannot necessarily rely on local legal environment and local practices to solve governance issues Information asymmetry between investors and management and between local investors and international investors can result in differentiated returns (e.g. salaries paid to managers, contracts to related third parties)

24. Good Models that Have Worked Partnerships with like-minded investors who have taken the time to get to know each other Annual business planning between shareholders and management, including projections, salary levels, dividend decisions, etc. Shareholder/board structure that includes diverse groups Conflict of interest policies that are followed and monitored Board approval of major funding, investment, managerial, third party contracts. A responsible, informed, ethical, local director with a good network Corporate governance training for all board members Peer evaluation among board members Auditors hired and report to Board Board committees to go into details People, the scarcest resource

25. The Difference that Governance Makes Evidence shows that good practices in corporate governance correlate with higher returns of the companies. Investors are willing to pay a premium for shares in companies with good corporate governance structures. Poor governance can contribute to intitutional failures and can lead markets to lose confidence in the ability of an MFI to proper manage assets and liabilities A recent reseach supported by FOMIN concludes that:* An institution�s governance structure proved to be the primary differentiating factor between those entities that overcame a crisis and those that did not The crises are not what cause the failures, but it is the way in which they are faced by the Board, the managers and the staff of a financial entity that explains if an institution overcomes the challenge. * Taking the good from the bad in Microfinance: Lessons learned from failed experiences in Latin America, 2010

26. Main Weaknesses of Governance that Explain Failed Experiences The detrimental concentration of functions in a single person (Member of the Board and CEO) Lack of regulating framework or entities. Although non regulated institutions are able to build up good governance structures, regulation and supervision can pressure to implement faster or improve good governance practices. Weakness of the boards. See next slide.

27. Weakness of the Boards: Different Board Types Many of you will be familiar with the typical board: A good old boys or gentleman club, characterized by conformity and ceremony. Unfortunately, only very few boards truly view themselves as boards that challenge and inquire, that seek to actually add value without meddling or micro-managing mgmt. Only a select few make the GD more effective, yet managing performance to ensure that this individual does not become all-powerful. The greatest vulnerability of MFIs created by one or two founders is management capture, when management dominates and the board serves as a rubber stamp for management.Among emerging MFIs, management capture occurs more frequently than its obverse, where boards egt too involved in management. Maintaining the delicate equilibrium between managemetn vs. board capture is the difficult art of good governance. But things are improving and we are seeing less of these types of board. Ironically, also a hands-on baord that loses sight of its primary strategic function is likely to cross the line into micromanaging the operation and thereby may become more harmful to the institution than the other baord types. Many of you will be familiar with the typical board: A good old boys or gentleman club, characterized by conformity and ceremony. Unfortunately, only very few boards truly view themselves as boards that challenge and inquire, that seek to actually add value without meddling or micro-managing mgmt. Only a select few make the GD more effective, yet managing performance to ensure that this individual does not become all-powerful. The greatest vulnerability of MFIs created by one or two founders is management capture, when management dominates and the board serves as a rubber stamp for management.Among emerging MFIs, management capture occurs more frequently than its obverse, where boards egt too involved in management. Maintaining the delicate equilibrium between managemetn vs. board capture is the difficult art of good governance. But things are improving and we are seeing less of these types of board. Ironically, also a hands-on baord that loses sight of its primary strategic function is likely to cross the line into micromanaging the operation and thereby may become more harmful to the institution than the other baord types.