MICROFINANCE: RISKY YET REWARDING
SAAD ANWAR HASHMI
Mar 5 - 11, 2012
Microfinance involves extending advances of small amounts, which may be as low as Rs10,000 to assist borrowers meet their short term financial requirements of personal use or business. These loans carry high degree of risk since the borrowers would not normally qualify for loans extended by regular commercial banks. 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 groups and live with minimum to no savings.
With the degree of risk and uncertainty of repayment involved, such advances are extended by specialized financial institutions willing to accept such risk charging a mark-up rate which justifies the risk undertaken often as high as 21 to 30 per cent.
In order to cater to the risk and specialized needs of such borrowers, microfinance banks have been set up to extend micro credits.
Microfinance banks have the objective of providing small loans with a business model to provide social service to the economy with current widespread poverty. 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.
Microcredit only reaches two million borrowers due to low financial penetration in rural areas whereas the total market size is estimated at 30 million borrowers, which present high potential for growth. Overall, financial penetration in the country is estimated at 10 to 12 per cent largely among urban districts where as rural areas are neglected.
Thirty two 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 per cent with perpetual repayments.
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.
With consistent rise in inflation, middle class is gradually being pushed below the poverty line, which further causes socioeconomic issues for the country. Need for finance is however paramount.
Another aspect of an informal network for extending loans is that the rate offered is not fully disclosed to the borrower, nor are the borrowers at times aware of the tenor through which repayments have to be made which may 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 advise given by others living in their neighborhood which further hinders small borrowers to approach the banking channel.
In case of any chance of default or possible delays in repayments, informal means of recovery such as harassment become problematic for the borrowers. The mechanism for recovery however is not seen as a top concern by micro finance banks since recovery rate for small loans for the industry 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 who are mostly aware of the micro loans extended on guarantees and 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 success model therefore for these banks is the geographic distribution and reach both in urban and rural areas where commercial banks do not extend credit.
Microfinance banks are primarily optimistic with the agricultural sector with farmers requiring short-term loans to procure seeds, fertilizers, and related expenses. SBP in particular is very keen about developing of microfinance institutions and conducts visits all over Pakistan to have an assessment of the need for microfinance and type of loans required.
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 capitalizing on mobile network to provide banking services with sales agents approaching the borrowers to assess their financial need. Another challenge, which the banks currently faces, 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 persons with the skills required to assess such financial need and approve advances taking on such risk is also one of the main challenges for micro finance banks.
Microfinance is still in a very early stage looking at the market potential and needs to be exploited. These banks are currently offering working capital loans to small businesses.
Personal loans may be availed for house construction, emergency, purchase of bikes and tools for conducting business to name a few. 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 may be 250 basis points to 350 basis points above the rate offered by commercial banks.
Pakistan classified as one of the poorest nations 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 may be instrumental in extending finances to rural areas. The objective of microfinance institutions will be poverty alleviation going forward. The capacity to run a profitable business is determined through recovery and swift repayments.