BANKING SECTOR AND PRACTICAL EXPERIENCE

SMALL BANKING AS ONE OF THE TOOLS

FOR EMPLOYMENT GENERATION AND POVERTY REDUCTION

Overview

In the developing world huge shift is taking place in attitudes to development and poverty alleviation.  Charity, handouts and welfare once seen as the answer to combating the scourge of poverty, are now perceived as increasing the dependence of the poor.  These so-called solutions have given way to more sustainable options that aim to alleviate poverty by enabling the poor to become self-reliant.  Today, we see the accountability mechanism as the key to breaking the poverty trap.

One way of using such a mechanism is through small leasing.  This involves the provision of finance through structures accessible to the poor at commercial or near-commercial rates and in the smaller amounts that the poor need.

The activity itself becomes commercially viable as the poor pay a price for acquiring the funds and in doing so, bring about a healthy change both in society’s perception of the poor and the poors’ perception of themselves.

Small credit to the people at the lower rung in our country can make a noticeable difference as it provides economic opportunities with dignity and self respect.

This is achieved through the participation of those remarkable men and women, who, throughout the country, provide employment to a vast majority of our potential work force and produce goods and services for over 70% of our population.  Their diligence, determination, commitment, honesty and sheer hard work is indeed exemplary.  Considering that most of them do not have any education or formal technical training, it is most re-assuring that they have provided the much needed economically priced goods and services, with the scarce resources at their disposal, to a large number of people at the lowest income levels.  Admittedly, the desired level of capitalization has not yet been achieved as no safety net is available to them.  Accumulated savings dwindle rapidly in the face of emergencies caused by ill-health, death, disruption in business activity and other social constraints.  Yet their confidence in themselves and the vision of a better future for their younger generation is most inspiring.

In a humble way, we are endeavoring to build our future on the strength of this inspiration.

The fundamental problem posed by credit

extension to small entrepreneurs

Small enterprises exhibit a large demand for financial services, a demand which traditional commercial and development financial institutions have failed to satisfy.

Generally speaking, the relationship between a borrower and a financial institution is characterized by an exchange of financial information between the two parties.  According to the rules of “traditional” credit extension, this problem is solved by the borrower providing, at his/her own expense, the kinds of data on his/her business which are needed to determine his/her creditworthiness, as well as a bankable collateral.  This reduces the informational asymmetry, and thus the loan in question becomes a calculable risk for the financial institution.

However, small entrepreneurs are not able to furnish the requisite information, or what a formal financial institution would consider to be an adequate collateral.  This precludes the use of traditional “asset-based” credit assessment, and as a consequence these entrepreneurs are frequently denied access to credit altogether.

Furthermore, the volume of funds borrowed by such entrepreneurs is small.  Thus, if conventional methods of assessing creditworthiness are applied, lending to small enterprises does not appear likely to yield a profit.  This means that even if they meet the criteria for creditworthiness, they are still denied access to credit facilities because the administrative costs involved in extending such small loans seem likely to exceed the income which the bank could expect to receive from this kind of operation.

However, taking into account the socio-economic characteristics, the higher than normal recovery rate and correctly evaluating the income generating capabilities of this target group, does enable the financial institution to extend credit on a cost-covering basis.  It should be emphasised that microfinance is a specialised operation and therefore the practitioners need to be focused on this aspect.  Normal commercial banks may not possess the special skills required to deal with such enterprises.

Small leasing instrument

Here credit is given in the form of a productive, income generating asset to the client.  The asset is purchased by the leasing company and given on periodic rentals for a specified term (3 to 5 years).  As the title to the asset vests in the leasing company, no additional security or collateral is required.  Thus the major stumbling block in access to credit to the small enterprises is overcome by resorting to this instrument.  After the bank period, the asset is transferred to the lessee at no extra cost.

The transaction ensures that the credit is strictly utilised for productive/income generating purposes.  The rates charged are market based.

It can also provide working capital by sale and bank back arrangement.  The existing assets need not be substantial.  Old equipment or tools and implements can serve the purpose.

Small enterprise financing landscape in Pakistan
General development scene

Until recently, the pattern of development in Pakistan was tilted towards mega projects and large undertakings.  It was hoped that such investments would result in raising the general income levels of the population under the “trickle down theory”.

Unfortunately this approach failed to produce the desired results and the planners are now realising that though large infrastructure projects are necessary, the emphasis must gradually shift from bricks and mortar development to human development.

Funding sources for SMEs

The major source of fund for small enterprises is the informal sector such as friends, relatives and private moneylenders.  Depending on the source, the cost of fund varies from 50% to 120% for capital investments and upto 240% for working capital financing.  The experience shows that even friends and relatives may charge interest on informal loans (50 to 100 per cent per annum).

The gendered nature of the problem is even worse.  Women have a negligible ownership presence in the urban/rural enterprises.  Studies show that nearly 30% percent of the workers are female in rural areas specially in the Punjab, whereas only 3 percent of the proprietors are female.  Due to the social set up in the country, women entrepreneurs face severe problems in getting a loan from the formal sector.  The studies however suggest that there is a reasonable demand for credit to finance their activities providing the environment is enabling.  However, due to lack of fund or because of the stringent conditions that have to be met to obtain funds, many potential enterprises never take off.

