September 2008

MicrofinanceIndustry Assessment:A Report on Pakistan

MicrofinanceIndustry Assessment:A Report on Pakistan

CITI NETWORK STRENGTHENING PROGRAM

Published by Pakistan Microfinance Networkin collaboration with the SEEP Network

Funded by the Citi Foundation

ABOUT PMNPakistan Microfinance Network is a network of organizations engaged in

microfinance and dedicated to improving the outreach and sustainability of

microfinance services in Pakistan through knowledge management,

capacity building, transparency and advocacy.

ABOUT THE CITI NETWORK STRENGTHENING PROGRAM The Citi Network Strengthening Program - an initiative of Citi Foundation in

collaboration with the SEEP Network - aims to strengthen national and

regional microfinance networks' ability to positively impact the

microfinance sector. Participating networks will have access to a range of

support instruments including high quality technical assistance, operational

support, local expert advice and peer learning opportunities. As a result of

this support, participating networks will be able to further promote growth

and development of local microfinance industries, to strengthen their

strategic focus on providing value to members, and contribute to

international innovations in the field.

Microfinance Industry Assessment: A Report on Pakistan

First printed in 2008 in Pakistan

Copyright 2008 Pakistan Microfinance Network (PMN)

38-B, Street 33, F-8/1, Islamabad, Pakistan

Tel: +92 51 2816139-41

Fax: +92 51 2854702

Email: info@pmn.org.pk

Website: www.pmn.org.pk

Authored by Aban Haq

Edited by Minerva John

Designed and printed at Channel 7 Communications Pvt. Limited.

PMN does not guarantee the accuracy of the data included in this

document and accepts no responsibility for any outcome of their use.

MicrofinanceIndustry Assessment:A Report on Pakistan

ACRONYMS MICROFINANCE PROVIDERS

AKAM Aga Khan Agency for Microfinance BRAC Bangladesh Rural Advancement CommitteeAKRSP Aga Khan Rural Support Programme

CSC Community Support ConcernCFI Commercial Financial InstitutionCWCD Centre for Women CGAP Consultative Group to Assist the

Cooperative DevelopmentPoorDAMEN Development Action for CIB Credit Information Bureau

Mobilization & EmancipationDFI Development Finance InstitutionFMFB First MicroFinanceBank Ltd.DFID Department for International KB Khushhali BankDevelopmentNMFB Network MicroFinance Bank FIP Financial Inclusion Programme

Ltd.FMiA First Microinsurance AgencyNRSP National Rural Support ProgrammeFY Fiscal Year OPP Orangi Pilot ProjectGDP Gross Domestic ProductP-O MFB Pak-Oman Micro Finance BankGLP Gross Loan PortfolioPRSP Punjab Rural Support ProgrammeGoP Government of PakistanRMFB Rozgar Microfinance Bank Ltd.HDI Human Development IndexSAFWCO Sindh Agricultural & Forestry IFAD International Fund for Agricultural

Workers Coordinating Organization DevelopmentSRSP Sarhad Rural Support ProgrammeMFB Microfinance BankTF Taraqee FoundationMFI Microfinance InstitutionTMFB Tameer Microfinance Bank Ltd.MFP Microfinance ProviderTRDP Thardeep Rural Support ProgrammeMIFF Microfinance Industry Funding

Facility MoF Ministry of FinanceNBFI Non-Bank Financial InstitutionNSO National Savings OrganizationOSS Operational Self Sufficiency PMN Pakistan Microfinance NetworkPPAF Pakistan Poverty Alleviation FundPPSB Pakistan Post Savings BankPRSP Poverty Reduction Strategy PaperROA Return on AssetsROE Return on EquityRs. Pakistani RupeesRSP Rural Support ProgrammeSBP State Bank of PakistanSECP Securities and Exchange Commission

of PakistanNotes: Exchange rate in June 2008: 1 US Dollar SEEP Small Enterprise Education and (US$ 1) = 67.7 Pakistan Rupees (Rs.)Promotion

SME Small and Medium-sized EnterpriseSPV Special Purpose Vehicle

Source: www.exchange-rates.orgZTBL Zarai Taraqiati Bank Limited.

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Contents

Foreword

Country Overview1.1 Macroeconomic Situation

1.2 Demographic Profile

Financial Sector Overview2.1 Financial Service Providers

2.1.1 Commercial Banks

2.1.2 Non-Bank Financial Institutions

2.1.3 Microfinance Providers

2.1.4 Other Financial Service Providers

2.1.5 The Role of Informal Financial Markets

2.2 Access to Financial Services

2.2.1 Financial Penetration

2.2.2 Barriers to Access for Low-Income Population

2.3 Regulations and Government Initiatives

2.3.1 Financial sector reforms

2.3.2 Key Strategies for Financial Inclusion and Poverty Reduction

2.3.3 Regulatory & Supervisory Framework

Microfinance Sector in Pakistan3.1 History

3.2 The Retail Level Players

3.2.1 Microfinance Banks

3.2.2 Microfinance Institutions

3.2.3 NGOs and RSPs

3.2.4 Commercial Financial Institutions

3.2.5 MFPs in Pakistan compared across Asia

3.3 Meso-level Organizations

3.3.1 Networks and Associations

3.3.2 Technical Assistance and Training

3.3.3 Rating Services

3.3.4 Credit Bureaus

3.4 Funding

3.5 Impact

3.6 Challenges & Opportunities

References

Further Readings and Resources

List of Tables, Boxes & Figures

Table 1: Key Macroeconomic Indicators

Table 2: Social Development Indicators: Regional Comparison

Table 3: Poverty Profile of Pakistan

Table 4: Financial Penetration Rural vs. Urban (December 2006)

Table 5: Key Statistics for MFBs in Pakistan

Table 6: Key Statistics for MFIs in Pakistan

Table 7: Key Statistics for some NGOs and RSPs in Pakistan

Box 1: Employment Profile

Box 2: Micro-Insurance in Pakistan

Box 3: Financial Inclusion Programme (FIP)

Box 4: Microfinance Sector Development Programme

Box 5: Pakistan Poverty Alleviation Fund (PPAF)

Figure 1: Differentiating between Access and Use

Figure 2: Average Deposit & Loan Sizes of Different Financial Service Providers June 2007

Figure 3: Origin of Microfinance Providers in Pakistan

Figure 4: Active Borrowers by Peer Group (March 2008)

Figure 5: Projected Capital Structure of Microfinance Consolidated MFI/MFB Assets

Figure 6: Composition of Debt in 2010 (Rs. billions)

Figure 7: Top 5 MFPs in terms of Outreach and their Sustainability

Foreword

Although a number of reports and publications are available on the microfinance sector in Pakistan, there is no one comprehensive document that provides an overview of the sector with a historical and futuristic approach. This Industry Assessment is designed to provide such an outlook while meeting certain other objectives which include, but are not limited to:

i. Contextualizing the microfinance sector within the country's financial sector landscape and access to financial services

ii. Providing a snap-shot of where the industry stands today, the important trends at the retail and meso level, and the gaps in the market in the medium term.

iii. Identifying the challenges for the sector and providing an outlook on the expected future developments, at least in the medium term.

iv. Serving as a resource to support strategic planning for networks, network members and external audiences such as donors, investors, policymakers, etc.

Given the scope and objectives of the assessment, this report has been structured into the following sections:

i. Section I gives a brief description of Pakistan's socio-economic situation, with a focus on the demographics and social indicators in comparison to other countries, so as to put the country's development status in context for the reader.

ii. Section II provides an overview of the financial sector in the country with a focus on issues most relevant to the development of an inclusive financial sector, along with taking a look at the regulations and government initiatives aimed at expanding access to financial services. This discussion will look at the overall financial sector reforms, as well as developments with respect to the microfinance sector.

iii. Section III takes an in-depth look at the microfinance sector: its history, major players (at the retail and meso levels), funding sources, the impact of the microfinance activities to-date as well as challenges and opportunities for the sector.

To facilitate readers interested in more information on the sector, a reading list has been included at the end of the report. The report draws heavily upon existing research and publications along with some primary research based on interviews with sector stakeholders.

Pakistan Microfinance Network (PMN) is indebted to all who contributed towards this effort, especially the Small Enterprise Education and Promotion (SEEP) Network and Citi Foundation USA, and hopes this report will prove valuable for all audiences.

Country Overview

Pakistan's political and economic history has threat to the economy over the past year. Some been a turbulent one, with periods of stability of the biggest challenges for the policy makers and growth often followed by instability and today include double-digit food inflation that economic slowdowns. It is thus important to can push an increasing number of people understand the economic and social below the poverty line, an energy shortage environment of the country in order to fully resulting in a slowdown in production and understand the context of the microfinance investment, increasing international fuel prices

and poverty reduction (see Table 1 for a sector in Pakistan.snapshot of macroeconomic indicators over the past five years).

