Improving Outreach and Possible Solutions to Micro Enterprise Financing

By: Sohailuddin Alavi Preamble This paper serves as the basis for initiating dialogue on concerns and possible remedies, particularly improving institutional outreach, for the lack of enterprise financing, specifically in the context of the State Bank of Pakistan (SBP)s strategic directions for the Year 2010. The author conducted Focus Group Discussions with key personnel from microfinance banks / specialized microfinance institutions, under the auspices of CIPE as a prelude to developing this paper. Challenge Statement In Pakistan, about one-third of the population is un-banked, or lacking access to finance, which if appropriately tapped can offer tremendous opportunities to both banking institutions and businesses. As a step towards mainstreaming the un-banked, SBP has envisaged increasing the size of micro and small enterprise (MSE) financing from one million borrowers to four million borrowers, and from Rs. one billion to four billion by the year 2010. In this context, increasing institutional outreach and sinking micro financing into the sector are considered pivotal strategies. Other areas of interest include regulatory regimes, product and process innovations, relationship management and monitoring, and market intelligence data. Background MSEs have been instrumental in fueling economic growth across the globe. These businesses are rightly considered as the backbone for a countrys industrial base; as an effective instrument of dispersing equal employment opportunities and gender mainstreaming; and as one of the tools to redress poverty, especially in the context of financial hardships. Financial institutions believe that this segment of the business community is the most viable for expanding banking opportunities, both from commercial as well as corporate citizenship perspectives. This is due to the fact that there exist a huge number of potential customers, while loan recovery rates are extremely high. However, it requires a focused approach by microfinance banks (MFBs) and other micro financing institutions. About 50% of Pakistan's workforce is self employed, typically owning or operating micro and small enterprises. This trend is likely to increase as corporate and industrial organizations continue to downsize, leaving former staff members with no option other than starting a business. Outsourcing is also on the rise in corporate and industrial setups, creating more business opportunities for MSEs. Though many micro and small entrepreneurs have demonstrated commitment and sound trade acumen, they tend to forego many opportunities to expand their businesses beyond the minimum level needed to sustain them and their families. Two major reasons are cited as lack of rational approach in managing the enterprise: lack of access to financial resources and lack of access to conventional financial services. The micro and small entrepreneurs can be clustered into different categories for the purpose of focusing on their diverse characteristics, needs, and expectations. Enterprises can also be categorized into groups representing different trades. This analysis provides a useful insight for identifying possible relationships.

a) Categories by Entrepreneurs
This paper was developed for CIPE Policy Roundtable on Microfinance (2007)

Prospering entrepreneurs with proven track record Have overcome market forces and progressed reasonably well Have built in fairly reasonable equity over time Have taken advantage of market opportunities Have the capacity to manage the enterprise, make use of the given and additional financial resources productively, and contain risk within fairly bearable limits Can meet financial obligations Have passion, commitment, business discipline, and integrity Mostly come from lower middle to lower strata of the society Relationship with such entrepreneurs tends to be commercially viable and sustainable, while from the entrepreneurs perspective the micro financial services are generally affordable at competitive prices Potential entrepreneurs Have the potential to succeed in business but have yet to prove abilities Have ideas, passion, commitment, business discipline, and integrity Can take advantage of market opportunities Have little or no equity Have the capacity to manage the enterprise, make use of given and additional financial resources productively, and to contain risk within fairly bearable limits Have reasonably fair chances of sustaining and progressing in the business Mostly come from lower middle to lower strata of the society Relationship with such entrepreneurs is potentially viable and sustainable; however, fiscal responsibility issues may arise. Hence relationship needs to be structured based on individual entrepreneurs requests and track record. Poorest of the Poor Have urgent need of survival (self and family) Have little capacity and unlikely to succeed Have little sense of direction Have no resource base Have urgent needs for consumption and enterprise financing Represent household below the poverty line Relationship may begin from a corporate citizenship perspective, but innovative microfinance services can make the relationship commercially sustainable for both in the long run. Hobbyists Have fairly sustainable alternate source of income generation Have no or little resource constraint Have rather casual attitude towards managing the business Use the enterprise for personal gratification or keeping oneself busy Mostly come from high middle class to affluent strata of the society Relationship most of the time is viable, with no accessibility / affordability issues at the customers end.
This paper was developed for CIPE Policy Roundtable on Microfinance (2007)

