. ‘Make digital payments free’

Mudassar Aqil is the CEO of FINCA Microfinance Bank Ltd. Since 2011, he has overseen the bank’s rapid growth and its recent acquisition by FINCA which makes the bank a part of one of the largest global network of microfinance institutions spread across 21 countries in 5 continents. Aqil is a banking industry veteran. Prior to joining FINCA, he worked for 14 years at a leading commercial bank in Pakistan and the United States. He serves as a director on the board of Pakistan Microfinance Network. He holds an MBA from Salisbury University, Maryland.

 BR Research had a detailed discussion with Mudassar, on the microfinance industry of Pakistan. The discussion covered aspects of digital payments, innovation, issues in the current system and much more. Below are edited excerpts of the conversation.

BR Research: To begin with, could you please shadow light on the state of affairs in the microfinance industry?

Mudassar Aqil: The access to credit for micro and small enterprises is still very low. Despite strong growth of microfinance sector in the last three years, we still have a long way to go. Currently, we have 4.5 million borrowers and the size of the market stands at 21 million borrowers approximately.

The microfinance industry of Pakistan has asked the State Bank of Pakistan to bring borrower figure to 10 million under the 2020 National Inclusion Strategy. For this, we need a funding of about Rs250-300 billion and Rs50-60 billion of capitalization. If we are taxed at 35 percent, we have an inherent disadvantage in terms of raising funds as compared to commercial banks.

We don’t have access to the discount window and we don’t have any lender of last resort. The other banks are still not a member of the RTGS. We are in a very tight band. Most banks which are giving individual loans would lose money on loans smaller than Rs50,000.

So, we are stuck in a transition crisis. We want transition but cannot do it. There is no collateral on half a million rupees that is usable for us except for gold-backed lending. When the gold-backed lending started, it took a completely new direction when it entered the microfinance sector and it has some regulatory restrictions imposed.

We have largely reduced our exposure in gold-backed lending. That is also a sort of an artificial barrier because if we talk about lower tier or small enterprises, Rs500,000 is not enough.

BRR: What’s the size of your book and what is your average ticker size?

MA: We have Rs11.5 billion in loans and Rs13 billion in deposits. The average ticker size is Rs90,000 which is highest in the market. The industry in essentially stuck in a dynamic of predominantly group lending in the rural market, that’s still over 80 percent of the microfinance lending in Pakistan.

Majority loans are to farmers, and their cash flows are linked to the crop cycle, so all of these are bullet loans. The problem now is that we have almost trained the market to take the bullet loan regardless of their cash flows. The bullets loans are very risky since the principal and interest payments are only paid on maturity and you become highly dependent on the crop.

We believe that farmers should be extended a loan which matches their cash flow cycle. Bullet lending amounts to one-third of our total loans. Rest are equal monthly installments and we find it very difficult to get the EMI loans going because they have been poorly trained. The MFIs are working well, but they have a problem of scale. They have funding issues, and lack of good governance and good sponsors. But they do a lot of good work at the small scale with communities and they give EMI loans.

Bullets loans are very risky since the principal and interest payments are only paid on maturity and you become highly dependent on the crop. To mitigate this, microfinance banks extend a small part of the loan at first, hence the loan size is small. They take a gross guarantee from about 6-7 people and give them small amounts of loans.

There’s so much demand in the market for MFBs, and there’s almost insatiable demand in the agro-economy that everybody continues to grow. If you look at the growth in 2016 of the majority of the MFBS, over 80 percent has come from agricultural bullet loans predominantly.

BRR: There are many businesses in the urban sector which you can cater to. Businesses are part of a value chain, so you can have a contract with their suppliers to ensure repayments. Are you working such enforcement mechanisms?

 MA: Yes, we are. When there is a lot of low-hanging fruit on one side, and there’s a lot of hard work, research, small pilots and unknown results on the other side then people take the shortest route.

Jobs in Pakistan are essentially created by the micro and small enterprises. Their collective share in the total credit extended to private sectors is about 2 percent and 6 percent respectively. So that’s the first problem that should be solved.

The rates are not the problem. Government’s interest free schemes did not put a dent in the actual demand. The solution is to keep the commercial capital going and get the private sector to come in and fill this gap. According to studies, microfinance loans have yielded 70 percent to 500-600 percent return on assets.

Our entrepreneurs have businesses with fantastic margins, but they do not have capital to grow. According to a study, 60 percent people in Pakistan use informal credit. So, the cost of informal credit is exorbitant, built-in and non-transparent.

BRR: What is your average rate of lending and why is your cost of fund on the higher side?

 MA: Lending rate goes as low as 23 percent and as high as about 40 percent depending on the product. Interest rates do have an impact on our margins, and even though we know that the interest rates are going to rise we cannot change our rates on that basis.

Our cost of fund is about 8.2 percent. It is high because we cannot compete with the commercial banks for current accounts because only 20 million people in Pakistan have bank accounts. Nearly 85 percent people in Pakistan do not have bank accounts. This is one of the worst numbers in South Asia. Our deposit base is only one-third of the GDP, which is half of India.

We are very weak in financial inclusion. The inherent disadvantage of MFBs is that corporate deposits are challenging for us to attract. All commercial and institutional depositors which have drafted their investment policies 20-30 years back stating that the deposits have to be with a scheduled bank. Secondly, a number of corporate current accounts are linked with the ancillary businesses that commercial banks are offering to those corporations. Thus, 60 percent of our deposits are term deposits and CASA is 40 percent.

BRR: How has the response been from the retirees? They seem to like you for your rates.