The last few years have been a period of high growth for Pakistan with an average GDP

Pakistan's socio-economic history reflects the growth rate of 7.0 percent during the last five country's constant struggle with sustaining years. Increasing investment, wide-ranging growth and improving the living standards of reforms, macroeconomic stability and its people. Periods of high growth have not reduction of poverty have been cited as major always translated into an improvement in the accomplishments for the economic managers social indicators and even today, Pakistan fares during this period. According to government poorly in comparison to other developing statistics, per capita incomes rose from US$ countries of the region on various social 586 in 2002-3 to US$ 1,085 by 2007-8. indicators, particularly those related to gender However, inflationary pressures and an and literacy (see Table 2 on next page). expanding twin deficit have emerged as a

1.1 Macroeconomic Situation

1.2 Demographic Profile

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FY04 FY05 FY06 FY07 FY08*

Real GDP growth rate (%) 7.5 9.0 5.8 6.8 5.8

Per capita income (US$) 669 733 836 926 1,085

Inflation rate (%) 4.6 9.3 7.9 7.8 10.3

Current Account Balance (% of GDP) 1.9 -1.4 -3.9 -4.9 -6.9

Fiscal Deficit (as % of GDP) 2.4 3.3 4.3 4.3 6.5

Foreign Direct Investment (US$ million) 949 1,524 3,521 5,140 3,482

Average exchange rate (Rs./ 1 US$) 57.6 59.4 59.9 60.6 61.6

Unemployment rate (%) 7.69 - 6.20 5.32 -

Table 1: Key Macroeconomic Indicators

* Data for FY08 pertains to July April. Source: Pakistan Economic Survey 2007-08, Finance Division, Ministry of Finance and Annual Report 2006-07, State Bank of Pakistan.

According to official statistics, 22.3 percent of employment seekers is thus one of the top the country's total population (approximately priorities of the government. 160 million) currently lives below the poverty

In addition to job creation, poverty alleviation with another 20.5 percent living in and provision of basic services are important vulnerable conditions (see Table 3 for the issues for the policymakers. Education and poverty profile of Pakistan for 2007-08). A large health facilities, sanitation, access to safe proportion approximately 79 percent of drinking water and infrastructure development these poor reside in rural areas. One of the in peri-urban and rural locations require challenges for Pakistan has been its rapidly targeted interventions. The lack of such increasing population, which has exerted facilities in these areas and little focus on pressure on domestic resources and labor development of agricultural value chains has markets. These pressures are expected to prompted urban migration, which has created increase, as currently 40 percent of the pressures on urban infrastructure and job population is under the age of 14 years. Job markets. creation to absorb the entry of potential

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Table 2: Social Development Indicators: Regional Comparison

PAKISTAN INDIA SRI LANKA BANGLADESH CHINA

HDI Rank* 136 128 99 140 81

Adult illiteracy rate (%) 50.1 39.0 9.3 52.5 9.1

Infant mortality rate (per 1000 births)

79 56 12 54 23

Life expectancy at birth (years)

64 63 71 62 72

Gender-related development index rank* 125 113 89 121 73

* Out of 177 countries: a higher rank implies a lower level of development. Source: Human Development Report 2007/08, UNDP.

Poverty Band Percentage of

Population

Estimated Head Count

(million)

Estimated Adult

Population (million)

Extremely poor [50% and 75% and 100% and 125% and 200% of poverty line]

20.9 33.63 21.9

Total Population 100 160.9 88.4 Source: Pakistan Economic Survey 2007-08, Finance Division, Ministry of Finance and PMN estimates.

Table 3: Poverty Profile of Pakistan

1 The national poverty line, according to the Government of Pakistan stands at Rs. 944.47 per month (for the year 2005-06), which is based on the conversion of a calorie intake of 2350 (adult equivalent) per person per day into Rupee terms.

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Box 1: Employment Profile

Approximately 73 million people are part of Pakistan's labor force, of which 72 percent are male. The official unemployment rate in 2007 was estimated to be 6.2 percent, although youth unemployment (between 15-19 years) was higher at 7.6 percent and urban unemployment at 10.1 percent.

Trends in the labor market show that employment indicators have changed in line with the economy's performance and structure in recent years. Agriculture is the largest sector with 43 percent of total employed people being related to this sector, although its share has been declining. This is followed by services (35.9 percent) of which wholesale and retail is the largest sub-sector, and then industry, of which manufacturing and construction are the largest sub-sectors.

The country's informal economy has also grown in recent years. The highest proportion of informal employment is estimated to be in the agriculture sector, followed by wholesale and retail, and industry. The majority of these informal workers are female.

Source: Pakistan Employment Report 2007, Government of Pakistan

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Financial Sector Overview

This section provides an overview of the Bank of Pakistan, remained in public hands, financial sector of the country, beginning with leaving only 20 percent of the banking system's a description of the financial service providers assets in the public sector. including banks and non-bank financial

By the end of September 2007, there were 36 institutions. Given the detailed discussion on commercial banks operating in the country, microfinance providers (MFPs) that follows in which included four public sector commercial the subsequent section, this sector is only banks, 26 domestic private banks (including discussed briefly here. A short discussion on the five Islamic banks), and six foreign banks. In role of informal financial markets is also addition to these institutions, there are four included. In addition, we also take a look at the specialized providing financial services regulations and government initiatives aimed at to the public. Together, these banks have over expanding access to financial services, including 7,500 branches across Pakistan. the financial sector reforms as well as the

developments with respect to the microfinance All commercial banks are full-fledged financial sector.service providers, offering products and services including credit, savings, investment and corporate banking, payment transfers, etc. One of the important trends in the banking sector in Pakistan's financial sector has undergone recent years has been the banks' aggressive significant reforms in the past decade, which movement into consumer finance including has resulted in the transfer of a large share of credit cards, financing of cars and consumer the sector from public to private hands. durables, and personal loans. Given the low Although there are other players in the interest rate scenario that existed until a couple financial system of the country, including Non-of years ago, this led to fast expansion in the Bank Financial Institutions (NBFIs), Insurance proportion of bank's credit portfolios tied up in Companies and MFPs, commercial consumer finance (increased from 2.2 percent dominate in terms of institutional composition in 2002 to 14.6 percent by 2007). On the with a share of over 70 percent in the financial liability side, high liquidity and stagnant low sector's assets. deposit rates meant banks earned huge profits, with the overall banking sector posting some of 2.1.1 Commercial Banks the highest returns in its history (2.1 percent return on assets (ROA) and 24.2 percent return The structure of the banking system in Pakistan on equity (ROE) for the year 2006). Although has changed considerably in the last 17 years. competition has increased in the wake of While in 1990 five state-owned commercial privatization, such high profitability means that banks dominated the system, by the end of there is little incentive for banks to move down 2004 only one of these large banks, National

2.1 Financial Service Providers

3banks

2banks

2 Namely National Bank of Pakistan (NBP), Habib Bank Limited (HBL), United Bank Limited (UBL), Muslim Commercial Bank Limited (MCB) and Allied Bank Limited (ABL).3 These are Zarai Taraqiati Bank Ltd. (ZTBL), Industrial Development Bank of Pakistan (IDBP), Punjab Provincial Co-operative Bank Ltd. (PPCBL), and SME Bank Ltd.

