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Microfinance involves loans which are given to those who would not qualify for conventional bank loans. The loans extended could be as low as PKR 10,000 to assist basic needs and small business startups. The idea for microfinance is to alleviate poverty to focus on economic development. With the risky profile of the borrower, loans carry high degree of risk. Collateral is ascertained primarily through estimates. The repayment is confirmed through crude assumptions based on discussion with the borrowers. Those availing such loans belong from mid to lower class economic group of the country and live from pay cheque to pay cheque with minimum to no savings. With the degree of risk and uncertainty of repayment involved and transaction cost of monitoring loans, such advances are extended by specialized financial institutions willing to accept such risk.
Microfinance may charge a mark-up between 18 per cent upward to 37 per cent to compensate for such risk. Since the rate charged is higher than that of commercial banks in terms of mark-up, microfinance banks are able to offer a higher rate on deposits, which maybe 250 basis points to 350 basis points above the rate offered by commercial banks.
Informal network of loans
Access to capital for those wanting to avail small loans and not catered to by regular commercial banks is the key determinant where microfinance banks operate and target as potential clients. Micro credit only reaches 2 million borrowers due to low financial penetration in rural areas whereas the total market size is estimated at 30 million borrowers, which gives high potential for growth. Overall financial penetration in the country is estimated at 10 per cent to 12 per cent largely among urban districts where as rural areas are neglected. With among the lowest financial penetration in the world, 32 per cent of our population is estimated to be served informally whereas the remaining 56 per cent is completely neglected. Since the poor have no access to financial capital and are largely unaware of financial services, loans to such borrowers are extended through an informal network often charging a rate as high as 40 to 50 per cent with perpetual repayments. Another aspect of an informal network for extending loans is that the rate offered is not fully disclosed to the borrower neither are the borrowers at times are aware of the tenor through which repayments have to be made which may be change on moment’s notice.
Microfinance banks are able to provide such transparency to the borrowers by disclosing the borrowing requirements and mark-up charged through a paper repayment mechanism. It is often seen that small borrowers also find comfort through the informal channel driven through advice given by others living in their neighborhood, which further hinders small borrowers to approach the banking channel. Having no alternative, such loans are extended with runs parallel to the banking system.
The average loan size of a micro loan is Rs20,000 with repayments primarily through wages and salaries or cash flows estimated through future sales for which funds are required today. In case of any chance of default or possible delays in repayments, informal means of recovery resorts to violence and harassment by the lenders which are a concern for the borrowers. The mechanism for recovery, however, is not seen as a top concern by microfinance banks since recovery rate for small loans for the industry in Pakistan is above 96 per cent with Tameer Microfinance Bank estimated at 98 per cent. The reason for low degree of default is the self respect of borrowers among the community who are mostly aware of the micro loans extended either acting as guarantors or as references. Since loans are primarily short term in nature and the borrowers already have an existing cash flow stream through salaries and wages or returns through business, repayments are met in a timely manner. With the mark-up rate charged well above industry average compared to normal consumer loans of commercial banks, principal extended by microfinance banks is recovered swiftly. The interest rate compensates for risk and transaction cost ensuring banks maintain their profitability. As a success model, microfinance banks need to focus on geographic distribution and reach both in urban and rural areas where commercial banks do not extended credit.
Challenges and competition
The challenge microfinance banks face is the competition through the informal network of lenders since such banking facilities are not widespread across the country. Microfinance banks are also exploiting and planning on the use of mobile network to provide banking services with sales agents approaching the borrowers to assess their financial need. Another challenge, which the banks currently face is the experience level required to assess the repayment capacity and identify who may or may not be extended credit since the assessment is largely subjective in nature. Attracting qualified and experienced personal with the skills required to assess such financial need and approve advances taking on such risk is also among main challenges for microfinance banks. Microfinance banks are primarily optimistic with the agricultural sector with farmers requiring short term loans to procure seeds, fertilizers and related expenses.
State Bank of Pakistan (SBP) in particular is very keen about developing of microfinance institution and conducts visits all over Pakistan to have an assessment of the need for microfinance and type of loans required seen as service to the poor who have been excluded by the target market of commercial banks.
With respect to personal loans, loans may be availed for house construction, emergency, purchase of bikes, working capital and tools for conducting business to name a few. Pakistan classified as one of the poorest nationals in the world with a wide population of those living below poverty line and in constant need of credit will give microfinance banks a wide playing field to expand the business. However, it must be noted that the target market for microfinance institutions are in constant need for financing and capital, therefore, banks need to keep a barrier and identify minimum acceptable criteria for extending credit, expected to be streamlined across the industry as the banks develop further. The wide use of mobile network in Pakistan maybe key in extending financing to rural areas and receiver installments electronically. The objective of microfinance institutions will be poverty alleviation going forward and the capacity to run a profitable business determined through recovery and swift repayments taking risky yet secured lending decisions.
