1 Introduction and background 1.1 Key demographic and economic data Pakistan is the seventh most populous country in the world, with a population of 129.9 million in 1995. It is located in West Asia bordering onto the Arabian Sea, and its principal neighbours are India to the south, Iran to the west, and Afghanistan to the north. Population growth averaged 2.9 per cent per year between 1990 and 1995, the highest for any of the nine countries included in the study. The total fertility rate was 5.2 births per woman in 1995, very high by Asian standards, and second only to Nepal among the countries included in this study. Nevertheless, population density remains much lower than in most other South Asian countries, with 163 people per square kilometre in 1995. GNP per capita stood at $460 in 1995, significantly above the levels recorded in Bangladesh, India and Nepal, but well below Sri Lanka and the four Southeast Asian countries included in the study. Pakistan’s recent economic performance has been disappointing with income per capita increasing by only 1.2 per cent per year between 1985 and 1995, the lowest growth rate for any of the nine countries studied. Possibly reflecting this relatively slow economic growth, the structure of production has not changed markedly over the last 15 years. The share of agriculture in GDP declined from 30 per cent in 1980 to 26 per cent in 1995, the smallest decline for any country in the study other than the Philippines. There was a corresponding increase in the share of services, from 46 to 50 per cent of GDP. In 1995, 35 per cent of the population lived in urban areas. Pakistan performs poorly in terms of human development, with most indicators well below those of countries with similar per capita incomes. For instance, while Pakistan has significantly higher per capita income than India, it has lower life expectancy, higher infant mortality and lower adult literacy. More generally, the World Bank (1995) notes that while Pakistan’s GNP per capita is higher than the average for all low-income economies: Pakistan’s total fertility rate is 65 per cent higher than the average for all low-income economies, its infant mortality rate is 30 per cent higher, its adult literacy rate is 25 percentage points lower, and its gross primary and secondary school enrolments are not much more than half the average for all low-income economies. Moreover, the disparities in life expectancy at birth, the under-five mortality rate, the adult literacy rate, and especially school enrolment ratios are wider for females than for males. 1.2 Poverty Estimates of poverty The incidence of poverty in Pakistan is estimated at between 30 and 35 per cent of the population. While cross-country comparisons of poverty inevitably suffer from a lack of comparable data, this is broadly similar to the rates of poverty observed in India and the Philippines. Official estimates of poverty in Pakistan are derived from the Household Income and Expenditure Survey, which has been carried out by the Federal Bureau of Statistics at irregular intervals since 1963–64. The poverty line is set with reference to a daily calorie intake of 2,550 calories per adult, as recommended by the Planning Commission. Poverty lines for both rural and urban areas were established for 1984–85, equal to the total level of expenditure, on both food and non-food items, at which this daily calorie intake was just satisfied. These poverty lines have been adjusted by movements in the consumer price index to obtain poverty lines for more recent years. Based on this methodology, the incidence of poverty declined from 46.0 per cent of the population in 1984–85 to 37.4 per cent in 1987–88 and 34.0 per cent in 1990–91. Using 1995 population data, this is around 44.2 million people. Indicators of the depth of poverty also fell substantially over the period. In 1990–91, the incidence of poverty was slightly higher in rural areas (36.9 per cent) than in urban areas (28.0 per cent). By province, poverty was highest in North West Frontier Province (NWFP) with 40.0 per cent, followed by Punjab (35.9 per cent), Sindh (27.6 per cent) and Balochistan (22.0 per cent). However, the coverage of the household survey in NWFP and Balochistan is known not to be fully representative. Another source of poverty data is the Pakistan Integrated Household Survey, conducted by the Federal Bureau of Statistics in 1991 with technical assistance from the World Bank and UNDP. This survey was based on a smaller sample than the household survey, but covered a broader range of topics and was designed to be nationally representative. Based on this survey, the World Bank (1995) established poverty lines based on the cost of a basic needs basket of goods and services. Poverty lines were set at Rs296 ($8.40) for monthly per capita consumption expenditures in rural areas, and Rs334 ($9.50) for monthly per capita consumption expenditures in urban areas. The broad estimates of poverty based on this method were similar to the official estimates, with 31.6 per cent of the population below the poverty line in 1991. Again, the incidence of poverty was slightly higher in rural areas (33.5 per cent) than in urban areas (27.0 per cent). However, the incidence of poverty by province was very different to that implied by the household survey, with poverty highest in Balochistan (41.2 per cent) and lowest in NWFP (19.7 per cent). This makes it difficult to come to firm conclusions about the regional distribution of poverty. Policies for poverty reduction In large part, Pakistan has relied on economic growth as a key means of reducing poverty. Nevertheless, as Amjad and Kemal (1997) have pointed out, the experience of Pakistan illustrates that there is no direct relationship between economic growth and poverty reduction. Over the last three decades, Pakistan has experienced periods of high economic growth and rising poverty, periods of low economic growth and falling poverty, as well as periods when economic growth has contributed positively to poverty reduction. There have been relatively few programs directly targeted at reducing poverty. The most important has been the income transfer program based on the religious taxes of Zakat and Ushr. Zakat taxes are levied on various financial assets at the rate of 2.5 per cent per annum, while Ushr taxes are levied on the produce of landowners in excess of 948 kilograms of wheat or other crops of the same value. These revenues finance income transfers to widows, orphans and disabled individuals not able to support themselves. They receive a monthly subsistence allowance of Rs225 ($6.40) per beneficiary. There is also provision for a one-off rehabilitation grant of up to Rs3,000 ($85). The program is administered by the central Zakat administration within the Ministry of Finance. Local beneficiaries are selected by around 40,000 local Zakat committees. However, partly due to avoidance practices, the government has been able to collect only a