KARACHI: There is still a very long road ahead, but some microfinance banks are currently focusing on setting up Islamic operations and wings, said Aameer Karachiwalla, the president of Khushhali Microfinance Bank Limited, in an interview with The News.
Q: How do you envision the extent of Islamic conversion in the microfinance banking sector?
A: I don’t think there are any major Islamic microfinance banks in Pakistan yet. Some of the industry members are working on establishing Islamic operations and wings now, but there is a very long road ahead. Islamic banking is largely about documentation, structuring, and identification of underlying assets. There will be some trial and error as the industry goes through the transition; however, I see challenges in identifying underlying assets for small ticket transactions and the concept of non-recoverability of overdue service charges.
Q: How much does the branchless banking setup support the microfinance sector?
A: Branchless banking presents both opportunities and risks for the microfinance sector. On one hand, it offers the potential for significant support by enhancing financial inclusion by reaching underserved and remote areas where traditional banking infrastructure is lacking. Secondly, it reduces operational costs, making financial services more affordable and accessible for both institutions and customers. Thirdly, it promotes transparency and security through digital transactions, reducing the risks associated with handling physical cash by field staff. Additionally, it enables faster and more efficient customer service, fostering trust and satisfaction. However, these advantages come with its own risks.
Branchless banking may divert customers away from traditional microfinance and reduce personal contact which is the foundation of microfinance business – with this the chances of default increases in lending. Moreover, solely depending on branchless can exclude individuals who lack access to or familiarity with digital technology, exacerbating financial exclusion. The risks of cybersecurity threats, fraud, and data breaches, are very high considering the awareness and educational level of microfinance customers which can erode trust in the financial system. Additionally, the shift away from face-to-face interactions can hinder the provision of personalized financial advice and support, potentially impacting the quality of services offered by traditional microfinance institutions.
Q: What model do you recommend to support the microfinance sector and its customers?
A: Like any other business, the microfinance sector must also adopt a diversified strategy. It has to build a healthy portfolio of secured and unsecured loans and match the repayment with the cash flow of the customers. On the acquisition side, there is a lot of debate on digital versus physical lending. I believe going forward, the industry must adopt a highly automated approach to lending, to reduce costs, however regular contact with the customer will have to be maintained to ensure timely recovery.
One can use data mining and advanced analytics to establish credit scores etc.; however, identification of customers, verification, and income estimation will continue to be a “hands-on” traditional visit to the customer activity. Personally, I advocate a hybrid model that combines physical branches with digital support and services. This approach can save costs, improve customer satisfaction, enhance engagement, strengthen controls, and reduce transaction costs for customers.
In addition, whatever model one adopts, one should not deviate from the tried and tested approach of defining the boundaries and rules of engagement. Every branch must adhere to the predefined operating radius, number of borrowers, and number of loan officers. It's crucial to have dedicated branch managers and loan officers who prioritize customer contact, quality customer service, and at the same time quality of business to uphold this banking model's integrity.
Regrettably, in Pakistan, microfinance institutions have strayed from this approach due to the pursuit of size and rapid portfolio growth. When microfinance banks (MFBs) deviate from the cost-efficiency model, including the personal contact and relationships with borrowers, they compromise on quality and long-term sustainability.
Q: Does the tightening of the financial system enhance the sector's credit risk which requires proactive monitoring and control of underlying risks?
A: The tightening of the financial system always increases credit risk, as interest rates are raised by central banks to curtail or stem inflation. Hence tightening indicates a high inflationary environment. And as microfinance lending is to the most vulnerable sector of society, high inflation does indicate lower capacity to repay and hence higher credit risk.
Nevertheless, the agriculture sector also has the ability to pass on the higher cost of input in their prices of produce. It is therefore important to understand the dynamics of the customers underlying business to reduce the credit risk in the portfolio. One also needs to evaluate how much of the higher interest costs can be passed on to the customers without increasing the credit risk.