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market or into the rural areas. Currently, only 2.1.2 Non-Bank Financial Institutions 33 percent of the banking sector's branches are (NBFIs)in the rural areas where 67 percent of the population lives. This number itself should be There are a number of NBFIs in the country carefully interpreted since nearly all of the rural providing a range of financial services to the branches belong either to the five large banks public. These include investment banks, leasing or specialized banks, and are a legacy of the companies, mutual funds, housing finance pre-reform period rather than a post-reform companies and Islamic financial institutions development. such as . Some of these are

discussed below.Another major development in the banking sector in recent years has been the introduction Mutual Funds is a growing industry in the of the parallel Islamic banking system. The country, with a number of new entrants in current regulatory structure allows for banks to recent years and holding the largest asset base offer Islamic banking services through a) within the non-bank financial sector. By June setting up a full-fledged Islamic bank, b) 2007, there were 67 such funds in operation of establishing a subsidiary that provides Islamic which 21 were and the rest banking services, or c) setting up a separate , with combined assets of Rs.310 Islamic banking branch. Giving people the billion. Half of these were either equity funds or option of Islamic banking has important income funds.implication for access since there are a number of people who are hesitant to avail traditional Of the 23 licensed leasing companies, only 13 banking services on account of religious beliefs. were classified as active by end June 2007 with Although assets of the Islamic banks still make total assets of Rs. 65.8 billion. Nearly 80 up a small part of the banking system, growth percent of the sector's disbursements are in has been rapid (increased from 0.5 percent in plant and machinery, and vehicle leases. 2003 to 3.8 percent in 2007). Unfortunately, like traditional banks, Islamic banks have also The insurance sector in Pakistan is relatively restricted themselves to urban areas and do not small with insurance of only 0.7 really target the low-income population. percent. Of the 54 companies in the sector, 47

are engaged in non-life insurance business with Currently, the State Bank of Pakistan (SBP), the only five in the life insurance business and two country's central bank, is encouraging offering Islamic insurance (called Takaful). consolidation in the banking sector and has Micro-insurance has also begun to take root in imposed a moratorium on issuance of new Pakistan, although on the back of credit commercial banking licences [except for setting services within the microfinance sector. Box 2 up an Islamic bank or a Microfinance Bank on next page summarizes the developments in (MFB)]. All commercial banks are expected to micro-insurance in Pakistan. raise their minimum paid-up capital to Rs. 6 billion by the end of the year 2009 under the Like commercial banks, these institutions do new Basel II regime that SBP plans to launch in not target the lower end of the market and the coming year. This is expected to drive their operations are concentrated in the larger smaller banks into mergers with larger urban centres of the country. institutions, leaving a few strong players in the market.

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064 The Modaraba Companies and Modarabas (Floatation and Control) Ordinance, 1980 defines a Modaraba as a business in which a person participates with his money and another with his efforts or skill or both his efforts and skill shall include Unit Trust and Mutual Funds by whatever name called and a Modaraba Company as a company engaged in the business of floating and managing modaraba5 A collective investment scheme with a limited number of shares.6 A fund that raises money by selling shares of the fund to the public.7 Defined as 'gross premium as percentage of GDP'. This can be compared to India: 3.1 percent, Malaysia; 5.3 percent and the U.S.: 9.4 percent. Source: Financial Sector Assessment 2005. SBP.

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also provide financial services to the public. 2.1.3 Microfinance Providers Amongst these are the National Savings Organization (NSO) and Pakistan Post Savings A variety of institution types make up the retail Bank (PPSB). landscape of the microfinance sector: MFBs,

which are regulated by the central bank and The NSO acts as an agent for the Ministry of are relatively new entrants into the market with Finance (MoF) and mobilizes savings through an average age of 2-3 years; specialized various types of deposits and savings microfinance institutions (MFIs), which are instruments. Its products are available through NGOs providing microfinance services only; and its own network of 368 centers, as well as in multi-dimensional NGOs and rural support post offices and branches of commercial banks programmes (RSPs), which provide across the country. Some of the products microfinance as a part of integrated offered by the organization are of interest to programmes. Of these, only MFBs can small depositors, as the minimum deposit is intermediate deposits, although many non-low (Rs. 100 for a savings account, Rs. 500 for bank MFPs mobilize deposits from their credit some savings certificates and the special clients. Some also offer insurance services savings account). Prize Bonds sold by the NSO bundled with credit. also come in small denominations and are relatively popular with the urban poor. In March 2008, the sector's outreach stood at

approximately 1.6 million active borrowers and Besides its core function of handling mail, 1.7 million active savers, with a gross loan Pakistan Post performs various agency portfolio of Rs. 16.5 billion and Rs. 4.2 billion in functions for the government, including savings respectively. Pakistan's microfinance providing deposit services to the general public sector was amongst one of the fastest growing through half of the 13,000 PPSB branches. globally, with an expansion of nearly 47 According to estimates, the PPSB holds percent during 2007. Most of this growth was deposits worth Rs. 56.6 billion in approximately driven by a few institutions belonging to 3.8 million accounts, of which an estimated 70 different peer groups (section 3 provides percent are below Rs. 10,000. In October details on the microfinance sector in Pakistan). 2007, Pakistan Post entered into a public-private partnership with FMFB which will allow 2.1.4 Other Financial Service FMFB to use 4000 of the Post's sub-offices for

Providers expanding its own microfinance operations. FMFB expects to serve a million clients and

Although not considered mainstream disburse Rs. 15 billion over the next three to

institutions, some public sector organizations five years through this wide network.

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Box 2: Micro-Insurance in Pakistan

Given the sector's credit focus in the past, developments in micro-insurance have been limited and slow in terms of product development and diversification. By end March 2008, there were approximately 1.4 million policy holders in the microfinance sector, of which 70 percent are covered by life insurance (or more precisely, credit-life) and the rest by health. Kashf Foundation has the largest number of clients with insurance (approximately 600,000), followed by National Rural Support Programme (NRSP), which offers both life and health insurance.

Establishment of the First Microinsurance Agency (FMiA), as an affiliate of the Aga Khan Agency for Microfinance (AKAM), is the first concerted effort to promote micro-insurance in the sector. FMiA is currently working with a number of MFPs such as First MicroFinanceBank (FMFB), Tameer MFB, Khushhali Bank (KB) and Kashf to develop and offer credit-life and health insurance products. It also plans to extend its product range to livestock and crop insurance in the future. At the moment, the target market for FMiA and its partners are their credit clients. The extension of stand-alone insurance products will take a few years. FMiA's back office functions are handled by New Jubliee Life Insurance Company Limited.

In addition to this, NRSP has also partnered with Adamjee Insurance Company Ltd. to provide health insurance to its clients.

Source: PMN and interview with Marketing Manager, FMiA Pakistan.

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strong incentives for their .2.1.5 The Role of Informal Financial

Any discussion of the country's financial sector There is mounting empirical evidence that must also take into account the large role financial development contributes towards played by the informal financial markets, which economic growth and thus, an increase in the have a history predating formal markets and incomes of the people. It is also widely where contracts and agreements are accepted that financial services not only matter undertaken without any official regulation or in the context of overall economic growth, but monitoring. Pakistan's urban, and particularly also for the general well-being of the people, rural, areas are served by a wide variety of by helping smoothen consumption and informal agents, including moneylenders and mitigate risks. However, more often than not, aartis, or commission agents, who favor and especially in the developing/emerging interlinked transactions providing, for example, economies, financial systems tend to be inputs to farmers and undertaking to sell their skewed towards the relatively better-off . Suppliers' credit is common in segments of the society. established markets such as textile, and

informal finance is common in the transport 2.2.1 Financial Penetration sector as well as in the shoemaking, dairy and

livestock industries among others. Generally, The financial sector has grown considerably these credit markets are stand-alone markets, over the last few years but this expansion has not interlinked or linked to formal systems, not reached all segments of the population or although one study (Irfan et. al. 1999) found all regions of the country. Estimations and that as much as one-third of the credit choice of indicators to measure financial distributed through these systems originated in penetration vary due to data limitations and formal sources. lack of international consensus on how best to

quantify access, or lack thereof. World Bank Informal financial systems provide services (2007) uses a composite measure of access where formal financial markets are not based on the percentage of adult population available, and may also provide services with access to an account with a financial unavailable in the formal markets or a cost intermediary. In case of Pakistan, this is advantage or convenience unmatched by estimated to be 12 percent, compared to 48 formal . They are very common in percent in India, 59 percent in Sri Lanka and 32 Pakistan's Small and Medium-sized Enterprise percent in Bangladesh. On the other hand, SBP (SME) sector. To a degree, their popularity may estimates that 37 percent of adults have bank also be linked to the underground economy accounts. Given the realistic assumption that and to a desire to avoid taxation. Carried on as one individual may have more than one they are without formal contracts, these account, the actual percentage is likely to be systems are characterized by speed, ease and lower. flexibility, as well as the dense network of

personal relationships and dependencies in Other widely used indicators of financial which they are embedded. Thus, it is not only a penetration include population per bank lack of access to formal systems which allows branch and borrowers as a percentage of them to flourish; they are also used because population. In Pakistan's case, per bank branch they are quick, simple, and simultaneously population is one of the highest in the region provide a way of expressing social debts, with 20,450 persons per branch whereas the loyalties and responsibilities, thereby providing number of borrowers (including the 1.5 million non-financial as well as financial value. While borrowers in the microfinance sector) stood at the formal financial sector may face some 6.7 million, or 4.2 percent of the population in difficulty competing with the non-financial 2007. aspect of such economic relationships, the transparency, efficiency, customer Financial exclusion is also estimated to be more confidentiality and security, as well as the severe in rural areas compared to urban as competitive financial terms which can be shown in Table 4 on next page. Although 67 offered by formal institutions, do provide

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8 This section comes from PMN's publication Country-Level Savings Assessment Pakistan, April 2008. 9 Under such financing agreements, farmers are obliged to sell at a substantial discount. See Qadir (2005) for a discussion of informal credit markets.10 As indicated in a study by the Punjab Economic Research Institute (2005), informal financial systems are often equated with unscrupulous moneylenders but are extremely complex, involving a number of different actors providing different sets of products and services at varying rates, and the characteristics of such systems are attuned to the sectors they serve. Costs to the user vary substantially depending on the sector and whether, for example, farmers borrow in cash or in kind. In one study, carried out in the Liaqatpur tehsil of the Raheem Yar Khan district, there was no difference in costs to farmers when borrowing from formal or informal sources (Hussain and Demaine 1992). It is also pointed out by Qadir (2005) that sometimes illegal practices by banks can make formal credit at least as expensive as informal sources.11 For an overview of informal finance in Pakistan including case studies of a number of sectors, see Qadir (2005).