Opportunists Fairly affluent Have fairly sustainable alternate source of income generation Create dummy enterprises to obtain easy financing Channel micro enterprise financing towards personal consumption Mostly come from high middle to affluent strata of the society Relationship is inherently riskier and unviable, unless specific risk management tools are used in managing such relationships, if at all deemed fit. b) Categories by Enterprises Retail Outlets By definition, these are shops owned and operated by a single person the entrepreneur (men or women). These shops generally sell consumer merchandise, or offer small scale manufacturing of consumer / household goods. Their profit function is based on buying and selling differentials multiplied by inventory turnover. Their financing requirements are generally for maintaining or creating an inventory and running expenses (working capital). Service Outlets By definition, these are individuals with technical skills who provide services within the local community artisans, technicians, utility service providers, transporters, etc. (men or women). These entrepreneurs provide various consumer services primarily to households and individuals. Their profit function is based on the services revenue multiplied by the activity level. Their financing requirements are generally for the equipment and running expenses. Vendors By definition, these are individuals or a group with technical skills that provide services to equipment (product) manufacturers, such as CMT units in the textile industry, accessories manufactures, after-sales service providers, etc. These entrepreneurs provide value-added services to the original equipment manufacturers. Their profit function is based on the value addition margin multiplied by the activity level. Their financing requirements are generally for raw materials, equipment, and working capital. c) Microfinance Operations in Pakistan Many organizations apart from MFBs are targeting microentrepreneurs in the informal sector, known as micro finance institutions (MFIs). Though their focus partially converges with that of financial institutions, the unique positions and products of MFIs differ due to their approach. These organizations offer micro financing as a social mandate, catering only to the poorest of the poor. Other financial institutions, however, operate from a much broader perspective and use a more systematic approach, as they are in a position to offer a stream of financial services most needed by entrepreneurs. This co-existence of MFIs and MFBs is creating unique diversity, which should be leveraged to broaden funding in both sectors.
This paper was developed for CIPE Policy Roundtable on Microfinance (2007)

At the end of 2006, nearly one million MSEs were active borrowers and savers in Pakistan. There was a drastic increase in active savers and borrowers during the last quarter of the year, especially compared to the overall past trends. The data further reveals that impact of development and growth in the urban areas has outpaced the expansion of the rural areas 1. According to SBP estimates, potential microfinance clientele in Pakistan includes 25 to 30 million people. Coverage to date is only slightly above 1% of the total target population. The percentage of female clientele is negligible in the present clientele pool 2. Table - Outreach of Microfinance Banks No. of Branches No. of Borrowers 253 266,720 (Jun 06) (51,819 female) Advances / Financing in rupees 2.739 million (Jun 06) No. of Savers 1,659,051 (Dec 06) Savings in rupees 2,610,318,109 (Dec 06) 997,778 (Dec 06) 10,742,710,407 (Dec 06)

