Lecture # 21
Role of Commercial Banks in Micro Finance
Sector
Micro Finance
• Micro finance is the provision of
financial services including Credit,
Savings, Insurance etc, to those
sectors of economy, which are not
serviced by traditional formal
financial institutions viz. commercial
banks and non-banking financial
institutions.
• Microfinance caters to the financial
services needs of the poor and
micro enterprises and is normally
collateral-free short term facility
whereas the commercial banks
generally deal with corporate
clients, SMEs and individuals with
• larger income levels and extend
financing facilities primarily based
on collaterals and borrowers
capacity to repay.
Microfinance in
Pakistan
Microfinance Providers
Broadly there are two types of
institutions in Pakistan providing
micro credit/microfinance services
to the poor households/micro
enterprises
• the Non Government-Micro finance
Institutions
(NGO-MFIs)
/Rural
Support
Programs
(RSPs)
extending micro credit to the poor
through sources other than public
savings and
• the formal microfinance banks
providing a range of financial
services to the poor and micro
enterprises including micro credit,
savings, payment transfers etc.
• While the Microfinance Banks are
eligible to mobilize public savings to
finance
their
operations,
the
Government has established a
wholesale window, the Pakistan
Poverty Alleviation Fund (PPAF),
• to provide wholesale funds/credit
lines and grants to NGOs for on
lending to the poor and capacity
and infrastructure building.
Law Implications
• The formal microfinance banks are
required to take license from State
Bank of Pakistan under MFIs
Ordinance 2001 to operate as
microfinance bank and are under
the regulatory ambit of the State
Bank,
• whereas the NGO-MFIs/RSPs are
registered
with
Registrar
NGOs/Provincial
Cooperative
Departments and are not under the
regulatory ambit of State Bank.
Suppliers of Microfinance
• Category 1: Informal Sources
• Category 2: Semiformal Sources
• Category 3: Formal Sources
Informal Sources
Informal Reciprocal Arrangements
Account for 83% of credit supply,
Commercial creditors that liaison
with marketing intermediaries, Land–
based credit arrangements extended
by landlords to farmers, Socially
based arrangements of friends and
family
Semiformal Sources
• Pakistan Poverty Alleviation Fund
(PPAF)
• NGOs
–Multi- sectorial NGOs offers
composite services:
• education
• Health
• Infrastructure
and
community
development
• Offers Micro credit as a minor
program
–Few NGOs with microfinance as a
core activity
• Government sponsored programs
NGOs in Microfinance
• A number of NGOs are working in
Pakistan, a few NGOs are doing
their job with the contribution of
international financial institutions.
Formal
• Commercial banks and licensed
MFIs, by State Bank of Pakistan,
Role of Commercial
Banks in
Microfinance Sector
• Microfinance in its broadest terms
can be defined as provision of a
range of financial services such as
deposits, loans, payment services,
money transfers and insurance to
poor and low income households,
and their micro enterprises.
• While a commercial bank is a
financial institution that offers a
broad range of deposit accounts,
including checking, savings, and
time deposits, and extends loans to
individuals and businesses.
• Primarily,
the
microfinance
customers are large in number,
scattered in far-flung areas with
very minute transaction sizes. Only
government or state bank alone
cannot reach out to millions of
potential Microfinance beneficiaries;
• A whole well knitted network with
almost doorstep reach is required,
which is only possible when the
commercial banks will be involved
in microfinance.
• In Pakistan it is estimated that as
many as 5.6 million households
need microfinance services but
these services reach only to less
than 1 percent, most probably
because of the absence of
commercial
banks
from
the
microfinance sector.
• This way a poor person just need to
visit his local commercial bank to
get access to microfinance benefits,
which will help reduce many
economic problems.
• One criticism over involving the
commercial banks in microfinance
is that commercial banks will
charge higher interest rates, further
lower the standard of living and will
exploit the public.
• The ground realities are totally
different; empirical evidence has
demonstrated that participants in
microfinance
programs
have
improved their living standards at
both the individual and household
level, and that this has provided
increased educational opportunities
for children.
• For example, the clients of the
Bangladesh Rural Advancement
Committee increased household
expenditures by 28% and assets by
112%. It was also demonstrated that
Bangladeshi children were sent to
school in larger numbers and stayed
for a longer time –
• almost all girls in Grameen Bank (A
commercial
bank!)
client
households had some schooling,
compared with the rate of 60% in
non-client households.
• No doubt on the other hand the
loans provided by the commercial
banks
to
the
microfinance
beneficiaries are a bit expensive, its
not to discourage the poor but there
is a sound reason behind it;
• Providing financial services to poor
people
is
quite
expensive,
especially in relation to the size of
the transactions involved. A $100
dollar loan, for example, requires
the same personnel and resources
as a $2,000 one thus increasing per
unit transaction costs.