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percent of the population lives in rural areas, Oxford Policy Management (2006) estimates, only 33 percent of the bank branches are based on the Pakistan Socio-Economic Survey located in rural regions. Only 14 percent of 2001-02, show that approximately 41 percent rural adults have bank accounts compared to of total households were receiving credit but

75 percent of urban adults. only 3.3 percent of these loans were received Estimates suggest that a large proportion of from formal or semi-formal financial the low-income population of the country does institutions (these included the Agricultural not use formal financial services. According to Development Bank of Pakistan, commercial Nimal A. Fernando's 2007 report for the Asian banks, cooperatives and NGOs). Development Bank on low-income households' access to financial services, formal and semi- 2.2.2 Barriers to Access for Low-formal financial institutions reach no more than Income Population 10 percent of the potential market at the low end in Pakistan. The paper goes on to say that The discussion on access must take into the financial access problem is a bigger account the difference between 'access' and challenge in large countries such as China, 'use of financial services': whereas the former India and Pakistan and [a]s a result, vast refers to the supply of financial services, the numbers of poor and low-income people in the latter refers to the result of the interaction region are unable to take advantage of between demand and supply of these services. economic opportunities and gainfully employ Stijn Classens's paper Access to Financial themselves and their family members, and Services: A Review of the Issues and Public create employment opportunities for others; Policy Objectives for the World Bank in 2006 unable to build assets that increase their offers an interesting discussion on the income-earning capacity and quality of life; difference between the two: availability of unable to ensure that their children get basic services is a necessary, but not sufficient, primary and secondary education; and unable condition for use. Even in the presence of to manage the risks of vulnerabilities resulting service providers, barriers such as high costs, from various types of external shocks that information asymmetries, regulatory adversely affect their already low living requirements or low financial literacy may standards. result in low access.

Other studies have also indicated that the use Institutional (or supply) barriers to access may of formal institutions to meet financial needs is be classified into two categories: those related quite low, especially amongst the low-income to individual financial institutions and those groups. For example, in his study on informal related to the institutional environment. In finance markets in Pakistan in 2005, Adnan terms of problems related to individual Qadir cites that the percentage of farmers institutions, these could range from high using institutional agricultural credit is only 15 minimum deposit requirements or high service percent, but that this number may also be charges, inappropriate products or collateral inflated due to the common practice of large requirements to simply attitudes of the bank land owners borrowing in the name of their staff or financial literacy requirements. At the

, servants and family members. The environment level, it has been seen that the 12haris 09

12 In the Sindhi language, hari refers to the landless peasant hired by landlords to work on their land.

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Table 4: Financial Penetration Rural vs. Urban (December 2006)

Rural Urban Total % of Population Poverty Incidence

67.0 28.1

33.0 14.9

100.0 23.9

% of Bank Branches 33.0 67.0 100.0 % of total population having bank accounts % of adult population (+19 years) having bank accounts

6.0 14.0

37.0 75.0

17.0 37.0

% of deposits (number) % of deposits (amount)

25.0 9.9

75.0 90.1

100.0 100.0

% of advances (number) % of advances (amount)

17.0 7.1

83.0 92.9

100.0 100.0

Source: SBP Governor's speech, Financial Inclusion Conference, London, 19 June 2007

quality of legal systems, property rights, credit requirements such as money laundering information availability, technological guidelines require proof of identification development and regulatory requirements all that the poor may not have.influence access.

There is reluctance on part of commercial banks The SBP also recognizes barriers to access and to enter into new markets and they do not classifies : have the appetite to gauge market demand.

Inadequate information about clients in the 1. Geographical constraints: a large absence of a comprehensive credit

proportion of population lives in rural bureau/credit history records, lack of alternative areas and there are pockets of areas with delivery channels and financial innovation are low population density and difficult all hurdles in the goal of financial inclusion. remote terrain. Figure 2 below uses the average deposit and

2. Provincial-level environment weaknesses: loan balances to proxy current markets for lack of an enabling environment at the different financial service providers. The provincial level due to poor land records average deposit size clearly shows nearly all and weak law enforcement. commercial banks are targeting larger

3. Banking practices: banking sector's depositors whereas the MFBs, NSO and PPSB stagnation in terms of target market, are currently reaching smaller depositors. The traditional modes and products, and high average loan size of the banking sector also transaction costs. shows the same trend except that, unlike in

4. Illiteracy and/or poverty of clients: low deposits, average loan sizes for foreign banks financial literacy of clients or cultural and are relatively small compared to other banks. linguistic barriers due to which the This is largely because these banks hold a large awareness and understanding of financial portion of consumer finance and credit card services is low. portfolios of the sector.

5. Regulatory barriers: regulatory

13them as

10

Figure 1: Differentiating between Access and Use

Source: Claessens (2006)

With Access Without Access Current

Consumers of Financial

Services

Voluntary Exclusion Involuntary Exclusion

No need No awareness?

Assumed rejection Inability to use due to income/ price

Rejected: high risk/bad credit = No access

Rejected: Discrimination = No access

Excluded due to price, product, income or respondent feature = No access

13 Source: SBP Governor's speech, Financial Inclusion Conference, London, 19th June 2007

Figure 2: Average Deposit & Loan Sizes of Different Financial Service Providers June 2007

Source: Statistical Bulletin, State Bank of Pakistan

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Average Deposit Size

13471

163

584

22 12 150

100

200

300

400

500

600

700

All

Bank

s

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ecto

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Fore

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s

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SO

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Post

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Average Loan Size

412

280

11

628

460

0

100

200

300

400

500

600

700

All

Bank

s

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rBa

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Dom

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e Ba

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s

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(Rs.

000

)

(Rs.

000

)

2.3 Regulations and Government Initiatives

based lending practices improved their profitability as the sector's ROA and ROE rose from -0.5 percent and -12.6 percent in 2001 to 2.1 percent and 23.8 percent respectively by 2.3.1 Financial sector reforms 2006. The sector's stability indicators have shown considerable improvement. Aggregate Financial sector reforms were initiated in the number of borrowers has increased as banks 1990s in Pakistan with the objective to: have diversified into consumer finance and SME lending. 'create a level playing field for financial

institutions and markets for instilling Despite the success of the reform process, its competition, strengthening their governance impact on access to financial services for low-and supervision, and adopting a market-based income people remains questionable. As the indirect system of monetary, exchange and privatized banks rationalized their operations, credit management for better allocation of they closed down a number of branches in the financial resources.' (SBP Annual Report, 2002).rural areas (over 700 branches were closed between 1997 and 2000, of which over 330 Given this objective, a number of reforms were were located in unbanked areas). Although initiated within the banking sector. Private competition has increased, it has not resulted ownership of financial institutions was in the down-market movement of commercial encouraged and four of the five large state-banks to target the low-income segments nor is owned commercial banks were privatized. there any apparent interest to do so in the near Credit ceilings were abolished and banks were future. The policy makers thus feel that there is free to establish market-based rates. Higher a need to have focused strategies to increase minimum capital requirements, use of access. These are summarized in Section 2.3.2. technological platforms and standards of

corporate governance were institutionalized 2.3.2 Key Strategies for Financial and external ratings were made compulsory.