Two divergent views prevail regarding microfinance. One popular view is that microfinance is for the poorA, to redress all financial hardships, be it household or enterprise-based. For instance, Mr. Basheer A. Chawdry3 says, Microfinance should be viewed as a social business enterprise that serves a cause, covers its costs and also earns a reasonable rate of return. Kanwal Saleem 4 quotes Faisal Bari, a renowned economist: Microfinance [serves] as financial services needs, including credit, savings, insurance, and payments transfers of the poor households and their enterprises. Shabir H. Kazmi5 in his article stipulated, Nearly one third of total population of Pakistan lives below the poverty line. While one may give a number of reasons for the prevailing poverty, many analysts say it is because of non-availability of finance to those who need it the most. However, some programs in the past were focused on distributing zakat and kherat to the poor without enabling the poor to develop their own income generating entities. The result is that despite distributing billions of rupees, the number of people living below the poverty line is on the rise. To begin with one point has to be made clear: that the sole objective of microfinance is not poverty alleviation but to create sustainable business entities. Therefore any lending [proposition] has to be reviewed in the backdrop of revenue generation and debt repayment ability of the borrower. The second objective is to improve the income generating capacity of the borrower. Another view was expressed by Mr. Nadeem Hussain, president and CEO of Tameer Microfinance Bank. More than three billion people in the world seek access to basic financial services essential to managing their lives. Microfinance is an essential but not the only tool in the reduction of poverty, said Mr. Hussain6. Mr. Hussain further highlighted 4 CGAP principles aiming to help governments and practitioners develop sustainable frameworks for microfinance. i) Financial systems built to serve the poor will only reach full potential if integrated into the country's mainstream financial system ii) Microfinance can pay for itself and must if it is to reach a larger number of poor people iii) Poor people need a variety of financial services, not just micro-loans iv) The governments job is not to provide financial services for the poor, but to create an enabling policy environment in which businesses can thrive. In light of the above, one can conclude that microfinance is an emerging portfolio of financial
This paper was developed for CIPE Policy Roundtable on Microfinance (2007)

services aimed to help bring marginalized potential entrepreneurs into the mainstream of the economy through sustained enterprise development. Putting it differently, microfinance aims at promoting micro business enterprises of all sorts. Poverty reduction, however, is another initiative, which needs two separate interventions: Supporting potential entrepreneurs to capitalize on their economic opportunities through financing and infrastructure support; and, the other is to provide socio-financial support to those who lack potentials to participate in economic activity themselves either permanently or temporarily. d) Generic Framework for Building Sustainable Micro Finance Bank (MFB)

Generic Framework for Building Sustainable Micro Finance Bank (MFB)

Intervening Indicators Internal: Strategic focus Systems approach Process management Technology Structures People skills External: Regulatory and policy alignment Alliances and linkages Institutional technical support/assistance Social mobilization Enabling Indicators MFBs should be able to develop their institutional capacity: To identify viable micro and small enterprises and to evaluate their potentials and risks, such as
Ability to make effective use of the money (credit) in the enterprise, Ability at present and/or in the due course of time to meet its financial obligations in a befitting fashion, Requisite competence of the trade, and Passion, commitment and discipline in enterprise.

Performance Indicators Should be able to offer full range of financial services to the micro enterprises by precisely satisfying their financial needs and exceeding their expectations in a profitable and sustainable manner Should be able to adhere to its CSR towards poorest of the poor in a generally acceptable manner

To reach to the door step of micro and small enterprises To develop and deliver financial services at competitive prices To develop and sustain essentially profitable relationships with all MSE customers To manage their profit function efficacy at all times To mobilize and deploy resources at optimal efficacy

e) Proposed Coordination Structures Along the value chain of a typical microfinance activity are microfinance banks, micro-enterprise service providers, non-governmental organizations, and international and government institutions. Coordination among these institutions is crucial to sustain entrepreneur and enterprise development. Hence, the following is a list of possible roles for discussion. Institutions Microfinance Banks (including MFIs) Roles and Responsibilities Financial experts. Provide range of micro-financial services to the entrepreneur, focusing on their specific and diverse needs and expectations. Links the entrepreneur and MFBs Focus on social mobilization, customer identification, relationship management, and recovery of monies on behalf of MFBs / MFIs.
5

Community Based Organizations (including NGOs)

This paper was developed for CIPE Policy Roundtable on Microfinance (2007)

Micro-Enterprise Service Providers

Enterprise and entrepreneur development experts Incubate enterprises, identify potential entrepreneurs, develop their competencies, and provide business counseling.

