Microfinance on the verge of collapse

Pakistan’s financial services landscape today looks vastly different from what it used to be a decade or two ago. At least in the urban areas, an average person even remotely linked to the formal net would be using some app, either to receive money from Bykea after doing a gig or a small shop owner whose customers want to pay digitally. Heck, they can even borrow a couple thousand rupees instantly from the same mobile application and pay back a week later.

The credit for this lies squarely on two sets of regulations, first on microfinance and the second on branchless banking. But the former is in serious trouble, with no signs of reprieve as yet. For more than half a decade, microfinance banks have been incurring net losses. Initially, it was just one player having an outsized influence on the aggregate numbers, but the rot has deepened and continues to spread.

In Q3FY24, microfinance banks reported a net loss of Rs 1.1 billion, according to the last available quarterly statistics compiled by the State Bank. This represents a doubling compared to the same period last year but an improvement of 80 per cent over the preceding quarter thanks to a terrible base.

The rot has spread well into equity and eaten up capital buffers. As of September 2024, the industry’s capital adequacy ratio (CAR) had fallen to a dismal 2.8pc against the minimum required level of 15pc. Things didn’t get to this point in one quarter, and CAR has been on a steeply downward trajectory for a while, first slipping below the minimum threshold all the way back in June 2022. Even those who were previously in the green are now turning red.

Despite expanding financial inclusion, Pakistan’s microfinance sector faces a deepening crisis, with rising losses, dwindling capital, and regulatory complacency threatening sustainability

And what do you do when numbers become uncomfortable? Well, hide them. It’s a classic lesson from corporate governance, one the executives of microfinance banks (MFB) took to heart as five out of 12 banks haven’t publicly disclosed their financial results for the latest quarter, ie Q3FY24. Some actually stopped bothering a while ago, like Finca, whose most recent report is from September 2022.

Others have now followed suit, given there are few repercussions, at least beyond the closed doors of central bank headquarters. In fact, even the central bank didn’t care enough to include Finca or Khushhali’s 2023 data in its publication on financial institutions. Either the regulator is trying to protect the MFBs, or there wasn’t enough money with the banks to even pay the auditor.

Are our MFBs so broke that they don’t even have Rs10 million to hire a firm? Do remember that they are required to submit Q1 and Q3 statements within 30 days. The simpler, and more plausible, explanation is that the regulator is quite fine with such information staying in the dark.

You would imagine such a situation would spur immediate action from the management and the regulator to correct the course. But the extent and speed of progress are muted at best. As per reports in the market, the central bank has been actively trying to find new sponsors for the practically bankrupt microfinance banks. In fact, we have already seen two acquisitions: Finca by TPL and Abhi, and Advans by Egypt’s MNT-Halan.

Five out of 12 banks haven’t publicly disclosed their financial results for Q3FY24 — Finca stopped as far back as September 2022

Meanwhile, some notable sponsors have put their money where their mouth is and made capital injections running into billions of rupees. The commitment is undoubtedly appreciable, but how much further can it continue? More importantly, is this allocation of capital even justified? Remember we are talking about a two-decade-old sector relying on the largesse of its promoters to avoid shutting shop.

In its latest financial inclusion strategy, the State Bank plays to a similar tune and talks about mobilising domestic and donor funding and creating credit guarantee facilities. While desperately needed right now, getting more money from new or old sponsors and providing them with some risk-sharing facilities can’t possibly be a long-term solution.

There needs to be a better fix, one where someone doesn’t have to constantly foot the bill for the underlying inefficiencies. Would that entail major changes in the regulations with respect to the MFBs’ mandate? Perhaps, or it could be that the distribution model is flawed, at least when you try to scale.

Whatever it is, there is an immediate need to figure out the right answer because, for all its financial ills, the sector’s reach to the masses is unparalleled and unlikely to be replicated by the legacy players.

The writer is the Co-founder of Data Darbar

Published in Dawn, The Business and Finance Weekly, January 27th, 2025