The central bank also underwent a number of Inclusion and Poverty changes in order to develop its capacity to Reduction effectively supervise and regulate the changing banking environment in accordance with I. STATE BANKS POLICY FOR international standards. Not only was SBP given FINANCIAL greater autonomy but extensive capacity building of its staff and technological base was

SBP believes that financial inclusion should undertaken. Banking laws (including the SBP focus on:Act, 1956; the Banking Companies Ordinance,

1962; the Banks (Nationalization) Act, 1974; Provision of full range of financial services the Banking Companies (Recovery of Loans)

i.e. going beyond credit to deposit and Ordinance, 1979 and the Banking Tribunals payment servicesOrdinance, 1984) were also amended in order Meeting requirements of individuals to allow the reform process to move ahead

smoothly. ranging from consumption to basic education, health and other services

In addition to the above, reforms were brought Catering to the requirements of small and about in the debt management process by new firms, anddeveloping a primary market for treasury bills Markets excluded by gender or to replace the on-tap system. The foreign [geographical] remoteness exchange regime was liberalized and indirect mechanisms for monetary policy management One of the key objectives of the financial were put in place. inclusion strategy of SBP is 'to support the

government's target of halving the income The reform process had very positive poverty headcount by 2015, and to eventually consequences not only for the health and reduce poverty to a single digit'. Major stability of the banking sector, but also the elements of the strategy include:whole economy. The cost of borrowing for the government decreased, with positive 1. The national level microfinance strategy implications for the fiscal deficit. Cleaning up (see section below for more).the banks' balance sheets along with market- 2. The Annual Branch Licensing policy: all

14INCLUSION

11

14 Source: SBP Governor Speech, 28th March 2008, Islamabad.

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commercial banks with 100 branches or 6. The SME financing strategy: to encourage more are required to open at least 20 lending to small businesses.

7. Promotion of Islamic banking: availability percent of their branches outside big cities of Shariah compliant products would allow and set up branches in the financial sector to serve those who do headquarters where no branch of any bank not currently avail its services due to exists. Sub-branches, booths and service religious reasons.centers may be established in places where

8. Development of commercially viable credit it is unfeasible to open a full-fledged enhancement mechanismsbranch.

9. Promotion of insurance products to 3. The Basic Accounts policy: Since November support micro and small lending: 2005, all commercial banks are required to proactively help develop Islamic insurance offer a 'Basic Banking Account (BBA),' products and work with private sector which can be opened with a minimum companies to develop non-collateralized deposit of Rs. 1000 and carries no fee, no lending and crop insurance products.minimum balance requirement and full

10. Promotion of electronic banking and use ATM facility. This account is targeted at the of technology.low-income people.

4. Promotion of the Post Office network: Some of these initiatives are already underway. explore possible collaboration between SBP has also partnered with Department for Pakistan Post and MFPs.International Development (DFID) for the 5. The prudential regulatory framework: implementation of a Financial Inclusion development of dedicated prudential Programme to enhance access of financial requirements for the different sectors such services to the poor in the microfinance, SME, as the Microfinance Ordinance 2001 and rural and the low income housing sectors. its supporting prudential regulations, Please refer to Box 3 for more on this prudential regulations for Agricultural partnership. Financing and Livestock Financing, etc.

15tehsil

1215 A 'tehsil' (called a 'taluka' in Sindh) is the second-lowest tier of local government in Pakistan. Each tehsil is part of a larger 'district' and each tehsil is sub-divided into a number of 'union councils'.

Box 3: Financial Inclusion Programme (FIP)

State Bank of Pakistan, with support from DFID, launched the Financial Inclusion Programme (FIP) in January 2008. With an estimated cost of 50 million over five years, the programme's purpose is to transform the level and quality of access to formal financial services in Pakistan, with a focus on increasing access for the poor and marginalized groups. FIP will focus on microfinance and small and medium enterprise finance in the first two years of the programme, whereas strategies for low income housing finance and rural finance will come into focus over the subsequent years, with Islamic banking and formalizing remittances being cross-cutting themes. Programme components include:

Development and management of a cohesive financial inclusion policy based on research and review.

Encouragement of financial innovation through funds to meet start-up and scaling costs.Improving delivery mechanisms through capacity building of human resources and

Institutional Strengthening Fund.

Development of a financial literacy strategy.Management, monitoring and evaluation of FIP

Source: IP Programme Office, State Bank of Pakistan.

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II NATIONAL MICROFINANCE unsustainable model will hinder the growth STRATEGY prospects of the microfinance sector.

Sustainability comes through effective cost The national level strategy for the microfinance recovery that calls for pricing loans in line with sector was prepared by the SBP in consultation the transaction costs, which could vary from with PMN, Consultative Group to Assist the client to client and from one region to another. Poor (CGAP) and other international agencies, Thus, subsidies should be restricted only for and was approved by the Prime Minister of poorer and resource deficit regions, capacity Pakistan in February 2007. The strategy focuses enhancement, innovation and growth rather on expanding the outreach of the sector and than regular operational costs.sets a target of three million active borrowers by the year 2010. The strategy proposes that Pakistan Poverty

Alleviation Fund (PPAF) should thus, define The goals and objectives of the strategy thus specific eligibility criteria for concessional are: financing to MFIs, and restrict such funding to

the following:I. Commercialization of microfinance is

critical to enhancing the outreach and MFIs willing to enter into contractual scale of the microfinance industry, and to obligations to eventually graduate to blending effectively both financial and adopting financially sustainable models.social sustainability in the operations. This Poorer/resource deficit regions where requires:

exceptionally high transactional costs render it difficult to operate in a socially Treating microfinance as a viable sustainable manner.

business that requires the market to Other recommendations for PPAF include:determine its pricing, aligning it to the cost of delivery and risk perceptions. Develop capacities and expertise to This, in turn, underscores the need for issue bonds and guarantees with an eventual phasing out of across-the- supportive government credit board reliance on subsidized lending, enhancement to raise the required which creates distortions and serves as domestic liquidity for a deterrent to growth and the MFBs/MFIs/NGOs.graduation of MFIs, and also renders Set up a center of excellence for commercially viable institutions

training microfinance providers and unprofitable.

clients with the support of PMN.Multiple players to infuse competition, Offer rating services that gauges MFIs'

which will be the principle element of default risk with regard to its overall as

offering clients competitive interest well as client obligations.

rates and service delivery.Focus on product innovation and best

practices.ii. Notwithstanding the above, geographical complexities make it difficult to deliver

Other recommendations of the strategy to commercially viable programmes to start with promote sustainable institutions include the in the poorer and resource deficit transformation of NRSP into a nationwide MFB regions/districts so: recommend confining to facilitate its development on a financially subsidized lending to these poorer and and socially sustainable basis, as well as to resource deficit regions/districts.bring KB under MFI Ordinance 2001 in order to offer a level playing field to all MFBs and sell The strategy stresses that the three things off the government's share in the bank to a which are essential for the sector to achieve its strategic partner.target include:

b. Private Domestic Capital: Achieving the a. Sustainable Operations: At the time of the three million active borrowers mark by 2010 preparation of the strategy, average lending implies that additional funds amounting to US$ rates in Pakistan's microfinance sector were 700 million would be required. It is impossible around 18 percent, well below regional levels, for donor or public resources to meet this gap, and leading to financial unsustainability (on and thus the sector will have to mobilize average, the sector's financial self-sufficiency private domestic capital. Sources for these stood at 62 . This financially funds are forecast as:

16percent) 13

16 Currently the sector's financial self sufficiency stands at 74 percent and the average lending rate is approximately 26.1 percent. Source: Pakistan Microfinance Review 2007, PMN.

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this defined segment of population that tend to be in local communities within total. SBP recommends facilitation of well-defined, geographical areas.private investors and allowance of Technology: Adopt innovative and subordinated debt as Tier II capital for

appropriate technologies that are designed MFBs. for helping upscale microfinance Savings banks should increase savings operations.from five percent to 25 percent of their Introduction of Credit Bureau for assets. MFBs and the meso level players

Microfinance Borrowers: SBP, in like PMN should thus undertake market collaboration with international experts, is research for designing the saving products developing an appropriate model for a for their customers, and the government Credit Information Bureau (CIB) in would assist their capacity building partnership with PMN, MFBs, MFIs and through the PPAF. Procedures to access NGOs in order to pool information on wholesale deposit windows of the borrowers and to facilitate prudent lending commercial banks should be developed. decisions about micro borrowers. However, mobilizing savings would require

sustainable institutions. Effective and synergistic use of Pakistan Post Office (PPO) resources: The Debt raise debt from domestic private government, SBP and PPO to reach sources such as commercial banks and consensus on their capacity to facilitate bond markets. The strategy recommends access to financial services. encouraging credit enhancement

mechanisms and guarantee funds. Other policy and regulatory initiatives: These include recommendations such as

c. Building the Human Resource Base: the incorporation of the requirement of Expanding outreach would create great public disclosure of social performance pressure on existing human resources in the (e.g. outreach to women, rural areas) by sector and the strategy forecasts that trained MFIs and NGOs, disclosure requirements to manpower of 20,000 (composition of which ensure transparent lending practices and will be: one percent senior management, 15 formulation of consumer protection laws, percent middle management and 84 percent removal of tax disincentives for MFBs, field staff) would be required by 2010. Of encourage Islamic microfinance, and these, training and capacity building needs are setting up of criterion for membership of minimal at the senior level. Most of the field clearing house for MFBs, etc. staff will be trained in-house and on-the-job.