small amount of Zakat revenue, equal to 0.2 per cent of GDP in 1993–94. This has reduced the number of beneficiaries. Local Zakat committees have been given a quota of ten beneficiaries, and directed to choose the ten neediest from within the target group. As such, the scheme is limited to around 400,000 beneficiaries. There have also been allegations of abuse and inappropriate selection of beneficiaries. Another program, Bait-ul-mal, was established in 1992 by the Ministry of Social Welfare. While it has a number of components, the two most important are the individual financial assistance scheme and the food subsidy scheme. The target group for the individual financial assistance scheme is widows, orphans and disabled persons who live in households with a monthly income of Rs1,500 ($43) or less and who do not receive Zakat assistance. They are eligible for a monthly grant of Rs500 ($14.30) if they do not own their own shelter and Rs300 ($8.60) if they do, plus Rs50 ($1.40) per child up to a maximum of four. The target group for the food subsidy scheme is other households with a monthly income of Rs1,500 ($43) or less that do not receive Zakat assistance. They are eligible for benefits of Rs150 ($4.30) per month per household. Again, the budgetary allocation for Bait-ul-mal is very small, around 0.05 per cent of GDP in 1994–95. As such, not all eligible persons are able to receive a benefit, especially under the food subsidy scheme. A more significant program is the Social Action Programme, initiated in 1992–93. While not directly targeted at poverty reduction, it is designed to improve human development on a priority basis. The key objectives are to improve primary education (especially among girls), primary health, nutrition, family planning and rural water supply and sanitation, particularly in the most disadvantaged regions. Public expenditure under the program increased from 1.96 per cent of GDP in 1992–93 to 2.55 per cent of GDP in 1995–96, and there is evidence that it has led to some improvement in a number of social indicators. 1.3 Overview of the financial system The banking sector in Pakistan includes four state-owned commercial banks (three ‘old’ banks and the relatively new First Women Bank), two privatised commercial banks, 15 private commercial banks and 21 foreign banks. In addition, there are four specialised banks, all owned by the government. These institutions, plus the investment banks, are supervised by the State Bank of Pakistan. Of these institutions, the three old state commercial banks, the two privatised commercial banks and the Agricultural Development Bank of Pakistan have the most extensive outreach in the rural areas, with around 8,000 branches between them. The ratio of money and quasi-money to GDP (a measure of financial sector development) was 40.9 per cent, higher than Bangladesh, Nepal and Sri Lanka, but lower than India and the three Southeast Asian countries for which data were available. Until recently, non-bank financial institutions such as leasing companies were also supervised by the State Bank, but supervisory responsibility for these bodies has now been transferred to the Corporate Law Authority. The banking system has traditionally been largely owned and controlled by the government, and has been subject to extensive regulation. Since 1991–92, there has been considerable deregulation. Two of the state-owned commercial banks have been privatised, and new private and foreign commercial banks have been allowed to establish. Restrictions on capital flows and foreign exchange transactions have been liberalised. Nevertheless, there is still considerable regulation. For instance, the State Bank administers a very complex scheme requiring the three old state-owned commercial banks, the two privatised commercial banks and the Agricultural Development Bank to lend a certain proportion of their loans to agriculture. Moreover, three of the largest commercial banks with a combined market share of around 60 per cent remain under government ownership. Legislation passed in May 1997 will reduce administrative control by the government of these state-owned commercial banks. There has also been considerable emphasis on Islamic banking. Interest rates are generally referred to as mark-ups, and in accordance with Islamic principles some lending and all deposit rates are set on a profit or loss sharing basis. In the past the mark-ups charged by banks were highly regulated, but they have now been largely deregulated. The only requirement is that banks must charge a minimum of 14 per cent for certain loans, and there is no maximum. Small loans are generally charged at the minimum of 14 per cent. While there is no requirement on the banks to lend at this rate, it is understood that they feel under a social obligation to do so. Given the relatively high inflation rate in Pakistan (13.0 per cent in 1995), this suggests that real interest rates on small loans are very low, and would be insufficient to cover costs. Loans to most other borrowers generally attract a higher mark-up. In addition to the banking system, there is also a system of cooperatives. The State Bank lends to the Federal Bank for Cooperatives (one of the four specialised banks) at a mark-up of 0.5 per cent. These funds are then on-lent to the provincial cooperative banks at 1.8 per cent, which in turn on-lend to some 53,000 primary cooperative societies at the village level. These primary cooperative societies on-lend to final borrowers, with a ceiling of 14 per cent applying to loans from the primary societies to final borrowers. The effective rate of on-lending from the provincial cooperative banks to the primary cooperative societies is based on a profit sharing arrangement, whereby the primary societies retain 70 per cent of the profits and remit 30 per cent to the provincial cooperative banks. The primary societies also raise some funds from members’ savings, but it is understood they are not very active in this regard. The cooperative banks are supervised by the Federal Bank for Cooperatives, while the cooperative banks and societies are regulated by the provincial governments. It is understood that the supervisory and regulatory framework is not very rigorous, and the cooperative movement is not generally well regarded. It has suffered from low repayment rates, and many cooperatives are dormant. It is understood that they also tend to be dominated by village elites, and do not tend to provide financial services to the poor. 1.4 Overview of microfinance Microfinance is much less prominent in Pakistan than in any other country covered in this study. While the government has given some limited emphasis to credit in its policy framework for poverty reduction, most government programs do not in fact reach the poor. Microfinance in Pakistan is almost entirely the preserve of non-governmental organisations (NGOs), and even here, there is only a small number of NGOs operating on a significant scale. The main