SMALL REMAINS SMALL
MICROFINANCE BANKS CAN HELP IN GRADUATING THE UN-BANKABLE INTO BANKABLE CATEGORY
SHABBIR H. KAZMI
Apr 28 - May 11, 2008
Poor can hardly seek a small loan and their ability to raise the level of living remains doubtful. The issues relating to poverty are complex and involve multiple factors i.e. education, water, food, health, housing etc. Lending small money to establish an insignificant enterprise does not provide sustainable solution to these complex issues.
Globally, as well as in Pakistan virtually all of the micro financing undertaken has been focused on those whose livelihood, which are based on some form of non-agricultural production. The loan of a small amount of money allows such people to acquire some inventory or tools which then provide them with an ability to exploit their energies in a setting that has not been agricultural.
Though, microfinance is a way of helping people come out of poverty but alone it is certainly not enough to deal with complex issues responsible for poverty. The desired goals cannot be achieved without bringing change in the attitude. Success begins with having a positive attitude towards life. People ought to be taught and educated on the principles of poverty eradication rather than being contented with whatever they have.
According to John F. Kennedy (former US President) the future promise of every nation can directly be measured by the current prospects of its youth. Therefore, young people have to be empowered by maximizing their talents. Exploiting potential is another way of making money and eventually the path to wealth creation. Every individual has a gift/talent which ought to be harnessed to bring about the desired changes. Therefore, microfinance should be seen as part of the toolkit, not as a panacea for poverty. There is often a primary need for access and tools for land cultivation, irrigation and potable water.
The solution based approach takes into account the goals of the people who come to participate and work for the development and improvement of all the participants. If it is possible to raise capital to build a factory, why does it appear so difficult to raise capital to build a community program that does not engage in charity but builds on skills and knowledge and expresses economic development in ways that would be as novel as the creation of automotive assembly line by Henry Ford?
Today's economic world is full of successful models where companies have operated based on value-added systems that yield profit the people involved both monetary and non-monetary ways. This is being done at the bottom of the economic ladder incorporating those who have been denied participation in new and novel organizations that are not charity and yet are more than just for profit.
Change is successful, meaningful and sustainable when it hits at an individual level. It is not possible without microfinance that brings people individually from a community to a position of action. They hold a strong line on individual accountability and contribution without defeating or undermining the importance of community.
Microfinance works in a big way, because it empowers people and places accountability at the individual level. It is a fact what people want is a fair shot at prosperity and survival. Microfinance gives people that individual control and opportunity to prove themselves. That's what makes it great. That's why more hopes that the country could see an end to poverty at a faster pace than anticipated. Microfinance is and will play a big role in creating success stories.
Another factor determining potential of microfinance in bringing people out of poverty is whether the recipients also receive educational support to further the enterprise they are borrowing money for. Not all that money is used in business, but in those programs that include business education as a mandatory component of borrowing for producing more significant results. The future of microfinance should be to incorporate education and offer peer support as integral elements in any lending program. Many microfinance programs already do this, but far too much focus on providing money alone as the solution.
Keeping in view the concept of promoting microfinance a closer look at the prevailing scenario in Pakistan presents a little disappointing picture. Some of the contentious issues facing the borrowers and the lenders need immediate attention of the government as well as the regulators.
To begin with, the regulators have not been able to differentiate between microfinance institutions and commercial banks. This perception is based on the similarity of prudential regulations governing two entirely different types of institutions.
According to some experts microfinance institutions are more stringently regulated compared to commercial banks. It may be because players as well as the regulators are familiar with rules of the game for commercial banking. As against this microfinance has a very brief history in the country and the institutions have employees who have already spent most part of their lives working for the commercial banks. While they are working for microfinance institutions they employ all the rules, measures and policies they have been exercising in commercial banks.
Historically, commercial banks have been lending short-term funds, for less than a year on the basis of collateral provided by the borrower. Such collaterals are mostly in the form of immoveable assets i.e. industrial, commercial and residential properties. These institutions hardly bother to examine business plan but are always ready to extend fund to a certain percentage of the fixed asset. As against this, lending to small and medium enterprises as well as micro enterprises has to be collateral free and on the basis of business plan. It is regrettable that financial institutions have not learnt to extend collateral free credit.
Another gross mistake is that people often fail to appreciate that microfinance institutions are not the charity distributing organizations. There prime responsibility is to help the borrower in creating sustainable business enterprises no matter how small or big. The microfinance banks are also not meant to be used by the government for poverty alleviation.