III. NATIONAL POVERTY REDUCTION For this, organizations would need to build stronger internal recruitment, training and STRATEGIESretention plans. The real challenge lies at the

Poverty reduction remains a challenge for the middle management level, which typically is the Government of Pakistan. Recognizing the need bottleneck for growth. This level needs for a strategy that ensures pro-poor growth generalized management training. and coordinated efforts to tackle this Recommendations include: ensuring challenge, the government began a organizations build strong in-house training, consultative process in 1999 to develop a and developing a management training track at comprehensive poverty reduction strategy. This recognized centers such as academic and process resulted in an Interim Poverty professional training institutions. Reduction Strategy Paper (I-PRSP) in November

Accelerating growth beyond the 3 million 2001 and a full-fledged Poverty Reduction mark - Strategy Paper (PRSP) in December 2003.

The four pillars of the strategy as highlighted in Efforts in six additional areas could yield large the PRSP included:scale dividends past 2010:

i. Achieving high and broad-based economic New Players: Government to facilitate entry growth focusing particularly on the rural of international MFPs with proven track economy, while maintaining record in achieving large scale outreach. macroeconomic stability. This pillar set the Credit Union Models: Explore potential for agenda for macroeconomic management, setting up of credit unions (CUs) in Pakistan building supportive infrastructure, that are not-for-profit cooperative finance developing a rural development strategy institutions, owned and controlled by its and supporting housing finance.members catering to the requirements of

Equity will make up 15 percent of the

14

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ii. Improving governance and consolidating strategy paper, there are several pillars built devolution, both as a means of delivering into the framework including i) acceleration of better development results and ensuring growth and macroeconomic stability, ii) social and economic justice. This pillar crafting a competitive edge in global markets, summarized the way forward for reforms iii) harnessing the potential of the people, iv) in core government services such as the financial sector deepening, v) developing world police and civil service, increasing access to class infrastructure, vi) effective governance justice, devolution of power to local and management, and vii) targeting the poor governments, freedom of information and and vulnerable. Once again, microfinance media etc. figures prominently in the government's

iii. Investing in human capital with a renewed poverty reduction strategy. emphasis on effective delivery of basic social services: This pillar put forth the 2.3.3 Regulatory & Supervisory framework for development of education, Frameworkspecial education, health, provision of drinking water and sanitation facilities, and The financial sector is largely regulated by the population welfare. central bank i.e. SBP and the Securities and

iv. Bringing the poor and vulnerable and Exchange Commission of Pakistan (SECP). backward regions into mainstream Although all banks are required to register with development, and to make marked the SECP, the sector is regulated and supervised progress in reducing existing inequalities: by SBP. NBFIs including Development Finance This pillar focused on targeted Institutions (DFIs), leasing companies and interventions for the poor and vulnerable housing finance companies fall under the including specific programmes (such as the supervision of SECP, as do the country's capital Khushhal Pakistan Program), social safety markets. nets and provision of microfinance facilities. With respect to the microfinance sector, MFBs

are licensed, supervised and regulated by SBP The GoP sees microfinance as a viable tool for under the Microfinance Institutions Ordinance poverty reduction and thus supported the 2001, whereas non-bank MFPs, which are creation of the Microfinance Sector mostly registered under the Companies Development Program with the assistance of Ordinance 1984 as non-profit companies, or the ADB (see Box 4 for more on the MSDP). under legislation for societies or cooperatives,

fall under the domain of SECP. Given the changing economic environment and global context, the government is currently The Microfinance Institutions Ordinance 2001 working on PRSP-II. A summary draft of the largely provides the regulatory framework for paper has been recently shared with the microfinance sector in . The stakeholders for feedback. Like the previous Ordinance defines the scope of business for a

17 Pakistan

15

Box 4: Microfinance Sector Development Programme

As part of its poverty alleviation strategy, the Government of Pakistan in collaboration with Asian Development Bank (ADB), launched its Microfinance Sector Development Program (MSDP) in 2000. The objective of the programme was development of the microfinance sector in order to provide sustainable and affordable financial services to the low-income groups through formal financial institutions. Two loans were approved by ADB under the program: a policy loan of US$ 70 million to support the reform program and an investment loan of US$ 80 million to provide microfinance services and institutional strengthening. The first initiative under the program was the establishment of KB in August 2000. Other initiatives included the setting up of endowment funds with the SBP such as the Microfinance Social Development Fund for providing credit, the Community Investment Fund (CIF) to provide credit for small infrastructure projects, the Risk Mitigation Fund (RMF) to protect borrowers against natural calamities and the Depositors' Protection Fund (DPF) to protect borrowers in case of liquidation of KB.

Source: ADB. Finance for the Poor. Vol 2. No. 4. December 2001 http://microfinancegateway.com/files/3308_file_03308.pdf

17 The full text of the Ordinance can be viewed on SBP's website http://www.sbp.org.pk/l_frame/index2.asp

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1618 Khushhali Bank was originally established under the Micro Finance Bank Ordinance 2000 but was recently converted into a public limited company and brought under the MFI Ordinance 2001. This had been one of the proposals made under the national MF strategy 2007 to provide a level playing field.

microfinance institution, the paid-up capital and liquidity requirements, licensing policies for such institutions, the basic structure of its management and administration, and SBP's powers for supervision purposes, etc. A number of amendments have been made to the Ordinance since 2001 in consultation with the sector stakeholders to make the framework more conducive and rational.

The enactment of the MFI Ordinance has had positive effects on the microfinance sector in the country. It has helped re-define microfinance as a core financial sector activity with not only social implications but also commercial opportunities. To date, six have been established in the private sector under this Ordinance with their collective outreach accounting for approximately 32 percent of the sector's active borrowers in December 2007.

Since the promulgation of the MFI Ordinance, a number of supportive regulations have also been issued by the central bank including:

1. Prudential Regulations for Micro Finance Banks (2003)

2. Guidelines for Mobile Banking Operations (2003)

3. Guidelines for NGOs Transformation (2005)4. Fit and Proper Criterion for CEOs/member

of Boards of MFBs (2005)5. Prudential Regulations for Commercial

Banks to undertake Micro Finance Business (2006)

6. Guidelines for Commercial Banks to undertake Micro Finance Business (2006)

7. Branchless Banking Regulations (2008)

The non-bank MFPs largely remain unregulated and for this reason are prohibited from providing a full range of financial services. The central bank has encouraged these institutions to transform into MFBs if they wish to offer services such as savings to their clients and other market segments. Currently, two of the largest MFPs are in the process of setting up their microfinance banks.

18MFBs

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17

Microfinance Sector in Pakistan

This section takes an in-depth look at the Poverty Alleviation Programme (UPAP) were microfinance sector in Pakistan, starting from a some of the highlights of the year. Another historical perspective. The sector's landscape at milestone for the sector was the establishment the micro/retail and meso level is also discussed of a national association for microfinance in terms of the various players, their roles and providers in Pakistan in 1998, called the the important trends. A discussion on the Microfinance Group-Pakistan, which later documented impact and the various evolved into a formal organization in 2001 in opportunities and challenges that lie ahead for the form of the PMN. The establishment of microfinance in Pakistan are also discussed. PMN spurred a focus on transparency,

performance reporting, capacity building and tracking progress in the microfinance sector.