These general experiences show that the financial landscape faced by small entrepreneurs is not particularly bright.  They have to borrow from informal market at exorbitant interest rate to start a business.  For expansion they have to rely on internal financing through reinvestment of profits.  However, the majority consumes a significant portion of profit, for living.  With insignificant retained earnings the growth and expansion of these activities become extremely difficult.

Lessons learnt so far

Small/micro leasing is a new product in Pakistan and it is different from other loan products in many ways.  The clients are given an asset instead of cash. In case of general loan, the client may borrow money in the name of say a sewing machine.  She might however use it for childrens’ wedding.  The reason is not that the client is necessarily dishonest.  At the micro level it is almost impossible to separate the private household from the business activities and therefore the temptations are enormous.  Such a misuse is difficult in case of leasing as the item is bought by the lessor through a competitive bidding process.  This ensures that the item is used strictly for productive purposes and thus reduces the probability of default.

The lessor must however, respond to the ground realities that ask for flexibility, constant improvements and innovations in product design.  The success of the leasing program would depend on the flexibility of its design.  A lessee should be able to make partial or substantial payment of the bank amount any time.  This allows the borrowers to take advantage of say an improved market condition.  The bank contract should be structured in order to accommodate seasonal variations and trade cycles.

The ability to make variable installments enhances the debt capacity of the borrower because it allows them to synchronize payment with income flow.  They pay a small down payment and the income from the asset pays for the installment amounts.

Leasing appears to be more conducive to enhancing the borrower’s sustainability.  It could solve the problem of graduation of successful borrowers.  In group lending, different members of the group differ in ability and entrepreneurship.  In these situations, it is difficult for a creditor to separate entrepreneurial borrowers from ordinary borrowers and reward them with larger and more flexible loans.  The lessor is able to reward clients who have a good repayment record and the instrument can also be used to reward successful clusters (live stock bank in villages).  Recent developments in group lending theory suggest that if the liability constraint binds and the borrowers are risk averse, the relatively better off among the poor borrowers may prefer loans based on individual incentives.  This is because as the wealth of the borrower increases, their incentive to monitor others in the group decreases.

The modest success of small leasing in Pakistan suggests some important lessons for the lessors.  It shows that poor people have diverse credit needs.  To help the poor borrowers graduate out of poverty, lessors have to provide different and flexible products.  If a lessor has a good institutional set-up in place and it can carefully design products that are flexible, borrowers will use the product to their advantage.

Real life situation

An ordinary sewing machine costing Rs.2,700 (US$ 45) bank to Jaan Bibi has made a significant difference to her life and that of her family.  She makes garments for children and works from home.  Buying old clothes from the Lunda Bazzar (market for used garments), she cuts and restitches them in children’ sizes and the re-done apparel that look almost new are sold in the neighbourhood.  As if being a poor man’s widow with young children was not difficult enough, she also has to provide for the parents-in-law who live with her.  With the new sewing machine, Jaan Bibi has not only increased her net income, she has also provided work for the in-laws who are engaged in de-stitching the old garments that she uses as raw material.

Bank contribution in Jaan Bibi’s modest prosperity of course is very small.  It is her hard work and resilience against overwhelming odds that has made the real difference.  Nevertheless, the sewing machine did provide her with an opportunity.

Vision and hope

Since the lessors are accountable to thousands of small shareholders, small bank operations have to be not only self sufficient from day one, but also economically viable.

We believe that this is the only way to make a break-through in the development of the small enterprise sector if it is to be made meaningful.

The financial markets within and outside Pakistan must see that small enterprise financing is a viable and sustainable proposition.  This we see as the process whereby the markets would feel comfortable in dealing with SME intermediaries.

The idea of small enterprise development will grow, but we should not measure its growth by the amount of finances alone.  Rather, the key criteria should be the quality and efficiency of the services, the effectiveness of the programs, the depth and quality of the partnerships developed with the clients, the financial and development community and the Government.  In other words the real benefits accruing to the clients.

It is hoped that in time to come, the leasing sector would also endeavor to expand its operations in the semi urban and the rural areas of the country.

By increasing the scale of activities in the rural areas, we would make a humble attempt to foster rural industrialization in agro based activities.  A strong and effective rural industrial base could be an important tool to reduce poverty.  Rural industries would create stable source of employment and check the out-migration of population to the urban areas.  It can be used to help the hardcore poor and thus create an environment in the country where at least some effort is made to develop the economy on a just and equitable basis.

Small enterprises will continue to play a significant role in the economic development as they will continue to create employment opportunities at relatively low capital inputs, provide the needed support linkages to other sectors and serve as effective training grounds for entrepreneurial and subsequently managerial talents.

Once the economic benefits start reaching the majority in meaningful ways, the role of small enterprises will become catalytic in the move towards prosperity.

We would hope that in not too distant a future, Pakistan may advance to the level of a middle income economy.  Not so much in terms of statistics, but more in the way of human development and dignity.  It has near ideal landscape and sea shores and is endowed with hardworking and enterprising people.  It would sooner rather than later, learn the art of economic and human resource management – equity – which is the main source of any meaningful progress.