Having said that, our primary focus lies in providing microfinance loans, which align with the core objectives of microfinance banks, namely financial inclusion and serving the underprivileged. This represents the fundamental business model of microfinance banks, marked by low loss rates and competitive pricing, enabling banks to establish sustainable and profitable operations. Unlike commercial banks, government securities are not a primary objective for the majority of microfinance banks.
Q: How does the government influence the microfinance sector?
A: The government has issued more licenses and allowed the microfinance banks to carve out a niche for itself. The government through the State Bank of Pakistan has developed regulations ensuring that the interests of customers and financial institutions are protected. The SBP by allowing MFBs to offer a wide range of digital payment services has greatly contributed to the growth in this sector. The number of borrowers has increased from 3.7 million in 2015 to 9.1 by the end of 2022 at a compound annual growth rate (CAGR) of approximately 15 percent and the amount lent increased during the same period from Rs93 billion to Rs491 billion at a CAGR of 27 percent. However, this did not come about without its own challenges.
For example, every time the government gives relief to the borrowers it comes at a cost to the industry. As the industry consolidates the government’s focus should be to strengthen the industry players so that they can expand their reach and achieve the financial inclusion and social development agenda, and empower MFBs to develop their own risk-mitigating policies within a broader framework aimed at supporting borrowers during economic hardships and calamities. The government may also consider minimizing offers for across-the-board waivers, which permanently damage the borrower’s repayment behavior.
Q: Which sectors have Khushhali Microfinance Bank Limited (KMBL) prioritised financing in?
A: Being largely a rural bank, we will continue our presence in this sector, but with a greater focus on risk mitigation and risk sharing. We have partnered with USAID to help build a sustainable business model focusing on women entrepreneurs and their financial inclusion. However, we will continue to diversify into more secure and EMI (equal monthly installment) based lending.
We're accomplishing this by improving our gold-backed secured lending segment. Simultaneously, we're actively encouraging salary and pension earners to transfer their accounts to KMBL to access priority financial services. Our foray into the housing sector has also produced good results, resulting in a robust and high-quality portfolio.
Agricultural financing remains a significant area of engagement as well. Although, we recognise the need for substantial restructuring due to lessons learned and historical very high concentration - which stood at approximately 85 percent of our overall portfolio. We will obviously continue to focus on agriculture though, with a view to maintain a diversified outlook and approach. This is a part of our gradually developing plan, to ensure we continue introducing diversity in our portfolio.
We are also actively trying to steer away from unsecured investments. Small businesses are a great example of these, where there might be some great potential upsides, they also have tremendous levels of risk attached to them. This is why we shut down all of our SME-focused branches, choosing to instead cater to the sector from our regular outlets instead.
Right now our asset portfolio underscores this diversification strategy, comprising 40 percent secured loans, 35 percent unsecured small loans, and 25 percent semi-secured loans; spanning various segments, including rural, urban, housing, agriculture, enterprise, EMI, and bullet loans. This strategic diversity positions us well to navigate through the evolving economic dynamics of the country while safeguarding stability and growth.
On the deposit side, we have a strong retail deposit base which we have built over the last six months. Our branches offer a full range of services for retail customers and would like to build transactional banking customers in the next phase. This will be a challenge as traditionally this has been the commercial bank's forte.
Q: Does KMBL have any plans over the next couple of years as far as transformation is concerned?
A: We are in the process of automating our services as much as we can. We have developed an in-house collection system which is being rolled out. We have to improve our digital offerings and enable both our staff and customers to use technology, mobile phones, internet banking, etc. Technology-focused transformation is very important, and we are working on numerous initiatives that will digitise our operations and offerings.
Our focus for now is on recovering from the challenging aspects of Covid-19, and its impact on our industry. The pandemic had a profound effect on the operations, customer repayment behavior, and profitability of microfinance entities in Pakistan and other geographies.