At the government level, concerted efforts for The presence of microfinance in Pakistan dates the promotion of the sector began in the year back to the 1960s when initiatives such as Dr. 2000 when an apex funding body, the Pakistan Akhtar Hameed Khan's Comilla Project Poverty Alleviation Fund (PPAF), started experimented with microcredit. Although there extending funds to partner organizations for were a number of initiatives during the microfinance, and the SBP set up a separate following decades including the Orangi Pilot microfinance division (which evolved into a full Project in Karachi, the Aga Khan Rural Support fledged microfinance department in 2007). Programme (AKRSP) rural credit and savings Legislation for setting up MFBs soon followed projects in the country's Northern Areas and in 2001 in the form of the Microfinance Chitral, and the Agricultural Development Bank Institutions Ordinance 2001, considered to be of Pakistan (now ZTBL) set up by the another turning point for the sector. This government to lend to poor farmers, it was not heralded the beginning of the 'commercial' era until the late 1990s that the sector gained for microfinance when microfinance was not momentum. viewed as just a 'social' service but rather a

The year 1996 is viewed as a turning point in sustainable financial enterprise as well. the history of the microfinance sector of Although an MFB, Khushhali Bank, had already Pakistan. This was the year that, for the first been established in 2000 by the government time, microfinance was recognized as a under a separate ordinance, the first private specialized activity and not just a part of multi- sector MFB, the First MicroFinanceBank Ltd., dimensional poverty alleviation programmes. was established in 2002 through the Establishment of the first specialized transformation of AKRSP's microfinance microfinance NGO (Kashf Foundation), the operations. To date, six MFBs have been spin-off of AKRSP's microfinance operations established in Pakistan (with two more into a separate unit to track financial expected as NRSP and Kashf are in the process performance, and the establishment of the first of setting up their affiliated banks), and several urban microfinance programme the Urban specialized microfinance NGOs are operating in

3.1 History

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the country (see Figure 3 for a timeline of government support (such as the tax origin of microfinance providers in Pakistan). exemption given to MFBs for five years, starting

from 2007) have been crucial in catalyzing the Thus, despite having a historical presence that growth of the sector in Pakistan. dates back to the 1960s, Pakistan's microfinance sector did not have a significant presence until recently. Previously, the sector was characterized by small players that relied The evolution of microfinance in Pakistan has on donor and government funding; pricing that led to different 'types' of organizations passed on subsidies to the clients and resulted providing microfinance services across the in unsustainability of institutions, and was country (see Figure 4 below for their respective entirely socially driven. The creation of a share in the sector). They can largely be network of institutions engaged in separated into institutions that are regulated

microfinance in Pakistan, PMN, proved and those that are unregulated. MFBs would undeniably useful in promoting international fall in the former whereas NGOs and RSPs, etc. best practices and policies, emphasizing the would fall in the latter category. As discussed importance of transparency and moving above, all microfinance providers are required microfinance towards sustainability. In addition to be registered either with the SECP, SBP or to this, macro-level initiatives like separate their respective provincial authority. However, legislation and regulatory framework for the the only significant regulatory oversight in the sector, development of a national level sector is provided by the SBP. microfinance strategy and other forms of

3.2 The Retail Level Players

18

CFIs: 18,290MFBs: 489,499

MFIs: 386,351RSPs: 621,054

NGOs: 75,932

Figure 4: Active Borrowers by Peer Group (March 2008)

Source: Pakistan Microfinance Network

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Source: Pakistan Microfinance Network

Figure 3: Origin of Microfinance Providers in Pakistan

SAFWCO

OPP

SRSP

NRSP

DAMEN

SUNGI

TF

1990 2000 1995 2005

Kashf

PRSP

TRDP

KB

Asasah

Rozgar MFB

Akhuwat

Network MFB

MULTI -DIMENSIONAL SPECIALIZED

FMFB

Tameer MFB

19

Although the range of financial services that an minimum paid-up capital required to set institution can offer is dependent on its legal up such a bank is Rs. 250 million.

d. A national level MFB, licensed to operate status, most MFPs are currently providing anywhere in the country. The minimum similar products and targeting similar markets. paid-up capital required to set up such a As in most countries, the sector is dominated bank is Rs. 500 million.by a few players in terms of market share and

growth, and these big players belong to various Other than the difference in capital peer groups/types of MFPs. These peer groups requirement, all types of banks face the same are discussed below. prudential regulations and can offer the same range of services to their clients. To date, six 3.2.1 Microfinance BanksMFBs - four national level and two district level (in Karachi district) - are operating in the Microfinance banks are relatively new players in country. The largest, in terms of market share the microfinance market in Pakistan, but have and geographic network, being KB (see Table 5 gained importance relatively quickly. All MFBs for key statistics of MFBs). are established under the Microfinance

Institutions Ordinance 2001 and are regulated Although banks can offer their clients services by the central bank. The Ordinance allows for other than credit, these products remain under setting up of four types of MFBs: developed, and with the exception of one or two institutions, not a lot of focus is placed on a. A district level MFB, licensed to operate developing deposit or insurance services. Most only within the prescribed district. The of the banks are currently using the same minimum paid-up capital requirement to group-based lending methodology as non-bank set up such a bank is Rs. 100 million.

b. A regional level MFB, licensed to operate MFPs, except for Tameer MFB, which deals with within five adjacent districts within the individual clients and offers larger loans same province. The minimum paid-up compared to the market average. However, capital requirement to set up such a bank MFBs such as First MicroFinanceBank Ltd. are

also diversifying into individual loans. is Rs. 150 .c. A provincial level MFB, licensed to operate

only within the prescribed province. The

19million

19 There was no provision to set up a regional level MFB in the original MFI Ordinance 2001. This regulatory change was introduced through the Finance Bill 2006, Section 18, Amendment 4 Clause (aa) and Amendment 5, Clause (a). For a look at other changes in the MFI Ordinance 2001, please refer to Ahmed and Shah (2007).

KB FMFB TMFB P-O MFB NMFB RMFB

Type of license National National National National District (Karachi) District

(Karachi) Year Founded 2000 2002 2005 2006 2004 2005

Outreach Indicators (December 2007)

Active Borrowers 330,952 102,604 26,029 15,008 2,305 2,316 Active Savers 0 81,158 44,560 15,762 2,891 4,565 Gross Loan Portfolio (Rs. Million)

2,911 1,234 427 97 60 34

Value of Savings (Rs. Million)

0 2,048 649 23 90 32

Financial Performance Indicators (December 2007) Operational Self Sufficiency (%)

80.1 89.7 47.3 60.4 46.0 49.0

Advances to Deposit ratio (%)

- 79.2 63.1 403.2 55.0 103.9

Portfolio at Risk - at 90 days (%)

0.7 0.8 4.6 5.9 8.2 13.9

Return on Assets (%) -9.3 -4.3 -21.4 -15.2 -17.4 -21.4

Yield on GLP - nominal (%) 21.7 27.4 28.8 24.2 28.4 27.0

Source: Pakistan Microfinance Network

Table 5: Key Statistics for MFBs in Pakistan

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(RSPs) are multi-dimensional organizations, 3.2.2 Microfinance Institutionswhich provide microfinance services along with

Microfinance Institutions (MFIs) are non-bank other interventions such as education, health or microfinance providers that specialize in infrastructure development to the poor. provision of microfinance services. Currently,

Institutions such as Development Action for five MFIs are operating in Pakistan and Mobilization and Emancipation (DAMEN), collectively, they reach 386,000 active Sungi Development Foundation and Centre for borrowers. These organizations are registered Women Cooperative Development (CWCD) fall with the SECP under the Companies Ordinance in the NGO category. This peer group 1984 as non-profit associations or under the collectively accounts for a small percentage of Societies Registration Act 1860, or as trusts the microfinance outreach with a five percent under the Trusts Act 1882, which fall under share of active borrowers in December 2007. provincial governments' jurisdiction. Given their Their services, usually limited to one or two non-bank status, they cannot 'intermediate' basic products, include credit and some basic deposits, although some do 'mobilize' savings insurance. International NGOs have also from their clients. Table 6 provides a snapshot entered the sector, with Bangladesh Rural of MFIs in terms of their outreach and financial Advancement Committee (BRAC) beginning performance. operations in 2007, and ASA expected to start this year.Currently, five major MFIs are operating in the

country. With the exception of one (SAFWCO), Rural Support Programmes originated in all others originated in Punjab and most of Pakistan during the 1980s when the first RSP - their operations are concentrated in this the AKRSP - was established in the Northern province. The flagship service of these Areas of Pakistan. In subsequent years, the RSP institutions is microcredit but some basic model based on community-organization and insurance services (mostly credit-life) are also mobilization was replicated across the country, provided to the credit clients. Group lending and currently there are over 10 RSPs operating remains the dominant lending methodology across Pakistan. These programmes are but some of the MFIs, such as Kashf and registered similar to microfinance institutions Asasah who are diversifying into larger loan and NGOs. The RSP mandate is primarily to sizes, are beginning to deal with individual work in rural areas and their services include clients as well.

not only microfinance but also infrastructure 3.2.3 NGOs and RSPsdevelopment, education and health. With respect to microfinance, they are the largest Both NGOs and Rural Support Programme

20

Source: Pakistan Microfinance Network

Table 6: Key Statistics for MFIs in Pakistan

Asasah Kashf SAFWCO Akhuwat OPP

Year Founded 2003 1996 1986 2001 1987

Outreach Indicators (December 2007)

Active Borrowers 24,692 295,275 16,742 10,194 22,129

Active Savers 24,692 - - - -

Gross Loan Portfolio (Rs. Million) 192

3,046 103 58 153

Value of Savings (Rs. Million)

4 - - -

Financial Performance Indicators (2007)

Operational Self Sufficiency (%)

64.7 164.0 90.4 64.8 224.7

Advances to Deposit ratio (%)

-12.8 9.3 -7.0 -11.9 12.6

Portfolio at Risk - at 90 days (%)

0.0 0.1 3.6 0.4 0.3

Return on Assets (%) 37.0 36.2 15.7 11.1 19.7

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Microfinance Institutions, released by the Asian peer group, accounting for 36 percent of active Development Bank in April 2008, ranks borrowers in December 2007. However, this individual MFPs across Asia along nine large share can mostly be attributed to the performance parameters including outreach National Rural Support Programme (NRSP), (borrowers and depositors), scale, market which accounts for 80 percent of this peer penetration, growth, profitability, efficiency, group's outreach. Again, due to their productivity and portfolio quality. Of the 392 multidimensional nature, the microfinance institutions included in the analysis, the only services offered by most RSPs are limited to one microfinance provider who managed to be or two basic credit products. RSPs also mobilize ranked in eight of the nine categories was from savings from their members but these are Pakistan Kashf. Institutions that figured deposited in commercial banks in the name of amongst the top 20 within different categories the community organizations. Health, along included Khushhali Bank in terms of outreach, with life (or more precisely credit-life) FMFB in terms of growth, and Thardeep Rural insurance, has also been recently introduced for Development Programme (TRDP) and Orangi members. Pilot Project (OPP) in terms of .

