- The role of microfinance institutions in poverty alleviation
Poverty is a pandemic that has attracted policymakers and researchers to postulate channels of poverty alleviation which need an immediate address so that the societies’ living standards can be improved.
According to the World Bank, 71 million-plus people on the continent have already been pushed into extreme poverty by the outbreak of Covid-19. Millions more are teetering on the brink. Research has shown that poverty can only be destroyed if societies are equipped with the necessary resources to quick jump-start their income economic activities such as small-scale farming, small business, and sole trading. According to the World Bank, poverty is pronounced deprivation in well-being and comprises many dimensions. It includes low incomes and the inability to acquire the basic goods and services necessary for survival with dignity. Poverty also encompasses low levels of health and education, poor access to clean water and sanitation, inadequate physical security, lack of voice and insufficient capacity and opportunity to better one’s life. World Bank says, if a person lives on $1.90 a day or less, they are living in extreme poverty. Currently, it is estimated that 767 million people in the world fall under that category. The poverty rate in rural areas is comparatively higher than that in urban. Poverty alleviation is the set of steps taken in an economic and humanitarian way to eradicate poverty in a country. Poverty alleviation, poverty reduction or poverty relief is a set of measures that raise and are intended to raise ways of enabling the poor to create wealth for themselves as a conduit of ending poverty forever. Poverty reduction occurs primarily as a result of overall economic growth. Theoretically illustrated that poverty alleviation involves improving the living conditions of already poor people.
The concept of microfinance has been present in rural and urban areas in the form of unsupervised cooperatives since a fairly long time. However, microcredit as a revolutionary social phenomenon was started by the Grameen Bank during the 1970s. Since then, the progress of microfinance in the world and especially in Asia has been inspired by the success story of the Grameen Bank. Established by Dr. Muhammad Younus to cater to the needs of the poor and the unprivileged segments of society on an experimental basis, Grameen Bank facilitated access of credit to the poor, especially women, with the aim of eradicating poverty and unemployment, the primary concern of any developing country. It not only provided funds to people generally considered to be financially unstable, but also proved that these people are credit-worthy, by a proven track record of recovery of loans at above 98 per cent.
Microfinance institutions (MFIs) are non-negligible financial intermediaries in the financial systems of less developed countries (LDCs) and emerging economies. MFIs, by their nature, have a completely different scope to banks and nonfinancial firms. They are hybrid organizations or institutions that combine a banking (sustainability, customers) and a development logic (poverty alleviation, beneficiaries). Over the past decades, microfinance has emerged as an effective instrument of financing for development and is now recognized as a development and financial inclusion tool although there is still a debate on the magnitude and importance of its real social impact. However, findings on the impacts of microcredit continue to evolve. Early evidence from randomized evaluations in low- and middle-income countries showed that the classic microcredit model did not lead to transformative impacts on income or consumption for the average borrower across many contexts. However, a subset of high-potential entrepreneurs saw high returns to microcredit. More recent research similarly finds that certain groups like experienced business owners can have high returns to credit, and the benefits of microcredit can extend to non-borrowers.
Evaluations of innovations to microcredit products, such as targeting high-potential entrepreneurs or providing flexible repayment options, led to higher business and household outcomes and show promise for financial service providers looking to reduce poverty through credit. Moreover, adjusting the mode of loan disbursement can crucially increase women’s control of capital.
Many policymakers are interested in entrepreneurship as a potential pathway out of poverty, and several studies show that small-scale entrepreneurs have access to high-return investments. Yet, low-income households have historically had limited access to financial services such as credit, savings, and insurance products that could lead to increased investments. Microcredit was designed to overcome credit market failures and help low-income borrowers take advantage of investment opportunities. It expanded access to credit around the world, typically in the form of small business loans with relatively high interest rates and immediate, biweekly loan repayments. In 2018, around 140 million people around the world were active borrowers from a microcredit institution, a 43 per cent increase from 98 million in 2009.
Giving the poor access to affordable financial services enables them to seize livelihood opportunities, manage cash flow spikes, and mitigate risks. About 2.7 billion people worldwide, or 70% of the adult population in the world’s developing countries, have no access to formal financial services, such as savings or checking accounts.
