Micro-financing in Pakistan - A Perspective

Updated: Aug 9

Poverty has been a major development problem of Pakistan. Micro-financing seems to be one of the effective solutions to support individuals and MSEs (Micro & Small Enterprises) and therefore give impetus to the poverty alleviation efforts. It can help the communities develop means for sustainable sources of income through business establishment and thus and decrease their vulnerability. It also works as an instrument of self-employment for men and women to bring about change. People with low income having limited access to formal financial institutions, are the main beneficiaries of micro-financing.


Micro financing success of Bangladesh


The growth of microfinance institutions (MFIs) in countries worldwide continues however there is also this debate over whether such programs truly benefit the poor. Proponents emphasize the need for innovative ways to provide poor populations access to financial services. Critics argue any successes may be temporary because microfinance programs require training and entrepreneurship skills, which many poor populations lack. In addition, some fear that beneficiaries may be charged high interest rates or become dependent on MFIs, borrowing more than they can pay back and becoming further trapped in poverty. Studies show that in Bangladesh microfinance institutions have had sustained benefits over two decades in reducing poverty and increasing incomes. Microcredit accounted for a 10 percent reduction in rural poverty in Bangladesh over that time lifting over 2.6 million Bangladeshis out of poverty.


The main objective of Bangladesh’s microfinance sector when it was established was reducing rural poverty by providing microcredit loans for off farm activities such as trading, livestock and poultry. The loans were funded mainly by the government and bilateral donors through group-based savings and lending programs.



According to latest figures Bangladesh’s MFIs benefit some 33 million members and distributes more than $7.4 billion annually. Moreover instead of relying on the savings of borrowers, MFIs now have access to institutional funds including commercial banks. In addition microfinance in Bangladesh has expanded its scope from home-based activities and self-employment to include savings and insurance, microenterprises and productive employment. It has also helped to diversify the economic activity of the borrowers boosting incomes in the process. Household income has grown steadily over the period, driven by rising non-farm income. The income growth of the households diversifying into non-farm activities was almost 29 percent higher than that of their counterparts focused exclusively on farming. The reduction in moderate to extreme poverty for this group was almost 8 percent higher. Improvement in mechanisms of access to credit was found to be a key factor in achieving this shift.


Micro Financing Institutions despite their focus on non-farm activities have also aided farmers. Borrowing from an MFI raised farm income and reduced reliance on wage income, producing significant positive effects for women and marginal farmers. A 10 percent increase in women’s credit use was found to increase crop income by 3.5 percent, non-crop income by 2.8 percent, and total farm income by 0.7 percent. Moreover borrowing by both males & females has had important impacts on income, labor supply, household assets and net worth, and children’s schooling.


Micro-financing in Pakistan


Pakistan though making substantial development in microfinance sector having than 40 accredited institutions operating in the sector lags well behind its peers – such as India, Bangladesh, Vietnam and Sri Lanka in terms of offering private-sector credit. Micro financing institutions in Pakistan serving 6.3 million borrowers with a loan portfolio of PKR197bn ranges widely in strategy, capacity and outreach. Interestingly over half of loans are made to women borrowers and 55% focused on rural areas. The loan sizes have also been increasing, with the current average size being PKR 52,000 (US$325). There is a growing reliance on smartphones as a mechanism for payments and to reach out to Pakistan’s 220 million population. According to GSMA intelligence, mobile phone subscriptions outnumber bank accounts by two to one.


Role of Government In Pakistan to Promote Micro-financing


State Bank of Pakistan (SBP) has been playing a key role in the development of microfinance sector. Pakistan’s microfinance sector is globally recognized for well‐developed legal, regulatory, and strategic framework. In order to stimulate growth of the sector on sustainable basis, SBP formulated national microfinance strategy in 2007. The strategy achieved a number of key targets as under:


· Enabling regulations to support alternative delivery channels, access to foreign and local currency funding, up scaling loan limits, microfinance borrower’s eligibility criteria, and access to MFB’s clearing house.

