Is Microfinance a panacea for poverty alleviation?

The News on Sunday, Pakistan

July 13, 2003

From Lahore to La Paz, and many places in between, micro-finance is an emergent industry. This industry or 'movement' has created an important nexus between a diverse group of individuals all around the world

By Fawzia B Naqvi

In Pakistan, micro-finance is a fledgling industry with tremendous potential. Nearly 7m low-income households, mostly rural, are estimated to lack access to any formal credit or savings services. Less than 5% are currently reached by the existing micro-finance providers.

Therefore, an overwhelming majority of low-income Pakistanis still depend entirely upon informal and extremely costly socio-economic arrangements, such as moneylenders, family or friends. Like in most other parts of the world, the poor in Pakistan incur interest costs upward of 100% when borrowing from moneylenders and other informal sources of credit. This is the heavy cost low-income households have to pay for their desperate need for liquidity because they simply have no alternatives.

However, micro-finance is not a magic panacea for poverty alleviation. It is one critical intervention that provides opportunities for low-income households to access credit as working capital for small enterprises, or to help a household through periods of economic hardship and to face emergencies. When saving services are provided, low-income households are given the opportunity to build assets and create cushions against future economic shocks, which so often not only devastate these families, but also send entire communities reeling back into abject poverty.

A majority of micro-finance clients is women who typically borrow for their households, for businesses run jointly with or separately from their husbands, to educate their children, to face medical and other emergencies, or to smoothen cash flow during periods of irregular income generation. Depending upon the institution, first-time loans range from Rs8, 000 to Rs10, 000. Regulated MFIs can lend up to a maximum amount of Rs100, 000 to a single borrower, while NGOs have the freedom to determine their own lending limits.

But the delivery and recovery of these small loans with short tenors is a manually intense and costly process for most institutions. And so, our biggest challenge today is to find innovative ways to streamline our processes and reduce overall transaction costs faced by the clients and the institution. In addition, stronger institutions should embark on an effort to assess their clients' capacity to repay loans by adopting an appraisal-based lending methodology. This methodology will further help mitigate the risk of default as well as ensure that low-income clients are receiving the appropriate loan amounts.

The lending methodology that is mostly used in Pakistan is the Grameen methodology, where groups of individuals, usually women, borrow together and have joint liability for loan repayments. The lending institution, in the form of compulsory or forced savings, deducts a percentage of the loan amount up front. In order to protect the saving of low-income households, most central banks around the world, including the State Bank of Pakistan, permit only regulated institutions to intermediate savings for on-lending purposes. Individual loans with no group guarantees and large-scale voluntary savings mobilization have yet to make their debut in Pakistan's micro-finance landscape.

Irrespective of the lending methodology used, institutions are advised to keep a daily vigilance over the quality of their loan portfolios. Institutions must ensure that their portfolio-at-risk (PAR) at 30 days is less than 5%, and that they are consistently and accurately able to verify the quality of their loan portfolio.

For micro-finance institutions, whether regulated or unregulated, the largest and most vital asset is their loan portfolio. Undetected or untreated portfolio problems can easily wipe out an institution's equity, risking low-income savers and leaving them, yet once again without access to reliable, formal financial services. Therefore, all institutions should implement excellent management information systems that can alert management about even the slightest deterioration in their overall portfolio quality.

Like all other clients of financial services, low-income clients also demand products and services that are better, cheaper and faster. And when given a choice, these clients will borrow from the best service (quickest loan disbursement) and lowest cost provider, and save where they can find the most security, liquidity and convenience of accessibility. When it comes to their savings, low-income clients evaluate whether an institution is trustworthy and will safeguard their hard-earned money, whether they can withdraw their funds at any time and frequently; they even take into consideration the institutions proximity to their homes.

Although not entirely price insensitive, low-income clients usually do not identify the rate of interest earned as a main reason to save, or not to save with an institution. Another key challenge for the micro-finance industry in Pakistan is to provide better services to low-income clients, i.e., they should design and deliver efficient, responsive, demand-driven financial services that truly match their clients' financial needs and aspirations. It is important for these institutions and their policymakers to recognize that 'the poor' are not just one large homogenous mass. They are legitimate clients of financial services.

There is a need to better understand the existing target market to define its parameters accurately and to conduct a segmentation exercise. Only then can we serve low-income clients relevantly.

The provision of micro-financial services in Pakistan has been significantly accelerated by the implementation of an enabling policy and regulatory framework, co-designed by the Government of Pakistan and the Asian Development Bank (ADB), which provided a $150m Micro-finance Sector Development Program (MSDP) loan in the year 2000.

Khushhali Bank, Pakistan's first retail micro-finance bank, was established within MSDP in the year 2000 as the catalyst for this sector's growth. This policy framework and the State Bank's prudential regulations for MFIs promote a diversity of transparent and financially viable private sector institutions, and support a healthy and calibrated growth of the overall micro-finance sector.

However, no regulatory framework is perfect and must remain a dynamic process. Therefore, policymakers and regulators are encouraged to continue consultation with micro-finance stakeholders, so that the regulatory framework remains responsive to the needs of what we hope will be a much expanded, diverse and evolved micro-finance industry in this country.
All micro-finance providers have the autonomy to set their own pricing, which reflects their real transaction and overall cost structures. The State Bank's prudential regulation specifically recognizes and safeguards pricing autonomy for MFIs, and is based upon the need to meet operational and financial sustainability. Pricing on micro-loans ranges from 20% to 22% for those institutions committed to attaining financial viability and eventually reduced dependence on concessional or donor funding.

Delivering small loans with short tenors is a costly proposition around the world. It is a manually intense process that usually entails fortnightly or monthly repayment schedules. Micro-finance providers usually go to their clients' residents to deliver these financial services, and thereby incur relatively higher overall transaction costs.

Institutions committed to greater outreach and expansion of delivery channels will incur higher cost as they expand their financial services to gain access to clients across geographical boundaries. However, it remains incumbent upon each institution to be sincerely focused upon continuously streamlining overall costs, allocating them accurately and passing the savings on to their low-income clients. Ideally, operating cost ratios should be between 15% and 20%, for those institutions in existence for more than five years.

Providing financial services access to a much larger number of low-income households in Pakistan will require existing NGOs and MFIs to institutionalize efficiencies at all levels of operations and strengthen their overall architectures, governance, management, systems, processes and products. It will also mean creating new institutions, as two or three providers will not suffice.

The problem in this country is severe. Lack of access is on a massive scale. However, the Herculean challenge in Pakistan is to create and then preserve sustainable, transparent and de-politicized financial institutions, so that low-income clients are given the option to choose financial services providers based upon quality and cost.

From Lahore to La Paz, and many places in between, micro-finance is an emergent industry. This industry or 'movement', as some may call it, has created an important nexus between diverse groups of individuals all around the world. These partnerships include low-income households, leaders of micro-finance institutions, donors both private and public sector, micro-finance networks, finance ministers and central bankers.

It is partnerships like these that have put Pakistan on the map of 'micro-finance friendly' countries and helped to construct institutional and financial architectures that support the inclusion of a large number of rural and urban poor into the formal economy.

But we have only just begun here in Pakistan and have a very long way to go before we can claim that our job is done, or claim victory over poverty. Each one of us holds a vital piece of the puzzle that helps shape these strong institutions and relevant financial systems, which allow millions of low-income families to access affordable and viable financial services.