See Table 7 for some headline statistics for these two types of MFPs.

3.2.4 Commercial Financial Institutions The meso level players have an important role

within the financial sector. They make up the To date, there has been limited interest of financial sector infrastructure, providing commercial financial institutions in the support services such as technical assistance, microfinance sector, especially as far as direct training and access to information. Within the provision of these services is concerned. At the microfinance sector in Pakistan, a number of moment, only two CFIs, namely Bank of Khyber organizations make up the meso level. (BOK) and Orix Leasing Pakistan Ltd. are involved in this business and their share in 3.3.1 Networks and Associationsoutreach is only a small one percent.

Pakistan Microfinance Network (PMN) is the 3.2.5 MFPs in Pakistan compared only national level network for microfinance

practitioners in the country. It emerged after across Asiathe first Microcredit Summit held in 1997 as an informal effort by some practitioners, and was The 2007 MIX Asia 100 Ranking of

20productivity

3.3 Meso-level Organizations

21

Source: Pakistan Microfinance Network

Table 7: Key Statistics for some NGOs and RSPs in Pakistan

NRSP PRSP DAMEN CSC

Year Founded 1991 1998 1992 1989

Outreach Indicators (December 2007)

Active Borrowers 407,641 69,361 32,627 15,525

Active Savers 760,425 333,714 - -

Gross Loan Portfolio (Rs. Million) 4,711 552 250 114

Value of Savings (Rs. Million)

969 82 - -

Financial Performance Indicators (2007)

Operational Self Sufficiency (%) 101.2 65.8 108.7 85.1

Advances to Deposit ratio (%) -1.8 -12.0 0.6 -8.3

Portfolio at Risk - at 90 days (%) 0.5 19.1 1.7 1.0

Return on Assets (%) 21.7 13.6 34.8 12.1

20 To see the complete rankings, please refer to the ADB's 2007 MIX Asia 100 Ranking of Microfinance Institutions

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formally registered with the SECP as a non- how gap through the services of international profit company in 2001. Its membership microfinance consultancy organizations (like currently includes 20 organizations from the Women's World Banking, ACCION, Mennonite various MFP peer groups who collectively Economic Development Associates and account for over 95 percent of the sector. The Development Innovations Group), these network's vision and mission revolve around organizations lack a local presence. ShoreBank expanding access of formal financial services International (SBI) is currently the primary and supporting retail institutions in achieving microfinance advisory and capacity building this objective through its services including service provider with a long-term local research, capacity building, promotion of best presence, offering a combination of practices and transparency, networking with international expertise and an understanding of policymakers and stakeholders, and knowledge the local context through a team of management. Its efforts towards promoting international and country-based consultants. transparency and creating an enabling Usually, SBI provides technical assistance to environment for microfinance in Pakistan have individual institutions but it has also been widely recognized. undertaken sector-wide initiatives. For example,

in 2007, SBI launched a Human Resource A few provincial level networks are also Development Initiative with the objective of operating in the country but except for the improving the quality of human resources Sindh Microfinance Network that was available to the microfinance sector in Pakistan. established through the efforts of the local The initiative targets the middle management NGOs, others have failed to move forward. through generic, sector-wide trainings;

customized training delivery to individual MFPs; Microfinance banks are also members of the and development/advice on institutional human Pakistan Bankers' Association (PBA), which was resource strategy and policies.established in 1953 to coordinate the efforts of the banking industry in Pakistan. 3.3.3

3.3.2 Technical Assistance and The JCR-VIS Credit Rating Company is one of two local providing ratings for financial institutions in Pakistan. It is also the

Training needs of MFPs vary for each level of only company that provides ratings for MFBs management. It is widely accepted that most and MFIs. MFBs are required to be rated organizations prefer to set up in-house training annually as per SBP's requirements, but some facilities that can provide customized trainings MFIs have also had themselves rated in order to to their field staff tailored to their own product ascertain 'where they stand,' or as part of their features, procedures and policies. The middle strategies to access commercial funding in the and senior management, on the other hand, future. require more generic tools and these can be provided through sector-wide training 3.3.4 Credit Bureausprograms.

Currently, there is no credit bureau in Pakistan One of the major roles for PMN in its initial that covers the entire microfinance sector. The years was to provide training services to the largest credit bureau is the CIB, housed in and microfinance sector. However, its major run by the central bank, and all banks are functions have evolved away from training over required to submit information on all recent years, and its strategy is to promote the outstanding loans to the CIB. Microfinance private sector to step in and fill this gap. banks are also required to report to the CIB. In Currently, PMN provides only two trainings per addition to SBP's CIB, a few private sector credit year, mostly aimed at middle management and bureaus also exist but they mainly serve the open for both members and non-members. banking sector. Along with this, it offers a number of international training courses to the senior However, efforts are underway to establish a management of its members. credit bureau for the microfinance sector. Due

to the strong interest of its members, PMN has Although Pakistan's microfinance sector has begun working on setting up a pilot credit bridged the experience and technical know- bureau in Lahore, covering all MFPs working in

22Rating Services

21 23companiesTraining

2221 Parts of this section come from PMN's publication Country-Level Savings Assessment Pakistan, April 200822 This section comes from PMN's publication Country-Level Savings Assessment Pakistan, April 2008.23 The other company is the Pakistan Credit Rating Agency Limited (PACRA). Foreign banks are rated by international rating agencies such as Moody's and Standard & Poor's.

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the district. Initially, this will house negative take the lead and the sector moves along a fast information only and is mostly intended to be a growth trajectory, these sources will prove test run for a full fledged, country-wide CIB for insufficient. the sector. In addition to the PMN, the ADB has

PMN projections show that by 2010, the sector also undertaken a feasibility study for the will experience a seven-fold increase in gross establishment of a CIB for the sector and their outstanding loans and a six-fold increase in its report is expected soon. asset base. In 2007, assets available in the sector stood at roughly Rs. 30 billion (23 billion already on the balance sheets of MFIs/MFBs, and another additional Rs. 7 billion of available The changing landscape of the microfinance funds with PPAF), which implies that there will sector in Pakistan also translates into changes be an incremental additional requirement of Rs. in the sources of funds for the sector. Given 40 billion by 2010. The expansion is projected that NGOs have dominated the sector in the to proceed as per Figure 5 below, which breaks past, donor money and apex lending (see Box 5 funding sources into four broad categories. for an overview of the apex funding body in

Pakistan) have played an important role in funding the microcredit market. However, as more commercially oriented players begin to

243.4 Funding

This raises some important issues related to factors driving capital structures:

23

Box 5: Pakistan Poverty Alleviation Fund (PPAF)

Currently, the only significant wholesale funding agency for microfinance is the PPAF, which was established in 2000 as a not-for-profit private company sponsored by the GoP and funded by the GoP and the World Bank. It was inspired by the success of Palli Karma-Sahayak Foundation (PKSF) in Bangladesh, which has a more narrow focus on microfinance. The PPAF was established to help the poor by enabling them to gain access to resources for their productive self-employment, to encourage them to undertake activities of income generation and poverty alleviation, and for enhancing their quality of life. As an Apex fund, PPAF disburses soft loans to a myriad of microfinance institutions in Pakistan. It cannot provide loans to MFBs since PPAF requires MFI/MFBs to give a charge on their loan book, and as per the prudential regulations for MFBs, they cannot give such a charge unless approved by the central bank. It also provides grants on a cost-sharing basis for development of small-scale community infrastructure, and strengthens development and MFIs by supporting their capacity buildin