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Saturday April 01, 2023

Defaulting lines

February 01, 2023

LAHORE: When inflation rises, loan defaults inevitably result in the transfer of assets into the hands of loan sharks, while microfinance loans that are provided at much above the market rates, rarely lead to defaults.

Most of the microfinance institutions operating on funds gathered on market rate mark-up from commercial banks are in a vulnerable position as they provided poverty stricken clients microloans at substantial premium.

In normal circumstances, 99 percent of the poor service these loans. The poor operated small businesses from these loans and after small savings were able to service their liabilities.

Market conditions have changed drastically in the past one year. Small businesses are losing sales and assets. The small investments used to supplement their regular income as farmers or labourers.

After sky-rocketing inflation accompanied with historic increase in food prices, these small business owners are unable to feed their family on their static income.

To meet expenses, they regularly liquidated their small business assets and started defaulting on loans. They are in no position to pay back. Most of them got loans without any collateral and microfinance providers are not in a position to recover their loans.

Some non-government organisations like Pakistan Poverty Alleviation Fund (PPAF)

did provide soft loans (much lower than market rate) to some NGOs serving their poor clients with comparatively less mark-up loans (still much higher than commercial bank mark-up).

Such loans were serviced for a longer time, but under current circumstances poor clients are unable to earn enough to service them. They have also started defaulting. Their food budgets have also increased beyond their income.

Microfinance has not been as successful in Pakistan as it had been in Bangladesh and India. Bangladesh set an example in the 1990s by pulling a large number of poor out of poverty. Today about 2/3rd of over 120 million microloans are served in India and Bangladesh.

We are still a non-entity in this field. The success in Bangladesh was attributed to the micro financiers that disbursed over 90 percent of the loans to the women.

They then strengthened their businesses through timely guidance and advice. Bangladeshi experience showed that a micro entrepreneur merely establishes business on the first loan.

On the second loan (after the first is fully serviced), the entrepreneur starts earning a bit for consumption. On the third loan, the entrepreneur built small assets and moved up the ladder.

Unfortunately, the micro-loans in Pakistan are usually provided on a one time basis. The beneficiary even after successfully servicing the first loan does not get the second to scale up. They remain poor.

Then there are cases when the poor somehow obtain a micro-loan for immediate family needs like marriage of daughter or for medical care. They usually service loans, but do not grow.

The micro-finance institutions lack the capability and capacity to evaluate the business model of the person seeking loan and there is weak monitoring after the loan is disbursed.

They feel satisfied if the loan is serviced in a timely manner. In Bangladesh and India, there is a check on the use of loan and the loan taker is provided guidance on market conditions as well.

Most of the microfinance providers in the country are too small to be able to function efficiently on funds provided at market based rates. Some renowned microfinance institutions have defaulted on PPAF loans as well.