The microfinance revolution provided loans to the poor by requiring social collateral in place of physical assets. It has grown into a $70 billion industry with an estimated 200 million clients. The average penetration of microfinance among the poor in countries with ADB support remains low at nearly 20% of the population at the end of 2011. Microfinance aims to reach out to poor clients, women in particular. However, the poorest segment of the population does not form the majority of microcredit clients because of lack of opportunity or ability to generate cash flow for loan repayment. There is a need to link microfinance services to complementary pro-poor interventions, such as livelihood programmes, food aid, skills training, and asset transfers that help people in extreme poverty to become economically active and creditworthy. There is ongoing public debate over the effectiveness of microfinance in reaching the poor and improving their welfare. A review of ADB’s microfinance programmes in Pakistan and Vietnam shows that smaller loans are better at targeting the poor but not as effective as larger loans in producing welfare benefits. ADB is one of the largest providers of microfinance support in the Asia and Pacific region. Over two-thirds of ADB’s microfinance portfolio supported the creation of an enabling policy environment for microfinance in recipient countries. Technology-based solutions, such as mobile phone and internet banking, payment cards, and electronic money, can help microfinance institutions reduce operating costs and expand the reach of their services.
There are three types of sources of microfinance:
- Formal institutions (i.e., rural banks and cooperatives)
- Semiformal institutions (i.e., nongovernment organizations)
- Informal sources (i.e., money lenders and shopkeepers).
Microfinance institutions are challenged by changes in competition, which impact them in various ways. Competition among microfinance institutions is unique because service to the poor, rather than profit alone, is their primary goal. Scientific research on microfinance institutions has increased dramatically over the last two decades.
It is widely acknowledged that small businesses can play a critical role in achieving sustainable growth in developing countries. This is especially true in Pakistan, where nearly 90% of companies are SMEs, most of them operating in the informal sector. As Pakistan’s government seeks to achieve its aim of becoming an upper-middle-income economy by 2025, helping these companies grow is a crucial part of efforts to increase financial inclusion and reduce poverty. When the government launched Vision 2025, it emphasized the importance of a development strategy for small business, highlighting in particular the need to improve access to finance and build financial literacy skills, and to simplify regulations to make it easier for people to set up and build a successful business. Reinforcing this, the State Bank of Pakistan sees microfinance as ‘pivotal for inclusive and sustainable economic growth of the country; crucial to livelihood creation; and a key driver of grass-root-level development.
As part of its National Financial Inclusion Strategy, in 2016, the government has created the Pakistan Microfinance Investment Company (PMIC), as a joint initiative backed by the Pakistan Poverty Alleviation Fund (PPAF) and the UK’s Department for International Development, through the non-profit organisation Karandaaz Pakistan and the German development bank KfW. It is registered as an investment finance company, operating under the country’s non-finance banking company regulations administered by the Securities and Exchange Commission of Pakistan. It is providing finance direct to target sectors as well as offering funding and support to other microfinance lenders.
Initiatives financed so far include renewable energy, crops and livestock, micro-insurance and digital finance; priorities for 2018 include low-cost private schools and housing.
In addition to contributing equity of US$60m to reinforce PMIC, its backers have also committed to providing a further US$140m in unsecured and subordinated debt. It is also strategically placed to raise funds from commercial banks as well as capital markets, using bonds and other financing tools.
PMIC’s key target borrowers are microfinance banks and other non-bank microfinance institutions. ‘Almost 44% of [all Pakistan microfinance] loans have been extended for agriculture and related business, while another 46% have been granted to small entrepreneurs for their micro businesses.
Managing the PPAF’s loan portfolio of PKR14.2bn (US$126m) of 30 microfinance institutions and banks is also vital. Partners are offered a range of funding instruments and financial services, such as senior debt, guarantees, debt syndication and subordinate debt. PMIC also offers to place equity in institutions that can accelerate their growth, boost their management and regulatory controls and offer more loans. In lending direct to businesses and partners, PMIC prioritizes women, who are better clients, exhibiting greater financial discipline, investing more in family, household durables and business expansion. The organization is also focused on developing financial products to support women-centric businesses, such as embroidery and stitching businesses, farm product initiatives, start-up incubation labs and low-cost private schools. Indeed, PMIC advises borrowing institutions to give women lending priority – so far 76% of PMIC-financed loans have been extended to women.
Ever since venture capital (VC) started flowing into Pakistan, the local ecosystem has seen polarising debates on whether the companies being built are sustainable, given their generally questionable unit economics.
From unbelievably high losses to calls for investigating lax corporate governance mechanisms, the space receives a high dose of flak, both fair and unfair, that may be disproportionate to the underlying scale. According to the State Bank’s Financial Stability Report, microfinance banks cumulatively posted a red bottom line for the fourth year straight. The post-tax loss of the sector reached Rs17.2 billion in 2022, significantly worsening from Rs8.08bn in 2021.
