Assignment on Microfinance Banking in Pakistan

Introduction to Microfinance banking

Microfinance is usually understood to entail the provision of financial services to micro-entrepreneurs and small businesses, which lack access to banking and related services due to the high transaction costs associated with serving these client categories. The two main mechanisms for the delivery of financial services to such clients are (1) relationship-based banking for individual entrepreneurs and small businesses; and (2) group-based models, where several entrepreneurs come together to apply for loans and other services as a group

For some, microfinance is a movement whose object is "a world in which as many poor and near-poor households as possible have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and fund transfers.Many of those who promote microfinance generally believe that such access will help poor people out of poverty. For others, microfinance is a way to promote economic development, employment and growth through the support of micro-entrepreneurs and small businesses. Microfinance is a broad category of services, which includes microcredit. Microcredit is provision of credit services to poor clients. Although microcredit is one of the aspects of microfinance, conflation of the two terms is endemic in public discourse. Critics often attack microcredit while referring to it indiscriminately as either 'microcredit' or 'microfinance'.

Microfinance banking in Pakistan

A commercial bank licensed and prudentially regulated by the State Bank Pakistan to exclusively service the microfinance market. The first Micro Finance Bank (MFBS) was established in 2000 under a presidential decree. Since then, seven MFBs have been licensed under the Microfinance Institutions Ordinance, 2001. MFBs are legally empowered to accept and intermediate deposits from the public. They are serving low-income, salaried, self-employed and micro entrepreneurs men & women with a range of financial products designed to allow them to grow their businesses and produce significant economic multiplier effects throughout local economies. The main goal of Micro finance banks in Pakistan is to 1) poverty elimination 2) sustainable development 3) economic empowerment are made possible by building a viable business model that meets the total banking needs of an individual, their house hold unit, their business and sources of earning and the community at large, in loans, savings, fund transfer, utility bill payment and special products, that are the need of the hour of the economically active yet economically disenfranchised micro customer

Impact
Following impact considered to be created by microfinance organizations operating in Pakistan

Increase of personal income Empowerment of women Improvement in nutrition Increased education of the borrowers children Access to clean water Increased access to medicine

These are different from the common areas of impact in domestic microfinance organizations:

Creation of jobs Business growth Increased income to the business owner Improved credit rating Graduating from social support programs Overall improvement of quality of life.

Over View of Micro finance Industry in Pakistan

Pakistans microfinance industry started 2010 aiming for stability and growth. The last three years have been challenging as the country experienced large-scale population displacement from its northwest region in the wake of a deteriorating security situation, a general economic slowdown due to reduced local and foreign investment, and a severe energy crisis. However, the floods of August 2010 resulted in a further extension of the industrys recovery phase. Pakistans macroeconomic and fiscal targets had to be revised within a month of the start of the fiscal year (FY). The agriculture sector in particular took a significant hit. As a result, the modest acceleration in credit outreach in the first half of 2010 was squeezed once again in the last two quarters of the year.

In response to the increase in poverty, the Government has introduced a number of social safety net programs in addition to existing ones like the Pakistan Bait-ul-Mal (PBM), with the objective to provide financial support to population segments living below a poverty line of PKR 110 per day (USD 1.25) . The Benazir Income Support Programe (BISP) The BISP envisages a monthly cash grant of PKR 1,000 to female-headed households with a monthly income of less than PKR 6,000. The aim is to ameliorate the conditions of the poorest of the poor through targeted subsidies. In the short to medium term, BISP is also intended to serve as a platform for complementary social assistance programs, the main being health insurance for

the poor and vulnerable. An amount of PKR 15.3 billion was disbursed during FY 2009 while PKR 32 billion was disbursed in FY 2010. An allocation of PKR 50 billion has been kept during FY 2011 for this purpose. With the up-coming elections, this number is unlikely to come down in the short term. Waseela-e-Haq This component of BISP was launched in October 2009 with the objective of providing interestfree loans. A total of 750 registered beneficiaries of BISP under the current targeting mechanism are selected through a monthly draw. The targeting mechanism is designed to identify a niche that can repay, but have no access to financial service providers. Each of them are provided with an interest-free loan worth PKR 0.3 million,repayable in installments over a period of 15 years. Pakistan Bait-ul-Mal (PBM) A total of PKR 2,261 million was disbursed in FY 2010 against PKR 3,432 millions in FY 2009, registering a 34 percent decline in disbursements and an 82 percent increase in beneficiaries (1.16 million to 2.11 million). The main reason behind this sharp decline in overall disbursement was the closure of PBMs Food Support Program (FSP) in FY 2010; the FSP was merged into BISP. With the launch of these safety net programs, the Government initiated structured targeting of the poorest segments of the population in the country. The introduction of targeted subsidies is a clear indication Policymakers are starting to understand that poverty encompasses an entire spectrum of people, some of whom need more support than others. This nuanced view of poverty bodes well for Pakistans microfinance industry, which has had to fill the vacuum that persisted with no safety net programs in place.