government scheme that actually reaches the poor is a small program operated by the First Women Bank and funded by the Ministry of Women’s Development. This scheme is discussed in more detail below. Some of the other state commercial banks, such as Habib Bank, also have very small microfinance programs. The largest NGO program in Pakistan is that operated by the Aga Khan Rural Support Program (AKRSP) in the Northern Areas and Chitral. AKRSP is an integrated development program, providing physical infrastructure, training, and financial and technical services, and has operated since 1982. A key element of the program is institutional development at the village level through the establishment of village organisations and women’s organisations. One function of these organisations is to operate credit and savings services. Members of these organisations are required to make a deposit at every meeting (generally fortnightly), and this money is deposited in a profit and loss sharing account (essentially a savings account) at a commercial bank or post office. Village and women’s organisations and individuals can then borrow from AKRSP through certain windows. First, AKRSP provides specific-purpose short- and medium-term loans at a 15 per cent mark-up. Second, village and women’s organisation credit programs can borrow up to the value of members’ savings from AKRSP at a mark-up of 12 per cent, and in turn approve and issue loans to their members. Individual members can borrow up to the value of their savings, or larger amounts with the approval of two guarantors who have not borrowed up to their limits. Village and women’s organisations typically charge a mark-up of 20 per cent on loans to members. Third, AKRSP makes uncollateralised loans direct to individual members of the village and women’s organisations, with the consent of the organisation. Loans are between Rs5,000 ($142) and Rs40,000 ($1,140), and attract a mark-up of 20 per cent. This program is funded by a grant from the government of the Netherlands. A number of other NGOs, which have received support from government or donor agencies, are also providing credit and savings services. Some of these, such as the National Rural Support Program, the Balochistan Rural Support Program and the Sarhad Rural Support Corporation, are based on the AKRSP model. Other prominent NGOs providing credit and savings services include the Orangi Pilot Project, Basic Urban Services for Katchi Abadis (BUSTI) and Sungi. One specialist microfinance institution (MFI) is the Kashf Foundation, established in Lahore in 1996 as the first Grameen Bank replication in Pakistan. Initial loans are Rs4,000 ($114), with repayments over 13 months and a mark-up of 18 per cent. Subsequent loans rise to Rs8,000 ($228) in the second year and Rs10,000 ($285) in the third year. The Kashf Foundation is currently at an early stage of operation, but plans to expand to cover a minimum of 10,000 borrowers. It is understood that Taraqee Trust in Quetta has also started replicating the Grameen Bank model. Total membership of these various microfinance programs is small, and does not cover more than a very small fraction of people below the poverty line. There is clearly a need for a dramatic increase in the outreach of microfinance programs. Moreover, the NGO programs are not sustainable at this stage. Almost all of these programs are operated by multi-purpose NGOs which charge relatively low mark-ups and meet most of the costs of their credit and savings activities through donor grants. For instance, the World Bank (1996) found that AKRSP operates efficiently, with operating expenses that are not excessive for an NGO or rural development project. However, at the time it did not cover the cost of its credit operations, and relied on subsidies from donors. It is understood that AKRSP now covers all of its direct operating expenses from its operating income. Other NGOs are understood to be operating well below self-sufficiency, partly reflecting the relative newness and the small scale of their microfinance activities. 2 Arrangements for direct support 2.1 Support for specialised microfinance institutions Existing schemes by donor agencies There is currently very little direct support for MFIs from either the government or donor agencies. There has been no systematic attempt by the government to increase access of the poor to microfinance, whether through specialist MFIs or some other avenue. In this regard, Pakistan is unique among the nine countries considered in this study. What little government support there has been for microfinance has been largely incidental, rather than the result of any coherent policy framework. And while there has been some support from donor agencies for microfinance, this has been primarily in the form of small-scale projects to support NGOs through seed capital or revolving funds. The World Bank microenterprise project has been operating since 1993. One component of the project, funded through a grant of NLG4.8 million ($3 million) from the government of the Netherlands, provides grants for seed capital and institutional strengthening for NGOs engaged in microfinance. Grants for seed capital have been provided to four NGOs, namely Orangi Pilot Project, AKRSP, Balochistan Rural Support Program and Basic Urban Services for Katchi Abadis (BUSTI). A fifth NGO was provided with some funds, but was suspended from the project due to poor performance. The project was intended to provide funds for on-lending to poor borrowers, although there was no specific means test for identifying borrowers. All funds have now been disbursed and the World Bank commented that the project was very successful, with all four NGOs achieving very high repayment rates on loans to final borrowers. A second, larger component was provided to leasing companies for financing leases to cottage industries, defined as those with less than ten employees (leasing is a popular technique in Islamic banking). The lessee makes a down payment of around 10 per cent, and monthly payments incorporating both principal and mark-up. At the end of the repayment period, the lessee acquires the goods. The project is not directed at poverty alleviation, and it is understood that it does not generally reach poor borrowers. Swiss Development Cooperation has also funded a leasing project. The International Labour Organization operates two programs which include a microfinance element, broadly defined. One project, funded by the government of the Netherlands, provides grants for revolving funds to groups of 10 to 25 women in the North West Frontier Province and reaches around 5,000 women. The other project, funded by the government of Japan, provides grants for revolving funds to groups of between 25 and 100 members throughout Pakistan, and reaches around 2,000 men and women. These revolving funds are used for projects at the group level, rather than being on-lent to individual borrowers. Poverty Alleviation Fund While