The number of loss-making institutions increased to six in 2022 from four in 2021. For quite a while now, some of the more notable players have been relying on the largesse of their sponsors for capital injections to continue operations — not too dissimilar to the VC-backed businesses. Similarly, the total capital to risk-weighted assets continued its downward trajectory for the fourth consecutive year, declining to 10.9 per cent in 2022 from 18.3pc in 2021. This is lower than the minimum mandated capital adequacy ratio for microfinance banks set at 15pc. The tier-one capital position has also posted a similar trend, falling to just 8.1pc.
While the sector only accounts for 2.2pc of the overall banking deposits, it still holds outsize importance due to the strong market penetration. As of 2022, there were 90.8 million microfinance bank accounts, of which 5.3m were borrowers with outstanding loans of Rs361.7bn.
During the first quarter of 2023, the microfinance industry achieved a significant milestone by crossing the PKR 500 billion mark in gross loan portfolio and penetrating almost one-fourth of the potential market. The number of active borrowers increased to 9.3 million, which represents a 1.8% increase on a quarter-on-quarter basis. A similar increasing trend was observed in the women clientele, with a 2% increase. Splitting the clientele into two peer groups, MFBs had 6.1 million active borrowers while NBMFCs had 3.2 million. MFBs had 66% of the total clientele, and 38% of the clientele was contributed by Nano Loans, closing the number of Nano Loans at 2.3 million. On the Gross Loan Portfolio front, the portfolio increased by 3.7% to reach PKR 509 billion. Splitting the Gross Loan Portfolio, MFBs closed their portfolio at PKR 394 billion, which translates into an increase of 4%, while NBMFCs closed their portfolio at PKR 115 billion, which translates into a 3.5% increase. In terms of market share, MMFB leads the clientele front with 2.6 million clients (43%), followed by KBL with 0.7 million clients (12%). On the Gross Loan Portfolio side, HBL MFB leads the landscape with a portfolio of PKR 92 billion (18%), followed by KBL with PKR 89 billion (17.5%). Analyzing the Loan Disbursement segment, the overall number of loans disbursed, and the disbursement value decreased by 6.1% and 19%, respectively. The total number of loans disbursed was 6.5 million, translating to PKR 136 billion in value. The recoveries in the flood portfolio have further decreased in delinquencies where PAR > 30 days experience another decrease from 5.6% to 5.3%. Unsecured Lending has been a primary source of lending, with almost two-thirds of lending through unsecured lending, while urban lending has increased by 5%, reaching 58% of total lending based in urban settings. Micro-savings indicators also displayed mixed trends in comparison to the credit side. The depositor base increased by 4.4% to reach 98 million, and TMFB increased its depositor base by 8%, adding 2.5 million depositors to its savers’ portfolio. MMFB and TMFB continued to dominate the market with a total of 81 million active saver bases. While there was a considerable increase in depositor base, there was a contrary trend on the deposit front, bringing the total to PKR 487 billion at the end of Quarter 4, 2022. The withdrawal by institutional investors and maturity of TDRs led to a decline in deposit value, where KBL experienced noticeable decrease of PKR 16 billion, followed by U Bank with a decrease of PKR 7 billion. However, despite the fall, KBL closed its deposit portfolio at 96 billion, representing 17% of the market, while HBL MFB leads the deposits landscape with a 23% market share and deposit value of PKR 110 billion. On the micro-insurance front, indicators demonstrated myriad trends, closing the figure at 8.4 million policyholders, an increase of 2.5% compared to the previous quarter. The insurance portfolio decreased from PKR 316 billion to a closing figure of 294 billion at the end of Quarter 1, 2023. The main reason for the decrease is that one MFI, Akhuwat, has stopped reporting credit insurance in their financial statements under insurance. This change was made following discussions between Akhuwat and SECP, whereby it is decided to reclassify insurance portfolio as contributory fund and hence must not be reported under microinsurance portfolio. Overall, the average loan size and average saving size decreased which is primarily linked to increase in Nano Loans and M wallets.
In the saving department, too, growth is visible for the sector. The number of savers reached really close to the 100 million mark, standing at 98 million as of March end 2023, growing 17 per cent year-on-year. The growth is primarily fueled by mobile wallets, which account for 87 per cent of active savers (albeit m-wallets’ share in ‘value’ pie of savings is small, as these are low-value deposits/savings by users). As of March 2023, 31 per cent of savers were females and 25 per cent of savers lived in rural areas.