 MA:  We like that segment since they place their funds for long term and want steady return. We benchmark our rates against national savings, which is our real value proposition. The opportunity lies with over 100 million people out of the conventional banking system. The cost for a commercial bank reaching them is also very high.

BRR: How many clients does a relationship manager have currently?

MA: In individual lending, one credit officer takes care of 200 clients at FINCA. In group lending, it can be up to 400-500. Fixed costs are relatively stable, so they are not going to grow with the same proportion after a certain time, so we can spread this extra income over the smaller fixed cost.

We are only doing productive lending as of now and not consumer lending. FINCA has been traditionally very reluctant in consumer lending. We have now realized that consumer lending is integral because even low-income people have consumption needs. We offer a product called stress loans to our existing borrowers without asking them any questions, but that can be only one-third of the total amount of their original loans.

BRR: What is the whole digital lending phenomenon and how rapidly is Pakistan catching up?

MA: The most exciting change emerging in Pakistan is digital lending. Around 50 million digital accounts will be opened by 2020, of which 80 percent have already been opened, but majority are inactive. People essentially own ATM cards and withdraw money without knowing there is a digital bank account or wallet behind it.

The 3G internet connectivity in Pakistan has changed the landscape. Now, there are 42 million people in Pakistan with internet connectivity. Estimate of smartphone ownership is around 40 million, projected to double over the next three years. We are adding a million new users a month on mobile broadband. New opportunities have opened up because of this.

We started working on this in 2015 and are now very close to a commercial launch. Our digital mobile bank, the one we have developed in cooperation with Finja, is being used as a pilot for about 7-8 months now. And there are 25,000 people who are using SIMSIM right now and over 300 merchants are using QR code payments from SIMSIM today.

BRR: Considering that there’s a new cafe or store opening up every day, and the unprecedented retail boom with brands, restaurants, and cafes experienced in the last decade, how is it that the number of credit card accepting machines hasn’t increased? 

MA: The fact is that there are 900,000 retailers in Pakistan and only 25,000 accept non-cash payments. The deterrent is that the MDR rate in Pakistan is 2-3 percent, so the merchant then has two options, absorb or pass it on. The majority passes it on, due to which the customer is unhappy.

Right now, our thesis says that right now there are 4-4.5 million borrowers in micro-finance. Through new technological developments, you can actually print a piece of paper with a barcode on it, which is an identifier for you as a merchant. So, you can put that up on the walls, it’s called a QR code. So, whoever has our sensor will scan that QR code and that will put money in the wallet of the merchant.

If you want to increase this in Pakistan, you will have to end MDR in Pakistan and increase QR-code payments. Small vendors are very much capable of having electronic payments and people are comfortable in conducting those transactions. The only problem is MDR.

The equivalent of digital wallet is digital payment, so if you make those payments free, people will adopt it the way they have adopted other things. Another principle is open access, which means that we are exposing APIs where we want people to integrate SIMSIM in their applications and build solutions.

We want to use all bank accounts in Pakistan as a potential funding source and for the cash that people have in their pockets. Once you make the payments free, you unlock new solutions that were not possible before.

In the long run, we envision that we will lend to these people. Eventually, the mobile wallet will become equivalent to the credit card. In the digital world, there are new models of credit scoring based on the character and wallet behaviour of the person. Artificial Intelligence and big data have made things possible. We want to give people low-cost insurance, small loans and all kinds of other products.

The next thing that we are focused on is how to convert all these merchants into mass numbers. The industry has understood that QR code is the future and increasing the number of merchants is the next thing.

BRR: Where do you see yourself in around 2020?

MA: We will double the size of what we are today. We are present in 95 cities right now, and 10 of our new branches will be opened in new cities.

BRR: We have seen that the ‘S’ in SME is doing really good. But it would be costly for a commercial bank to give such small-sized loans. Can you not move into the ‘S’ segment?

MA: We do want to. It is the SBP’s domain to amend the license. There are a few players like FINCA with expertise and should now be allowed to increase lending limits and start serving this sector. The ‘S’ segment is really un-served in our opinion and doesn’t even have the collateral.

BRR: Can you elaborate why not more loans are extended to the small-sized enterprises?

MA: The products are wrong, lending models are incorrect, sales models are broken. We disburse loan in 72 hours and are digitizing the process to cut it down to 24 hours. Secondly, we have made our risk models decentralized, and disburse loans faster.

In Pakistan, with all due respect to the commercial banks in Pakistan, credit models are non-existent. Basically, they say that they want collateral with a margin of 30 percent, then they get it hypothecated and after some signs, they disburse the loan. They take property as collateral and get its valuations, plus personal guarantees are also demanded. What credit analysis would there be in this case if the loan is only given on the basis of collateral?

I believe if the loan is only given on this basis, there are more chances of it to default as compared to the loan which is disbursed after a thorough analysis of a person’s repayment capacity. The assessment of repayment capacity is very poor for SMEs in commercial banking. The model that we use for the cash flow analysis was learned from Bolivia which is a very advanced in microfinance market in the world.

When somebody comes to us for a loan, even if that person is really poor, we first try to find out the disposable income of that person by evaluating a number of factors. Then once we have found his disposable income, we add a little margin to it and come up with his repayment capacity against which we can decide whether to extend him the loan or not. This model can go in the ‘S’ of SME.

BRR: Do you think if better credit guarantee schemes are launched, they would benefit the ‘S’ segment?

MA: Risk guarantee schemes are very effective. This is the right kind of intervention where government shouldn’t be giving subsidies to anyone. The government should just be taking targeted risk coverage to bring the commercial capital in that segment. There will be an influx of commercial capital once these measures are taken. But the risk models in commercial banks need serious up-gradation.