there is very little direct support for microfinance at present, the government and the World Bank are developing a major new initiative for providing support to MFIs, in the form of the Pakistan Poverty Alleviation Fund. It is understood that the government will provide an initial grant of $100 million to establish the fund, while the World Bank will provide a loan of a further $100 million. The fund will be set up as a joint stock company under the Companies Ordinance of 1984. The board of directors will be chosen by the government, but it is intended that it will include representatives from the private sector and the NGO community. The fund will not lend directly to individual borrowers but will operate as a second tier microfinance institution, lending to NGOs and possibly other community-based organisations for on-lending to self-help groups or final borrowers. While the policy on mark-ups has not yet been determined, it is envisaged that it would lend to NGOs at slightly concessional rates, and that NGOs would charge full commercial rates to final borrowers. Detailed criteria for the selection of partner NGOs have not yet been developed, but it is understood that the main criteria will include a good governance record, transparency, a strong tradition of accountability and results-oriented arrangements. It is intended that the fund will be available to support a variety of models of microfinance. It is not yet clear whether there will be a specific means test for final borrowers, and if so, how this will be determined. The proposed establishment of the fund is a very positive development. Similar institutions have been successful in a number of other countries in the region, most particularly Bangladesh but also India, the Philippines, Sri Lanka and Thailand. Experience from these countries suggests that the fund is likely to be most successful if it adopts a number of the following principles. The fund should be as independent and as free from political interference as possible. The plans to set the fund up as a joint stock company, and to include representatives from the private sector and the NGO community on the board of directors, are encouraging. Nevertheless, these measures may not be enough in themselves. Additional measures may be to enable private and NGO bodies to appoint representatives to the board directly, to provide for fixed-term appointments, and to spell out clearly the objectives of the fund while allowing the board maximum independence to meet these objectives. It will also be necessary for the fund to set and enforce appropriate performance and reporting standards for the MFIs that it funds. This will mean striking an appropriate balance between the need to increase outreach and the need to strengthen the capabilities of existing MFIs. It would be appropriate to require all partner organisations to meet a set of minimum standards, and to increase these gradually over time. These standards should ensure a level playing field between MFIs, and should not be prescriptive as to the particular lending methodologies adopted by individual MFIs. The fund should ensure that all MFIs to which it lends target their programs to the poor. MFIs should be required to set appropriate means tests that are transparent and readily enforceable. And it is important that the fund emphasises the need for MFIs to become financially self-sufficient. Given the vast unmet demand for microfinance in Pakistan, the need for self-sufficiency is even more critical than in most other countries. MFIs should be free to charge mark-ups that are sufficient to cover their costs, and should be required to have realistic plans for attaining self-sufficiency. 2.2 Support through the banking system Directed credit schemes The State Bank of Pakistan administers a scheme requiring some banks to lend a certain proportion of their loans to agriculture. The scheme applies to the three old state-owned commercial banks, the two privatised commercial banks, the Agricultural Development Bank and the cooperative banks. There is a complex procedure for determining the allocations for individual banks. First, the government develops an annual credit plan for the economy as a whole, specifying the maximum loans outstanding for the banking system. It then estimates the requirements for agriculture that are expected to come from the formal financial system. The two figures are not directly comparable, because the overall credit plan is expressed in outstandings whereas the allocation for agriculture is expressed in disbursements. This annual requirement for disbursements to agriculture is then allocated to individual banks depending on a range of criteria, including area of operations, deposit ratios, and the particular bank’s own plans and projections. For instance, in 1996–97 the global allocation for agriculture was Rs26 billion ($740 million), of which around Rs10 billion ($285 million) was allocated to the commercial banks, around Rs12 billion ($340 million) to the Agricultural Development Bank, and around Rs4 billion ($115 million) to the cooperative banks. In the case of commercial banks, it is understood that the requirements mean that around 5 per cent of the value of loans outstanding are to agriculture. Within this allocation, commercial banks are required to ensure that 50 per cent of their disbursements to agriculture are for small farmers (this requirement does not apply to the Agricultural Development Bank or the cooperative banks, although it is understood that the cooperative banks probably meet it anyway). Small farmers are defined on the basis of their landholdings, whether as owners or tenants. In more fertile areas with irrigation, small farmers are defined as those with 12.5 acres of land or less. In desert areas with irrigation, the ceiling is higher, ranging from 16 to 32 acres. In rain-fed areas, the ceilings are double those in irrigated areas. It is unlikely that many poor farmers benefit from this allocation. It is understood that around 70 per cent of farmers fall within the definition of small farmers, and even so, some large farmers have managed to find ways of obtaining loans. Under the supervised credit scheme, the State Bank has required the banks to establish mobile banking units for reaching small borrowers, and has also provided banks with territorial jurisdiction. These measures have led to higher repayment rates on small loans than had previously been the case, with repayment rates now in the 70 to 75 per cent range. It is understood that the State Bank has been giving preliminary consideration to extending these rules, to require all banks to allocate a part of their loan portfolio to microfinance. Alternatively, banks may be required to reinvest a certain proportion of the resources they raise from a particular village or region back into that village or region. However, no decisions have been taken yet. Microfinance program of First Women Bank There are a number of government