The Pakistan Microfinance Network (PMN) is the microfinance sector’s prominent body representing about four dozen service providers, including Microfinance Banks (MFBs), Microfinance Institutions (MFIs), Rural Support Programs (RSPs) and other organizations that provide microfinance services as part of their overall service offering. About two-thirds of the sectors reported ‘active borrowers’ are served by MFBs, about a quarter by MFIs, and about a tenth by RSPs. Some 97 per cent of sector’s deposits are held by MFBs, and rest by RSPs.
Based on the latest data released by PMN, the headline figures for both the lending (credit) and saving (deposit) areas are robust, growing in double-digits year-on-year in the first three months of the calendar year to March. Some of the growth is contributed by the digital financial services, as the nano-loans and the mobile wallet-based savings are becoming prominent as the time goes by.
At the end of March 2023, the number of active borrowers of the microfinance sector had reached 9.25 million, reflecting 13 per cent increase (over a million net additions) since March 2022. As of March end 2023, PMN data show that 45 per cent of active borrowers were females. Some 42 per cent of active borrowers belonged to rural areas. Active borrowers belonged to a number of sectors, the prominent ones being livestock/poultry, trade, agriculture, services sectors, manufacturing/production, and housing. During this quarter, the sector reached an important milestone, as Gross Loan Portfolio (GLP) crossed half a trillion mark to close at Rs510 billion by March end (growth of 22% YoY). Since the addressable market of micro borrowers is 4+ times larger than existing coverage, there is opportunity to expand the loan book. As of March end 2023, nearly two-thirds of the sector GLP was ‘unsecured’ lending, whereas the remaining was ‘secured’. Micro-enterprises comprised 22 per cent of the sector’s Rs510 billion GLP.
The aggregate saving value in microfinance sector reached Rs488 billion as of March 2023, which translates into 14 per cent growth compared to March 2022. (This level is, however, 5 per cent lower than the Rs514 billion peaks seen at the end of December 2022). The branches (mostly MFBs’) hold 81 per cent of deposits by value, with the rest channeled via m-wallets. Public savings provide the MFBs with crucial, relatively cheaper capital to lend onwards. Over time, deposits have become a reliable financing source.
While both those indicators look comparatively better than last year, the loan quality saw relative deterioration. The sector’s overall ‘Portfolio at Risk’ (PAR, greater than 30 days) stood at 5.3 per cent at March end 2023, higher than 4.2 per cent at March end 2022. (PAR, however, improved from 5.8% seen at Dec. end 2022). Between March 2022 and March 2023, the PAR for MFBs increased from 5.3 per cent to 8.8 per cent; for MFIs it increased from 3.7 per cent to 4 per cent; and for RSPs, the PAR actually declined from 4.2 per cent to 2.3 per cent.
A central feature of the economic lives of the poor is the combination of low incomes, volatility and unpredictability. Effectively coping with a volatile and unpredictable income is made easier by ready access to financial services, but the small transactions begotten by low incomes combined with fixed administrative costs make it exceedingly difficult for the market to provide those services. That has historically been the rock on which attempts to bring low-income households into the formal financial services market have crashed.
Serving such households requires business model compromises that lower the costs and risks for providers. History reveals that the costs of those compromises eventually come due. For instance, early rural credit cooperatives lowered costs of customer acquisition and monitoring by relying on the strong, local social networks among farmers. However, that made the cooperatives vulnerable to local shocks and limited their ability to intermediate and scale—ultimately dooming many of them either through insolvency or competition. The modern microfinance movement seemed to have escaped this trap. Over the course of the last 40 years, hundreds of millions of people have gained access to formal financial services. There is a meaningful microfinance sector in more than a hundred countries. While a large literature has explored the customer-facing innovation such as group liability, standardized products and dynamic incentives, equally important to the success of modern microfinance is innovations in access to capital—especially the ability to access capital beyond that of the customers served. The combination of innovations to lower the cost and risk of serving low-income customers and of accessing capital from outside of low-income communities has allowed microfinance to cope relatively easily with a number of serious crises of the type that had often devastated financial service providers to low-income households in the past.
The author, Mr. Nazir Ahmed Shaikh, is a freelance writer, columnist, blogger and motivational speaker. He writes articles on diversified topics. Mr. Shaikh can be contacted at firstname.lastname@example.org.