More efficient business models required

SHABBIR H. KAZMI, Special Correspondent
Aug 20 - 26, 2007

This performance of Micro Finance Banks (MFBs) needs to be evaluated dispassionately. The performance of these institutions has to be evaluated on the basis of an enabling policy environment, a supporting infrastructure, institutional development through developing alternate delivery channels, human resource, use of technology and outreach.

Since the largest percentage of population of the country lives in the rural areas, the effective outreach of micro financing plays the most important role. According to State Bank of Pakistan, currently four nationwide and two district-based MFBs provide financial services to the poor segment of the society in the country. During the CY06, the branch network of MFBs continued to expand. The number of branch was 145 in CY06 as compared to 91 in CY05. However, this growth has been based in urban areas. Most of the new branches/service centres opened during CY06 are located in the big cities i.e. Karachi, Lahore, Rawalpindi, and Peshawar.

The existing regulatory framework defines eligibility criteria for borrowers' selection based on their annual income. The average loan size was less than Rs 9,000, indicating the depth of outreach. As the permissible maximum loan size is Rs 150,000, MFBs still have plenty of space to enhance their loan size.

The key issue is that the deposit base of MFBs is smaller than the debt portfolio. The sector's weakness in this area can be assessed by the fact that the biggest micro finance bank has not started deposit operations as yet. At present, none of the MFBs has positioned itself to be a deposit-oriented institution.

As sector continued to expand, the overall balance sheet footing of MFBs also recorded an expansion of 24% to Rs 10.514 billion from Rs 8.458 billion in CY05. This year, growth momentum was somewhat diluted as the largest MFB could not pursue the previous growth pattern. A critical factor to the bank's conservative strategy was not to start generation of internal fund through deposit mobilization even in the wake of drying up of credit lines.

The asset composition of the MFBs shows that most of the funds are still placed in treasury assets. This is mainly because of the fact that the pioneer MFB endowed with large capital base and funding surplus from credit lines has a considerable portfolio in treasury assets. Despite marginal increase in advances, the ratio to total assets remained unfavorable to meet the sustainability objectives of the MFBs. Micro-credit has to be the prime source of revenue for any successful MFB.

It is encouraging that the portfolio quality has remained satisfactory as Non Performing Loans (NPL) to Assets Ratio registered a decline from 4.4% to 1.8%. The decline is attributed to the revised and stringent criteria for loan classification better management of loan quality and fresh disbursements for which the quality test takes time.

Another key issue is that the funding structure of the sector continues to be dominated by owners equity and borrowings. The funding structure in last three years saw only minor adjustments. The borrowings continued as major funding component at about 49% followed by shareholders equity at 36%. The capital to asset ratio at 36% indicates that MFBs are still under leveraged.

However, the operating performance of MFBs has so far remained weak since these suffered from negative returns on assets. The adverse returns have largely been attributed to the fact that the sector remained in a phase of market and institutional development.

During the year operating expenses of MFBs exceeded gross income as compared to 87.6% for the preceding year. As a result the operational sufficiency of the sector declined from 84% to 76% whereas financial sufficiency ratio improved from 51.5% to nearly 62%.

Bringing sustainability to the operations of MFBs is a big challenge for their boards and management. This requires a high degree of responsibility and use of professional expertise. MFBs need to monitor their performance against the pre-defined performance benchmarks.

All the MFBs should focus on scaling up their core business, rationalize loan yields, improve operational and productive efficiencies, and build deposit base to finance their loan growth, which would certainly add to their performance and stability.


To begin with, it would be premature to give any comment about the viability of the MFBs. However, a few structural weaknesses have to be highlighted, the worst being the credit size and approval methodology. It must be made clear that MFBs are not involved in poverty alleviation. They have to create and support operations of economically viable enterprises on sustainable basis. Therefore, any effort on the part of the government to use these institutions for poverty alleviation has to be resisted.

The other key issue is high interest rate. Lending at more than 15% per annum to the poorest is unjustified and even KIBOR plus approach become punitive. The government must help the MFBs in soliciting soft-term credit from the international lenders.

The central bank should also make it mandatory for the commercial banks to contribute one percent of their total deposits every year to an endowment fund from which MFBs could borrow at 2.5%. This could help in bringing down interest rate for the borrowers, to begin with. As the endowment fund size grows the rate could be further reduced.

Based on the global experience, particularly that of Bangladesh, the MFBs should also come up with a business model. However, the model must ensure collateral-free lending. The staff of MFBs should also be trained to work for collateral-free lending. Changing mindset is not easy but the enormous latent demand for funds, require coming up with non-orthodox models.

A Focus Group, established by the Centre for International Private Enterprise, is busy in identifying the key issues affecting lending to micro enterprises. In one of its recent meetings Dr. Shamshad Akhtar, Governor, State Bank of Pakistan also delivered the keynote address. Both the government and the SBP are serious in resolving the issues, now it is the responsibility of the all the stakeholders to take part in the deliberations to achieve the best possible results.