programs designed to provide finance for small and microenterprise development. However, the only one that appears to reach poor borrowers is a relatively small program operated by the First Women Bank, a state commercial bank established in 1989. In 1993 the Department of Women’s Development provided a grant of Rs48 million ($1.4 million) to establish the program, and it is understood that it is considering a further allocation of Rs19 million ($540,000) to extend it. Under this program, the bank provides loans up to a maximum of Rs25,000 ($712) with a mark-up of 12 per cent to women with household income of less than Rs2,000 ($57) per month. Loans are generally provided to individual borrowers, although in some cases borrowers organise themselves into groups and provide group guarantees. In addition, 22 NGOs are associated with the program as non-financial intermediaries, in identifying and training borrowers. The bank has also lent to five NGOs as financial intermediaries for on-lending to final borrowers. In some cases, the NGOs themselves use smaller community-based organisations as non-financial intermediaries. The NGOs borrow from the bank at 13 per cent and on-lend to final borrowers at 17 to 18 per cent. To date, the program has achieved a cumulative repayment rate of around 97 per cent. It has provided loans to around 5,040 borrowers (excluding sub-loans granted by the National Rural Support Program, a large NGO which has received a line of credit under the program). As at May 1997 there were 2,160 current borrowers, again excluding sub-loans by the National Rural Support Program. The program appears to have been quite successful, especially compared to most microfinance programs channelled through commercial banks in other countries. This may reflect the fact that First Women Bank is a relatively small bank with a particular focus on women, and the use of NGOs as financial and non-financial intermediaries. 2.3 Other major programs The main government agency for lending to small borrowers is the Small Business Finance Corporation (SBFC), established in 1972 under the Ministry of Finance. The National Development Finance Corporation (NDFC) and some other agencies also provide loans to small and microenterprises in addition to their other activities. The SBFC operates three main loan programs. First, its main program is to provide loans to small businesses. The maximum loan amount is Rs2 million ($57,000), with a mark-up of 15 to 18 per cent. Second, the national self-employment scheme provides loans of between Rs10,000 ($285) and Rs300,000 ($8,550) to self-employed persons, at a mark-up of 14 to 16 per cent. The average loan size is around Rs150,000 ($4,275), with very few loans at the bottom end of the range. Third, the Youth Investment Promotion Society Scheme provides loans of between Rs10,000 ($285) and Rs200,000 ($5,700) to unemployed high school graduates aged between 18 and 35 for self-employment projects, with a mark-up of 14.5 per cent. This scheme is administered by another government agency, the Youth Investment Promotion Society, which identifies the borrowers and provides technical training. However, loans are disbursed through the SBFC. The nature of the target group means that it does not tend to reach the poor, and most loans are for considerably more than Rs10,000 ($285). The SBFC currently has around 90,000 borrowers, and loans outstanding of around Rs12 billion ($342 million). As well as not reaching the poor, it has low recovery rates in the range of 30 to 40 per cent. Since March 1996, the SBFC has required collateral in the form of a mortgage equal to at least 50 per cent of the value of the loan, in an effort to increase repayment rates. In the past, the SBFC has been funded mainly through lines of credit from the State Bank of Pakistan, but it has not had access to such funding for the last two years, and is relying on recycling loan repayments to maintain its lending. It is understood that the government is currently considering the future of the SBFC. Given the poor financial performance of the SBFC and the fact that it does not reach poor borrowers, it would be appropriate for the government to consider reallocating some of the its funds to the proposed Poverty Alleviation Fund. 3 Regulation of non-bank microfinance institutions 3.1 The broad regulatory framework There are no specific provisions relating to NGOs engaged in microfinance. Hence, the regulatory framework for such NGOs is the same as for other NGOs. NGOs do not have to register in order to carry out their work. The NGO Resource Centre (1991) found that many NGOs that have chosen not to register have functioned well, achieved their objectives and gained recognition. However, registration provides a legal status and may facilitate access to financial support. There are five main avenues for NGOs to seek registration, and all of these could apply to NGOs engaged in microfinance. First, they can register as a non-profit company under the Companies Ordinance of 1984. There are two different avenues for registration under this Ordinance. An NGO can register itself at the provincial level with the Assistant Registrar of Joint Stock Companies, or at the national level with the Corporate Law Authority. The second avenue is to register with the Registrar of Joint Stock Companies as a society under the Societies Registration Act of 1860. Third, they can register as a cooperative society under the Cooperative Societies Act of 1925. Registration is with the provincial Registrar of Cooperative Societies. The fourth option is registration as a voluntary social welfare agency with the Directorate of Social Welfare, pursuant to the Voluntary Social Welfare Agencies Registration and Control Ordinance of 1961. Finally, they can register as a public charitable trust under the Trust Act of 1882. This is the simplest method and entails no reporting requirements. However, it may be restrictive, as operations must be funded out of earnings and cannot be funded out of the capital of the trust. In broad terms, the requirements for registration as a non-profit company, a society, a cooperative society or a voluntary social welfare agency are similar. A minimum number of members is required, ranging from around seven to ten. The application must include a constitution or a memorandum and articles of association providing details of the NGO — including name, address, aims and objectives, areas of operation, membership, details of the governing body, organisational structure, arrangements for meetings, and similar matters. Moreover, all of these bodies are required to prepare an annual report, maintain accounts, have the accounts audited annually, and submit these documents to the registration authority. It was reported that the process of registration under these various Acts can be time-consuming. For instance, the NGO Resource Centre (1991) found that NGOs regarded the procedures for registration as problematic. They cited