The microfinance sector in Pakistan has achieved remarkable success, currently serving over 9.3 million active borrowers. Its contribution to financial inclusion and serving underserved areas and segments like small businesses, farmers, and rural coxmmunities is commendable. However, the sector is currently under stress due to multiple internal and external factors. For example, the Microfinance Banks (MFBs) in Pakistan encounter numerous obstacles, ranging from conventional business model, steep operational expenses exacerbated by inflation to the complexities of service delivery models and reaching rural communities. These challenges are interconnected and impact the sustainability and effectiveness of MFBs in their crucial role of financial inclusion.
Operating in rural areas with branches scattered across vast distances, MFBs provide vital doorstep services to their customers. For example, Khushali Bank has 205 branches and an active customer base of around 3 million of its loans and deposit account customers, mainly in rural areas. However, the present business and service delivery model lead to increased operational costs, particularly with the persistent rise in inflation. This inflationary pressure also affects the policy rate set by the State Bank of Pakistan (SBP), making deposit and funding expensive for MFBs and subsequently raising interest rates on loans.
For borrowers, especially those with low incomes whom MFBs primarily serve, high inflation erodes their ability to repay loans. This results in repayment issues, compounded by crises in the agricultural sector, such as climate change impacts and challenges in selling produce at fair prices. These challenges necessitate a fundamental shift in MFBs’ business models.
Acknowledging the need for adaptation, MFBs are making strides in reshaping their lending practices. They are shifting away from traditional very low-ticket loans, improving underwriting, risk models, and embracing more structured and secured and semi-secured lending portfolios. Although, this has also impacted as the main mandate of MFBs is to serve financial services to the poor and underserved segments. Additionally, there’s a push to diversify the concentration of portfolios and educate borrowers on more manageable repayment structures, transitioning from lump-sum payments to monthly instalments. This will also improve the staff work load and retention. Again for example, Khushhali Bank, which used to have an 80% unsecured portfolio, has changed its portfolio to MSME, secured, and currently, the bank’s 70% portfolio is either secured or semi-secured monthly installment loans. This 70% portfolio has a 99% repayment rate.
However, for positive and swift change to occur, systemic adjustments are crucial. Firstly, reducing policy rates is essential to alleviate the burden of high-interest loans on both MFBs and borrowers, enabling MFBs to offer more competitive interest rates and enhancing financial access for clients.
MFBs must; i- overhaul their deposit mix, prioritizing the generation of current account deposits, which currently represent less than 10% of total deposits of conventional MFBs. This shift would diversify funding sources and reduce dependence on costly deposit options, contributing to overall cost reduction. ii- The dependency on large ticket institutional deposits should be reduced, and retail small ticket deposits should be generated. Once again, Khushhali Bank has done excellent in this as their 91% deposit is individual small and medium ticket size. Only 9% deposit is institutional. Despite this, the bank has high concentration in remunerative deposits and very low current account deposits.
Furthermore, increased automation and improved service delivery are urgently needed to streamline operations and cut operating costs. Embracing technological advancements will enhance efficiency and improve the customer experience, fostering greater trust and loyalty within the communities served by MFBs.
Additionally, to encourage MFBs to continue serving the underserved, poor, and rural population, the government must support MFIs and MFBs by providing low-cost funding and credit guarantees for these targeted segments. Otherwise, there is a risk that the microfinance sector, like commercial conventional banks, may gradually move away from serving such underserved segments.
In conclusion, the challenges facing MFBs in Pakistan are significant but surmountable which require the government, regulator and shareholders support. By embracing strategic changes in their business models, building good teams, advocating for favourable policy adjustments, and leveraging technology, MFBs can navigate the complexities of the microfinance landscape and continue their mission of empowering underserved communities with access to financial services.
Muhammad Aftab Alam
Chief Business Officer, Khushhali Microfinance Bank Limited