Microfinance industry initiatives

A number of industry-wide initiatives were launched during 2010 and 2011, and existing initiatives expanded. A MoU has been signed between SBP, PPAF, and PMN to expand the Credit Information Bureau (CIB) following a successful pilot in the district of Lahore. The project is in the planning phase and is expected to go into implementation in the fourth quarter of 2011. Fifteen MFPs participated in the pilot phase. According to an assessment report by Shore Bank International (SBI), 233,956 client entries constituting 73 percent of the total microfinance penetration in Lahore have been reported; 29,926 enquires have been made as of June 2011, of which 3,242 loan applications were turned down for reasons of multiple-borrowing and a history of fraud and default. As a result, approximately PKR 66.7 million of possible default and subsequent loss has been averted. The SBP has played a key role in facilitating continued access to commercial funding for the industry via the Microfinance Credit Guarantee Fund (MCGF).

This facility provides incentives to commercial banks and development financial institutions (DFIs) to provide funds to MFPs at commercial rates. The incentives include a guarantee on repayment of 40 percent of the funds provided. In addition, banks and DFIs may deduct funds loaned to MFPs from their demand and time liabilities when calculating their statutory liquidity and the cash reserve requirements for regulatory purposes. The Institutional Strengthening Fund (ISF) was established in 2009 with the objective of increasing the capacity of MFPs by providing grants to make advances in human resources, management, governance, internal controls, business development, cost reduction mechanisms, product innovation, and technology implementation. With good performance, MFPs may be recipients of grants several years in a row. MCGF and ISF were both established in 2009

Risk assessment in Microfinance Industry Credit risk

Credit risk remains the greatest risk faced by the banks. It remains the top-most concern from the point of view of practitioners, investors, and depositors. The current economic situation has been a difficult one for Pakistans microfinance industry. The security situation, inflation, and food security have all had an impact on credit risk with large parts of funding being diverted towards consumption.

Market risk
Market risk is the risk that the value of a portfolio (investment portfolio or trading portfolio) will decrease due to changes in value of market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices. The market risk is quite high due to the current economy situation in Pakistan.

Operational risk
The operations a company or firm undertakes when it attempts to operate within a given field or industry, is defined as operational risk. Operational risk is the risk that is not inherent in financial, systematic, or market-wide risk. It is the risk remaining after determining financing and systematic risk, and includes risks resulting from breakdowns in internal procedures, people, and systems. Operational risk can be summarized as human risk; it is the risk of business operations failing due to human error. It is an important consideration to make when looking at potential investment decisions. Industries with lower human interaction are likely to have lower operational risk as compared to labor intensive industries. Being in the service industry where person-to-person contact is very important, the operational risk is likely to be quite high . However, it can be lowered by having effective internal controls.

The Way Forward

Way Forward is to identify and analyze the challenges and opportunities faced by the microfinance industry in Pakistan.

Branchless banking
Using alternative delivery channels in the form of branchless banking and opportunities created by leveraging Pakistans technology infrastructure, Micro Finance banks have a golden opportunity to expand their outreach, especially to rural areas. This can result in significant cost reductions by replacing a labor-intensive business model with banking agents.

Islamic microfinance
Islamic microfinance has the potential to expand financial access to a clientage which currently rejects microfinance products that do not comply with Islamic law. While conventional microfinance products have been very successful in Muslim countries, they do not fulfill the needs of all clients. Just as there is demand from main stream banking clients for Islamic products, there are also many poor people who insist on these products. Islamic microfinance represents the confluence of two rapidly growing industries: microfinance and Islamic finance. Unlocking this potential could be the key to providing financial access to many Muslim poor who currently reject microfinance products that do not comply with Islam.

Risk mitigation fund and deposit Protection fund

In recent years, Pakistan has faced a number of natural disasters like the devastating floods in 2010, the earthquake in 2005, and recurrent droughts, especially in the southern reaches of the country. This has resulted in significant losses for MFPs. keeping this scenario in view, the requirement for a risk mitigation fund cannot be denied.

Corporate governance
As the microfinance sector matures, the need for strong corporate governance cannot be denied. Key challenges faced are board effectiveness, management control, disclosure and transparency, shareholder and stakeholder relations, and succession planning. Boards should be composed of people with backgrounds and understanding of commercial finance, people from academia and the development sector, people from subcommittees overseeing various important management functions, and people with proactive roles in strategic planning and implementation. Strong internal controls, risk management, and operational internal controls are aspects that MFPs must continue working towards.

References.
Feigenberg, Benjamin; Erica M. Field, Rohini Pande. Building Social Capital Through MicroFinance. NBER Working Paper No. 16018. Retrieved 10 March 2011. www.microfinanceconnect.info Littlefield, Elizabeth; Morduch, Jonathan and Hashemi, Syed (2003-01-01). "Is Microfinance an Effective Strategy to Reach the Millennium Development Goals