Address microfinance banks’ feeble business models before deposit insurance: IMF

KARACHI: The International Monetary Fund (IMF) has urged the government to resolve microfinance banks’ ongoing vulnerabilities before allowing them to participate in the deposit insurance scheme.

The IMF made these remarks in its staff report on Pakistan, issued on Friday.

“While microfinance banks (MFBs) play a critical role in financing the poorer segments of society, their persistent vulnerabilities and weak business models need to be addressed before they join the deposit insurance scheme,” the IMF said.

The IMF has set some structural benchmarks for Pakistan under the new $7 billion loan programme. These benchmarks include obtaining parliamentary approval for changes to the bank resolution and deposit insurance laws. Undercapitalized private banks must be either fully recapitalized by the end of October 2024 or enter into a legally binding agreement for a merger with other banks or a new sponsor by the same date, with the goal of achieving full recapitalization by April 2025.

“Amendments to the bank resolution and deposit insurance legislation, which should be advanced expeditiously and operationalized subsequently, will further strengthen Pakistan’s crisis management and bank resolution framework and improve tools to address failing banks,” the IMF said.

Taking actions to unwind the interconnections resulting from the sovereign-bank nexus -- including fiscal consolidation, better cash management, and capital market development -- will limit risk of financial contagion, it said.

According to the IMF, the SBP should take action in line with its supervisory framework to ensure that currently, undercapitalized private banks complete recapitalization or otherwise be placed under resolution in case recapitalization efforts fail.

The government is keen on promoting a deposit protection scheme to safeguard depositors’ interests and enhance confidence in the banking sector. Earlier this month, the Deposit Protection Corporation (DPC) increased the guaranteed amount for all eligible depositors of its member banks from Rs0.5 million to Rs1 million.

In an annual report for the year 2022-23 published last year, the DPC suggested to expand the scope of coverage to digital and microfinance banks under its safety net. Since digital banks are supposed to create new customer experiences and advance financial inclusion by offering affordable financial services to underserve and unserved segments of society, it is imperative that they fall under the purview of deposit protection mechanism.

“Digital banks, once operational, shall become members of the DPC as per the relevant laws. Accordingly, the potential depositors of the digital banks would also fall under the umbrella of DPC’s protection scheme,” the report said.

It stated that, as of June 2023, 11 MFBs were providing services to 98.2 million depositors, with a deposit base of approximately Rs520 billion. A failure of any of these entities might have a significant impact on the socioeconomic fabric of the larger population, given that they serve the bulk of the financially unsophisticated portion of society. Thus, these depositors require a clear and limited protection.

“Although a deposit protection mechanism already exists under the MFI Ordinance 2001, whereby each MFB is required to create its own depositor protection fund from its annual profits, however, there is a need to provide a better and more reliable safeguard mechanism for the depositors of MFBs,” it said.

“The DPC may provide an independent, credible and robust mechanism as a crucial safeguard for depositors of MFBs that would not rely on the profitability of the institutions,” it added.

The corporation proposed appropriate changes in its statute that would enhance its scope and require MFBs to become compulsory members of DPC, enabling it to provide coverage to their depositors.