the lack of clear direction, inadequate guidelines, the time taken in getting the required documents together and the loss of time in making amendments and corrections. However, once they were registered, they generally had no problems. Clearly, it would be desirable to streamline and simplify the procedures for registration where this is possible. In terms of the reporting requirements, different regulatory agencies enforce them differently. It is understood that the agencies regulating non-profit companies tend to enforce the requirements quite rigorously. Other agencies are less rigorous, and usually do not enforce the requirements that accounts be audited and submitted to them. Some NGOs engaged in microfinance, such as the Aga Khan Rural Support Program (AKRSP) and Kashf Foundation, have registered as non-profit companies because of the added credibility that this brings. NGOs receiving donations from abroad are required to inform the Economic Affairs Division of the Ministry of Finance. They are required to submit an annual report, providing details of the amount received and the usage of the funds. In practice, however, it is understood that this requirement is rarely enforced. In 1994, the government introduced a new bill to provide for the registration and regulation of social welfare agencies, to be called the Social Welfare Agencies (Registration and Regulation) Act of 1994. The NGO movement was critical of certain aspects of this bill, and initiated discussions with the government. Following this, the bill was withdrawn and revised, and a new one was introduced in March 1996. The Pakistan NGO Forum argues that the new bill does not take account of the consultative process held during 1994–95. One concern is that all NGOs would be required to be registered under the new bill, regardless of whether they receive public funds or not. It would also give wide powers to the registration authority, with opportunity for misuse. NGOs also consider that the reporting requirements would be onerous, particularly with respect to the use of foreign donations. Further, there would be considerable scope for NGOs to be dissolved, with inadequate right of appeal. The bill has been tabled in the Upper House but is still pending, with its current status unclear. It is beyond the scope of this study to analyse the proposed Bill in detail. However, it is important that any legislation strike an appropriate balance between ensuring that NGOs are properly monitored and accountable to their members and third parties, while minimising bureaucratic interference into their affairs. It is also desirable to limit the discretionary power of the regulatory authority as much as possible. Regulatory and prudential requirements should be set out clearly and transparently, with any NGO that meets these standards free to operate without restriction. 3.2 Mark-ups In general, there are no regulations concerning the mark-ups that NGOs involved in microfinance can charge borrowers. However, mark-ups charged by cooperatives are regulated, with a ceiling of 14 per cent on loans from the primary societies to final borrowers. There also appears to be considerable social and political pressure on financial institutions in general, including microfinance institutions (MFIs), to keep mark-ups low, and this may make it difficult for MFIs to operate on a sustainable basis. It would be appropriate for the government to remove the ceiling on the interest rate that cooperatives can charge, and issue a clear statement that MFIs should charge mark-ups sufficient to cover their costs. 3.3 Prudential regulation and supervision NGOs engaged in microfinance are not subject to any prudential requirements covering matters such as minimum capital, capital adequacy, reserves, liquidity or loan loss provisioning. Other than the requirements to maintain accounts and have them audited annually, there are also no financial reporting requirements. Most commentators consider that it is not appropriate for MFIs which do not accept deposits from the general public to be subject to full prudential regulation and supervision. The question of appropriate standards for MFIs is also not as pressing in Pakistan as in some other countries, given the small number and scale of MFIs. Nevertheless, given the risks inherent in providing financial services, some standards would appear appropriate. This is discussed below. 3.4 Performance and reporting standards of second tier institutions As noted above, there is currently no second tier microfinance institution operating in Pakistan. However, it is proposed to establish the Poverty Alleviation Fund, to lend to NGOs and possibly other district-level organisations for on-lending to self-help groups and final borrowers. It will be necessary for the fund to set and enforce appropriate performance and reporting standards for the MFIs that it funds. The relatively late development of microfinance in Pakistan means that Pakistan can benefit from the experience of other countries, and establish an appropriate policy regime at an early stage in the development of the microfinance sector. It would be useful to study the policies and experiences of second tier institutions in other countries, particularly the Palli Karma Sahayak Foundation in Bangladesh (see the Bangladesh country study). 3.5 Self-regulation A national microfinance network has recently been established, with the Kashf Foundation taking the lead role. All of the major NGOs involved in microfinance have joined, including the Kashf Foundation, AKRSP, Sungi Development Foundation, Aga Khan Foundation, Orangi Pilot Project and Network Leasing, and the initiative is being supported by the Asia Foundation. The network aims to promote an enabling environment for microfinance by:
The establishment of this kind of apex body is a positive development. Over time, such a body could perform a number of important roles, including information exchange, training, research, policy dialogue with government and donor agencies, and establishing standards for self-regulation. All microfinance NGOs in Pakistan should be encouraged to play an active role in the new body. 4 Regulation of banks 4.1 Licensing and minimum capital requirements As in most other countries, MFIs are not permitted to accept deposits from the general public. All institutions which accept deposits of money from the public for the purpose of lending or investing are required to be registered as banks under the Banking Companies Ordinance of 1962. Unlike most other countries in South Asia, there is no network of small banks operating in the rural areas in Pakistan. Moreover, the regulatory framework precludes the establishment of small banks. The main avenue for establishing a bank is to obtain a licence as a commercial bank. The minimum capital requirement is Rs500 million ($14.2 million), although it has been suggested that this may be increased to Rs1,000 million ($28.5 million). There are also some