Some of the critics often say that microfinance banks operating in Pakistan have not been able to play their due role. Some of the critics go to the extent of saying that these institutions are inefficient because they have been posting huge loss. However, these critics hardly take into account the working environment for the microfinance institutions. While commercial banks have been operating in those areas now comprising Pakistan, microfinance is a new word, not even understood in its true spirit.
The first and most common allegation on the microfinance institutions is that they charge very high interest rate. But critics hardly make any suggestion aimed at reducing cost of fund. Most of the microfinance institutions have not gone beyond utilizing their seed capital. The deposit mobilization campaigns have also remained unfruitful because the general public is not keen in keeping their saving with microfinance institutions.
One of the reasons keeping the general public or small savers away from microfinance institutions is the past experience, to be precise various financial scams i.e. cooperatives and investment companies. In both the financial scams the depositors lost their life savings but big borrowers made a fortune. People still perceive microfinance institutions similar to cooperatives and investment companies.
One of the reasons for higher lending rates is that most of the microfinance institutions lend on Kibor plus approach and at times the interest rates come close to 20% per annum. The rational behind higher interest rate is higher cost of fund as well as cost per transaction. The average amount of credit disbursed is often less than 50,000 rupees and at times as little as 5,000 rupees. Therefore, recovery of such a small amount in 12 or 24 installment results in exceptionally high cost per transaction.
According to many critics though, the amounts involved are very small but the real problem is that delay or inability to pay couple of installments increases the chances of delinquency. The borrower does not have the capacity and/or ability to settle the outstanding liability in one go.
For example a microfinance institution extends credit to a panwala and an incident of December 27, 2007 magnitude takes place and all types of businesses remain close for days, the repayment plan completely goes out of control. If shops and all types of businesses remain close for three days how could the borrower payoff his/her liability and also feed the family members.
There is a common saying that "big borrowers are habitual defaulters" and small borrowers are prompt in settling their liabilities and the probability of default is also low". However, small borrowers are more susceptible to "circumstantial default". The irony of the fate is that DFIs and commercial banks are always ready to reschedule payments of big borrowers but take the extreme measures in case on small borrowers.
As suggested earlier the preferred mode of lending in case of micro financing is developing an alliance with different NGOs, which mostly have close contacts with the community. However, the biggest fallout of this type of alliance is that NGOs try to overstretch their muscles and try to influence the lenders. These institutions try to further their inter-mediation power by acting as a "big broker". The net result is promoting the objectives of NGO supersedes the basic objective of ensuring funds for the small and most neglected borrowers. However, this is not big issue and can be overcome by creating a balance between the two players.
If the government, the NGOs, the regulators and the players are serious in developing microfinance institutions as sustainable entities they have to come up with appropriate rules of the games. The basic objective should be "lending for creating sustainable business entities" by ensuring availability of funds at affordable cost. The lending rates should not be more than Kibor plus 2%.
To ensure availability of funds at this cost, it should be made mandatory for the commercial banks to contribute one percent of their total deposits every year towards an endowment fund for the next five years. This should be interest free and accepted as part of salutary liquidity requirement (SLR). The central bank should manage this fund and microfinance institution should be allowed to borrow from this fund at 2% per annum interest rate.
One of the arguments against this proposal could be that "now central bank does not follow SRO-based lending". However, this is incorrect because the central bank fixes target for banks for lending to agriculture. Not only this but if banks fails to meet this target they are liable to pay penalty. This strategy has helped in higher lending to the agriculture sector. It is on record that at one time banks preferred to pay penalty rather than lending to farmers.
One of the reasons for being more than cautious in lending to micro enterprises is, "probability of loan becoming delinquent is higher". However, this risk can be minimized by getting insurance cover. Initially, this cost has to be borne by the lenders and after five years the cost should be equally shared by the lender and the borrower.
It is regrettable that the largest population of this country is still considered "un-bankable" because of low literacy level, lack of documentation and poor outreach of commercial banks. It is also on record that the rural population is reluctant in dealing with banks. Therefore, if microfinance finance institutions develop better understanding with the rural population this un-bankable segment of population can be developed into a strong bankable community.
To achieve this all the stakeholders will have to follow "out of box" strategy. Employees of the microfinance institutions have to come in contact with people understand their business plan and financing needs and also help them in documentation. Once the borrowers are able to develop trait to deal with financial institutions, they could also become a major source for mobilizing funds.