· Innovative models/partnerships were adopted to deploy Branchless Banking solutions.

· Mainstreaming of the two largest MFIs (Kashf, NRSP) was completed

· Funding mechanisms were set up to better manage the funding and institutional capacity constraints

· Reforms in key institutions (Khushhali Bank, NRSP and PPAF)

· New players such as ASA and BRAC, established operations in Pakistan


The previous government under its National Financial Inclusion Strategy created the Pakistan Microfinance Investment Company (PMIC), providing finance direct to target sectors as well as offering funding and support to other microfinance lenders. PMIC established in 2016 is registered as an investment finance company operating under the country’s non-finance banking company regulations administered by the Securities and Exchange Commission of Pakistan. The company was established as a joint initiative through the support of Pakistan Poverty Alleviation Fund (PPAF) and the UK’s Department for International Development, through the non-profit organization Karandaaz Pakistan and the German development bank KfW. Initiatives financed so far include renewable energy, crops and livestock, micro-insurance, digital finance, low-cost private schools and housing and women led MSEs (Micro & small enterprises).


The main objective of PMIC is to offer a wide range of financial services to microfinance institutions and microfinance banks to promote financial inclusion in Pakistan, alleviating poverty and catalyzing broad-based development. It has targeted microfinance banks and other non-bank microfinance institutions as borrowers and almost 44% of loans have been extended for agriculture and related business, while another 46% have been granted to small entrepreneurs for their micro businesses.


Constraints in Micro-financing spread


I. Funding:

MFIs depend mainly on subsidized funding from Pakistan Poverty Alleviation Fund for lending operations which is limited. They have yet to create a sustainable internal fund generating mechanism. The commercial banks have always been reluctant in funding MFIs in the past. However pro-active approach of SBP through its microfinance credit guarantee facility has been effective in improving the spread of lending through MFIs.


II. High Operating Costs:

The sectors high operating costs to loan ratio (approximately 23%) points to the lack of viability of MFI as a business model.


III. Credit Risk:

The overall portfolio quality of the sector remains satisfactory however the quality of the spread by the MFIs has still to be effective. Moreover high inflationary trends over the last few years have affected the repayment capacity of the borrowers and increased the risk of default.


IV. Organizational Development:

There is still a lot to be achieved in having a strong and effective organizational system in place for MFIs reflected through quality of governance, management teams, technology and internal control systems.


V. Macro-Economic Situation:

Moreover macro-economic challenges facing the country are also preventing substantial growth of micro-financing sector.


Suggestions to strengthen Micro-financing Sector and improve the outreach


Improve skills and marketing opportunities for the poor

Mere credit disbursement is not enough to boost productivity, sustain rising incomes and reduce poverty. Vulnerable populations need skills training and better marketing networks to expand their non-farm activities and earn a sustainable income.

Rationale interest rates

The MFI interest rates are lower than those charged by informal moneylenders however they still need to be on the lower side while realizing sufficient returns.


Competition among MFIs

State Bank of Pakistan through its policies needs to facilitate establishment of new MFIs and protect smaller ones operating in the market to prevent monopolization of the sector by established MFIs and thereby encourage competition.


Diversity

The government needs to stay committed to greater financial inclusion to promote inclusive economic growth. It will be important to continue implementation of policy approaches providing the incentives for sustainable financial access and utilization of a broad range of services (including savings, credit, payments & transfers, insurance).


Innovation

The policy makers and microfinance players need to promote technological and institutional innovation as a means to expand financial system access and utilization. Greater emphasis on digital platform and initiatives such as challenge funds is expected to strengthen the mechanism and encourage the people to utilize micro financing services.


Consumer protection and empowerment

SBP needs to review and strengthen its regulatory and supervisory mechanisms to ensure protection of rights of microfinance clients.



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