International and Govt. Institutions

Socioeconomic development catalysts. Create an enabling policy environment and provide necessary economic assistance to the system

Microfinance Prospects and Challenges No business opportunity comes without challenges. Similarly, microfinance opportunities in the MSE sector face challenges manifested in the immediate environment and institutions capacity. Those who tackle the challenges rationally will take the lead in unleashing the right opportunities at the right time. According to SBP data, 99% of the potential customers in the MSE sector are untapped. The MSE sector offers more sustainable growth potential and employment to marginalized populations, including women and those with no or little formal training or education. Furthermore, a large number of potential customers in the MSE sector are capable of using the credit responsibly and will offer fair returns to the lenders as their share of profits. Last, recovery percentages in this sector have been encouragingly positive to date. As mentioned above, the challenges can be grouped as external or internal to the institution. Converting external challenges into enabling factors needs a joint effort of all the stakeholders, while redressing the internal challenges entails broadening the institutions vision of its potential market to also include, besides the poorest-of-the-poor, the entrepreneurs who may not qualify to be poorest-ofthe-poor; business policy, processes, and product alignment; and capacity building. External challenges as identified by the stakeholders in the two focus group discussions broadly include: inadequate policy environment and market infrastructure; undocumented segment of the economy; higher enterprise vulnerability to socioeconomic contingencies, primarily due to lack of fiscal protection available to the MSEs against cutthroat competition and potentially exploitative practices of the local conglomerates and international businesses; lack of access to technology; unavailability of the full range of financial services to the sector; and the non-commercial attitude of entrepreneurs towards their businesses and especially towards loans. Among the internal challenges the foremost is the inadequate flow of cheap funds to private sector institutions; limited outreach; institutions general inability to assess and therefore mitigate the risk factors of standard practices in finance and banking; lending orientation; incompatibility of conventional banking processes and products with microfinance needs; constraint to compete for quality human resources within the overall financial services industry with scarce funds; minimal usage of technology, especially in the financial services delivery process and customer relationship management; and lack of effective alliances along the microfinance product development, delivery, and relationship
This paper was developed for CIPE Policy Roundtable on Microfinance (2007)

management value chains. To conclude, microfinance programs in Pakistan have reached a point that warrants consolidation, if outreach is to be increased within a short period of time. Simultaneously, other problems need to be resolved to ensure the right impact of microfinance in various dimensions. Such challenges include: deepening the microfinance system into the MSE sector; creating an enabling environment both for the enterprises and microfinance banks and institutions; developing home grown microfinance banks and institutions framework, processes, and products to achieve higher organizational and financial stability; and strengthening coordination (value chains) between various stakeholders for higher synergy for all.

This paper was developed for CIPE Policy Roundtable on Microfinance (2007)

References (a) According to the Government of Pakistans definition, a person in the state of poverty (poor) lacks access to material (land included), economical, social (education included), political, and cultural resources, leading to lack of choices of services, depravation of basic rights and security, vulnerability, and the general feeling of powerlessness. The Swiss Agency for Development & Cooperation considers poverty as a multidimensional problem, including deprivation of social justice, political and economic empowerment, and the lack of equal opportunities (esp. economic and employment) to which every human is entitled. Beyond income and basic services, individuals and societies are also poor and tend to remain so unless they are empowered to participate in making decisions that affect their lives. 1. Muntazir Haider; Microfinance Growth and Expansion. Pakistan Gulf Economist, May 21 27 2007 2. SBP's annual report for the year 2005-2006 vol. II, Banking sector Review up to June 2006 / Muntazir Haider; Microfinance Growth and Expansion, Pakistan & Gulf Economist. 3. Mr. Basheer A. Chowdry an exclusive interview to Pakistan & Gulf Economist. 4. Kanwal Saleem; Microfinance an effective tool to alleviate poverty, Pakistan and Gulf Economist May 21 - 27, 2007) 5. Shabbir H. Kazmi; Microfinance for poverty alleviation, Pakistan and Gulf Economist May 21 - 27, 2007) 6. Nadeem Hussain, President and CEO Tameer Micro Finance Bank; Micro financing: Empowering the un-banked, Pakistan and Gulf Economist May 21 - 27, 2007)

This paper was developed for CIPE Policy Roundtable on Microfinance (2007)