• Loan officers must visit the client's
home or place of work, evaluate
creditworthiness on the basis of
interviews with the client's family
and references, and in many cases,
follow through with visits to
reinforce the repayment culture.
• It can easily cost US$25 to make a
micro loan. While that might not
seem unreasonable in absolute
terms, it might represent 25% of the
value of the loan amount, and force
the institution to charge a “high”
rate of interest to cover its cost of
loan administration.
• If commercial banks are to be
involved in the micro finance by no
means it would be a wrong decision
for them as regard to their primary
aim, profitability.
• Yes it can. Data from the Micro
Banking Bulletin reports that 63 of
the world's top MFIs had an
average rate of return, after
adjusting for inflation and after
taking out subsidies programs
might have received, of about 2.5%
of total assets.
• This compares favorably with
returns in the commercial banking
sector and gives credence to the
hope of many that microfinance can
be
sufficiently
attractive
to
mainstream into the retail banking
sector.
• Many feel that once microfinance
becomes mainstreamed, massive
growth in the numbers of clients
can be achieved. According to a
recent analysis conducted by the
Consultative Group to Assist the
Poor (CGAP),
• the compound annual growth
rate of the world’s leading
microfinance providers over the
last five years has been a
whopping 15%.
Micro-insurance
• Micro insurance is the provision of
insurance
to
low-income
households.
• Poor households are especially
vulnerable to risk, both in the form
of natural calamities as well as
more regular occurrences of illness
and accidents.
Micro-insurance
• Microfinance Institutions (MFIs) have
played an active role in reducing or
protecting against this vulnerability
through
providing
credit
for
increasing
income
earning
opportunities and through providing
savings services to build up
resources that can be drawn down in
cases of emergencies.
• However,
some
events
still
translate into crisis for many poor
households
and
erode
the
economic gains they have made as
clients of microfinance programs.
Micro-insurance
• Credit and savings services are
inadequate when households are
exposed to risks which cause losses
that are beyond their means.
• Insurance can serve as a promising
response to such client needs.
• Today micro insurers are providing
different forms of insurance for life,
health,
property,
disability,
agriculture (crop), etc.
• Poor households pay a small
premium for limited coverage in the
event of losses.
Basic Insurance principles
• Basic principles that should be
observed by micro insurance
providers
are
universal
to
insurance and risk management.
They include:
Basic Insurance principles
1) Similar units exposed to risk.
2) Limited policy holder control over
the insured event.
3) Existence of insurable interest.
4) Losses are determinable and
measurable.
5) Losses should not be catastrophic.
6) Chance of loss is calculable.
7) Premiums
are
economically
affordable.
State Bank of Pakistan
& Micro Financing
• The State Bank of Pakistan’
mission is to promote monetary
and financial stability
• Foster a sound and dynamic
financial system
• Its primary functions include:
• issue of notes,
• regulation of the financial
system,
• lender of the last resort,
• And conduct of monetary policy
SBP secondary functions include:
• The management of public debt,
• Management of foreign exchange,
• Advising the Government on policy
matters,
• Anchoring payments system, and
maintaining close relationships with
international financial institutions.
• Responsibilities of the State Bank of
Pakistan go well beyond the
conventional functions of a Central
Bank, by including the economic
growth objective in its statute and
supporting the development of
new financial institutions to
promote financial intermediation.
• SBP has also directed the use of
credit according to development
priorities,
providing
subsidized
credit.
• State Bank Pakistan support to
microfinance commercialisation
• The State Bank of Pakistan has
encouraged the entry of private
sector institutions into microfinance
through an enabling environment.
• As Pakistan's financial regulator,
SBP has been entrusted by the MFIs
ordinance 2001 with the licensing,
regulation and supervision of
Microfinance Banks (MFBs).
• SBP is the implementing agency for
strengthening
supervision
and
regulation under the Rural Finance
Sector
Development
Program
(RFDP).
• SBP is also incharge of special
funds of more than US$70 million
to lend support to the microfinance
sector and provide risk mitigation
mechanisms to poor depositors and
borrowers of microfinance banks.
Regulatory framework
• The framework (MFIs Ordinance
2001) allows the establishment of
three
categories
of
formal
microfinance banks, with minimum
paid-up capital required:
 Nation
wide MFBs: Rs. 500 million
 Province
wide MFBs: Rs.250
million
 District wide MFBs: Rs.100 million
• NGOs and other microfinance
providers can bring their loan
portfolio to contribute to up to 50%
to the capital requirements.