additional requirements that prevent the establishment of small banks operating at the local level. For instance, it is necessary to establish a branch in each of the four provinces of Pakistan and the disputed territory of Kashmir. It is also necessary to be a publicly listed company with public shareholders to the extent of at least 50 per cent. The difficulty in establishing a bank is illustrated by the experience of the Aga Khan Rural Support Program (AKRSP), which is currently seeking to establish a bank in northern Pakistan. Because of the restrictions on commercial banks, AKRSP is considering establishing an investment bank. The minimum capital requirement for investment banks is Rs100 million ($2.9 million). While successive governments have agreed in principle to AKRSP’s establishing an investment bank, there have been protracted discussions and negotiations over a range of hurdles that need to be overcome. Investment banks are also not allowed to accept short-term deposits or maintain cash counters. This clearly limits the range of deposit services that any MFI established as an investment bank would be able to provide. Given that small banks are much more likely to provide services to poor borrowers in remote locations than large banks, the restrictions on establishing banks reduce the likelihood that banks will engage in microfinance. They also make it extremely difficult for MFIs to establish banks so that they can accept deposits and offer a wider range of services. It would be appropriate for the government to establish a framework for licensing small banks, by imposing more realistic minimum capital requirements and by removing other restrictions such as the requirement to establish a branch in each province. In this regard, the experiences of countries such as Indonesia and the Philippines may be useful (see the Indonesia and Philippines country studies). It should be noted that in some cases, it may be possible to establish a small bank in the form of a cooperative bank. Under the Cooperative Societies Act of 1925, the minimum capital requirement for a cooperative bank is only Rs20,000 ($570). However, cooperative banks are not regulated by the State Bank. Moreover, they are generally owned and controlled by the provincial governments, and it is not clear if they would permit the establishment of new cooperative banks. Cooperative banks are subject to little prudential supervision, and generally have low credibility with the public. As such, they have difficulty in attracting deposits from the public and rely on the Federal Bank for Cooperatives for most of their funds. Hence, even it were possible, licensing as a cooperative bank would not provide a sound basis for a microfinance bank. 4.2 Mark-ups As noted above, the only regulation applying to the mark-ups charged by commercial banks is that they must charge a minimum of 14 per cent for certain loans. There is no maximum. Nevertheless, there appears to be considerable pressure on banks to keep mark-ups on small loans low, and small loans are generally charged at the minimum of 14 per cent. Small loans are not commercially viable at this mark-up, and are subsidised by the banks’ other operations. Clearly, this situation makes it very difficult for regulated banks to engage in microfinance on a commercial basis. It would be appropriate for the government or central bank to issue a clear statement that regulated banks should set mark-ups on small loans at a level that is sufficient to cover all the costs of making such loans, and to make it clear to the banks that they should not feel under any political pressure to maintain mark-ups on small loans at artificially low levels. 4.3 Prudential regulation and supervision Commercial banks are required to maintain capital equal to at least 7.5 per cent of total time and demand liabilities, a cash reserve of 5 per cent of deposits, and liquidity of 30 per cent of deposits, including the cash reserve. Under the loan loss provisioning requirements, banks are required to maintain a provision of 2 per cent for other assets especially mentioned, 25 per cent for sub-standard loans, 50 per cent for doubtful loans, and 100 per cent for loss loans. Commercial banks are required to provide weekly position reports to the State Bank, as well as fortnightly, monthly, quarterly and annual reports on various aspects of their operations. The requirements listed above would not appear to impose any undue burdens on banks engaged in microfinance. However, there are two major restrictions of a prudential nature that make it extremely difficult for banks to establish linkages with NGOs or self-help groups. Among the countries included in this study these restrictions are unique to Pakistan, with no comparable restrictions in any other country. First, banks are only permitted to make unseccured loans up to Rs100,000 ($2,800). This limit was raised from Rs50,000 ($1,400) in 1996, and even then only for loans of less than three years for trade, commerce or business. For other loans, the clean limit is Rs25,000 ($700). For all loans above these limits, the State Bank requires that the loan be fully collateralised. While loans to individual borrowers of above Rs100,000 ($2,800) could not be considered microfinance, this rule greatly restricts the scope for banks to lend to NGOs, village organisations or self-help groups for on-lending to poor borrowers. Second, other than individuals, banks are only allowed to lend to structured bodies which meet certain conditions. For instance, structured bodies are required to maintain audited accounts, and are subject to regulations concerning debt-equity ratios and other matters. This makes it very difficult for banks to lend to relatively informal group structures, such as village organisations and self-help groups. AKRSP is holding discussions with the State Bank to amend these rules or to exempt loans to NGOs and village organisations from these requirements. Nevertheless, as they stand, these restrictions are clearly a major barrier to banks establishing linkages with NGOs and self-help groups of the poor, and it would be appropriate to remove them. 5 Summary and recommendations GNP per capita in Pakistan stood at $460 in 1995, higher than the levels recorded in Bangladesh, India and Nepal, but lower than for the other countries included in this study. Performance in terms of human development is poor, with most indicators well below those of countries with similar per capita incomes. For instance, while Pakistan has significantly higher per capita income than India, it has lower life expectancy, higher infant mortality and lower adult literacy. The incidence of poverty is estimated at around 34.0 per cent in 1990–91, equivalent to around 44.2 million people. Microfinance is much less prominent in Pakistan than in any other country covered in this study. While the government has given some limited emphasis to credit in its policy framework for poverty reduction, most government programs do not in fact reach the poor. Microfinance is almost entirely the preserve of NGOs, and even here, there is only a handful of NGOs operating on a significant scale. They do not reach more than a very small fraction of people below the poverty line, and there is clearly a need for a dramatic increase in the outreach of microfinance programs. Arrangements for direct support There is currently very little direct support for microfinance institutions (MFIs) from either the government or from donor agencies. There has been no systematic attempt by the government to increase access of the poor to microfinance, whether through specialist MFIs or some other avenue. In this regard, Pakistan is unique among the nine countries considered in this study. The State Bank of Pakistan administers a complex scheme requiring some banks to lend a certain proportion of their loans to agriculture. It is unlikely that many poor farmers benefit from this allocation, and it is clearly not a cost-effective way of reaching the poor. Similarly, the Small Business Finance Corporation (SBFC) does not reach the poor and has performed poorly. The government should consider reallocating some of its funds to the proposed Pakistan Poverty Alleviation Fund, discussed below. The only government-sponsored program that appears to reach poor borrowers is a relatively small program operated by the First Women Bank, a state commercial bank. Maximise effectiveness of the Poverty Alleviation Fund At present, the government and the World Bank are developing a major new initiative for providing support to MFIs, in the form of the Pakistan Poverty Alleviation Fund. It is understood that the government will provide an initial grant of $100 million to establish the fund, while the World Bank will provide a loan of a further $100 million. The fund will lend to NGOs and possibly other community-based organisations for on-lending to self-help groups or final borrowers. This is a very positive development. To maximise its effectiveness, the government should ensure that the fund is as independent and as free from political interference as possible. The fund should set appropriate performance and reporting standards for the MFIs that it finances, ensure that MFIs target their programs to the poor, and require them to have realistic plans for attaining self-sufficiency. Regulation of non-bank microfinance institutions Streamline and simplify registration procedures There are no specific provisions relating to NGOs engaged in microfinance. While NGOs do not have to register in order to carry out their work, registration provides a legal status and may facilitate access to financial support. NGOs can seek registration as a non-profit company, society, cooperative society, voluntary social welfare agency or public charitable trust. It was reported that registration can be a time-consuming process. The government should streamline and simplify the procedures for registration where this is possible. Provide for appropriate regulation and minimise interference In 1994, the government introduced a new bill to provide for the registration and regulation of social welfare agencies. The bill has been criticised by the NGO movement, and its current status is unclear. The government should ensure that any new legislation strikes an appropriate balance between making sure that NGOs are properly monitored and accountable to their members and third parties, while minimising bureaucratic interference into their affairs. It should limit the discretionary power of the regulatory authority as much as possible. Ensure mark-ups sufficient to cover costs In general, there are no regulations concerning the mark-ups that NGOs involved in microfinance can charge borrowers. However, cooperatives are subject to a ceiling of 14 per cent, and other MFIs seem to be under pressure to keep mark-ups low. The government should remove the ceiling for cooperatives, and issue a clear statement that MFIs should charge mark-ups sufficient to cover their costs. Establish and enforce appropriate standards NGOs engaged in microfinance are not subject to any prudential requirements covering matters such as minimum capital, capital adequacy, reserves, liquidity or loan loss provisioning. Reporting requirements are also minimal. Most commentators consider that it is not appropriate for MFIs which do not accept deposits from the general public to be subject to full prudential regulation and supervision. However, the proposed Poverty Alleviation Fund should set and enforce appropriate performance and reporting standards for the MFIs that it funds. It would be useful to study the policies and experiences of second tier institutions in other countries, particularly the Palli Karma Sahayak Foundation in Bangladesh. Support new apex body for MFIs The recent establishment of a national microfinance network as an apex body for MFIs in Pakistan is a positive development. Donor agencies should encourage all microfinance NGOs in Pakistan to play an active role in the establishment of the new body. Regulation of banks Establish framework for licensing small banks Unlike most other countries in South Asia, there is no network of small banks operating in the rural areas in Pakistan. Moreover, the regulatory framework precludes the establishment of small banks. Given that small banks are much more likely than large banks to provide services to poor borrowers in remote locations, this reduces the likelihood that banks will engage in microfinance. It also makes it extremely difficult for MFIs to establish banks so that they can accept deposits and offer a wider range of services. The government should establish a framework for licensing small banks, by imposing realistic minimum capital requirements and removing other restrictions, such as the requirement to establish a branch in each province. Support mark-ups which recover costs While banks are not subject to a ceiling on the mark-ups they can charge, they appear to be under considerable pressure to keep mark-ups on small loans low. This makes it very difficult for them to engage in microfinance on a commercial basis. The government or central bank should issue a clear statement that regulated banks should set mark-ups on small loans at a level that is sufficient to cover costs. Abolish prudential restrictions which discourage bank-NGO linkages There are two major restrictions of a prudential nature that make it extremely difficult for banks to establish linkages with NGOs or self-help groups. First, banks are only permitted to make clean loans up to Rs100,000 ($2,800). Second, other than individuals, banks are only allowed to lend to structured bodies which meet certain conditions. These restrictions make it very difficult for banks to lend to NGOs or self-help groups, and the government should abolish them. It should be noted that Pakistan is the only country included in this study to impose restrictions of this nature. References
|
