"Cost of performing digital transactions must come down," Ali Sarfraz, CEO, Karandaaz

Ali Sarfraz is the CEO at Karandaaz, an Islamabad-based not-for-profit organization. Funded by the United Kingdoms Department for International Development (UKAid) and the US-based non-profit Bill & Melinda Gates Foundation, Karandaaz is now in its third year of operations. It focuses on access to finance for SMEs directed investments and financial inclusion for individuals through digital solutions.

BR Research recently sat down with Ali Sarfraz in Islamabad and discussed issues related to SME finance and financial inclusion. Selected excerpts follow:

BR Research: Lets start with access to finance. What is Karandaaz doing on the SME Finance side?

Ali Sarfraz: We are actually focused on MSMEs micro, small, and medium enterprises. Three main things have happened on that side. First, on the micro side, we have invested 15 million pounds in the Pakistan Microfinance Investment Company (PMIC), giving us around 37.5 percent stake in it, alongside other shareholders such as the German Development Bank and the Pakistan Poverty Alleviation Fund. PMIC will drive sophistication in wholesale microfinance and over time assist in linking the local microfinance sector to the capital markets.

On the SME front and we define SMEs as any entity having revenues less than $15 million our focus is more towards the S side. So, the second thing that we have done is the credit window. We are working with a few NBFIs on a supply-chain finance pilot. In this model, we have a financial institution, a corporate, and the vendors/distributors to the corporate. The corporate gives visibility to their distributors and the financial institutions are better able to extend credit to the vendors.

So far we have contributed 10 million US dollars and the NBFI has levered it up by a factor of three or four. There is no liability on part of the corporate. We have asked the banks to provide clean lending for working capital. And for term finance, we have asked them to lower the requirements for underlying collateral.

The third area is where we provide growth capital by taking up equity stake in SMEs. We look at an investment time horizon of five to six years and look at ticket size of $1 to $2 million, which is suitable for an SME. We are looking to close our first deal soon after completing the due diligence issues concerning the market, legal aspects and financial issues.

BRR: Which financial institutions have gotten on board with Karandaaz so far?

AS: In terms of partnerships, we have signed up with two financial institutions Orix Leasing Pakistan (OLP) and Meezan Bank Limited (MBL). We will shortly sign up with a third one.

To give an example of how this partnership works, in the case of MBL we have a total credit facility size of $50 million out of which Karandaaz is providing $10 million and MBL is providing $40 million. We recently had a program where Engros farmers were provided lending by MBL via this facility. Similarly, vendors of Millat Tractors are also getting financing from this facility. Same is with OLP, which focuses on the S side of the business.

BRR: Those vendors or distributors may already be in the mainstream, having worked with big corporates. What about SMEs that are not working with the formal corporate sector?

AS: We are trying to experiment a model for supply-chain finance. Right now, even formal entities are not getting enough credit from the banking sector. We are looking at those segments of business, such as retail, where there is little banking credit penetration.

There are challenges on both the supply-side and demand-side. On the supply side, financial institutions complain that they dont lend to SMEs because of their high NPLs, double books, etc. It is difficult to change that mindset within the banking industry. Hardly any clean lending is being done; it is only 5 percent of the SME portfolio.

On the demand side, there are issues, too. I have sat down with SME businesses and they didnt want to avail bank credit, for reasons such as tax, faith, etc. If they become transparent, however, they will benefit in the long run. A lot of SMEs are trying to fund long-term needs through short-term, informal sources and that is a problem.

BRR: What kind of sectors are you targeting for your growth capital?

AS: We are not looking for just the financial returns, but also development returns. We are looking for sectors where there is job creation, especially for women and youth. If a prospect has low financial returns but higher development returns compared to another project, we will still fund it.

Specifically, we are looking at existing SME businesses in the manufacturing industries. These industries have potential for higher job creation. Besides, existing firms need to be more productive to compete locally and internationally. But we are not restricting ourselves to manufacturing. We are open to doing deals in the knowledge economy, too, such as the Information Technology sector. We are looking to conclude three to four deals by 2018 end.

BRR: How much capital is available for funding?

AS: Under the agreement with our sponsors, we have 15 million pounds for PMIC, 20 million pounds for credit, and then 5 million pounds for equity. Thats about 40 million pounds. Once we have demonstrated that we have the right model, we will be able to raise more capital.

BRR: Lets pivot towards financial inclusion. How does Karandaaz look at financial inclusion as a concept?

AS: By financial inclusion we mean an increase in the usage of financial services by the unbanked. Financial inclusion is not about simply making over-the-counter (OTC) transactions, but using a bank account such as a digital transaction account to perform a transaction.

BRR: How do you view the state of affairs in the countrys branchless banking segment?

AS: There has to be value creation. On the supply side, everybody seems to be fighting for agents. There is dependency on agents, and this doesnt help the uptake of mobile wallets. Then there has to be interoperability among service providers, such that users of one m-wallet service can financially interact with users of another service. It has to be an open-loop system. And then, the fees have to be lower than they currently are.

On the demand side, there is the issue of having the population use digital money. We have developed wireframes for apps which could be used by m-wallet providers. The USSD channel, which is an option, is a complex system. Smartphone penetration is increasing and I think that is the way to go for an m-wallet app interface.

BRR: What can m-wallets do without an ecosystem?

AS: Unless an ecosystem is there, mobile wallets will have little use. Right now m-wallet users still have to go to the agent to withdraw their money. Digital money is not accepted in a lot of situations, such as buying vegetables, groceries, eating out, shopping, etc.

BRR: Where do you see the big push coming for such an ecosystem to develop?

AS: One of the big push can come from P2G and G2P payments digitization. Once those flows are digitized, there will be huge volumes. We have an engagement with the Benazir Income Support Program (BISP) to make beneficiary accounts transactional instead of withdrawal-only account. We are also working with the National Bank of Pakistan and the National Savings Scheme, and also with the State Bank of Pakistan (SBP), to help build this ecosystem.

BRR: Branchless banking service costs hefty fee even for a small transaction. What are your views on reducing the cost of performing digital transactions?

AS: Unless we have a low-cost payment system, where you are probably charged five paisa per transaction, this system will not work. The payment switch cannot charge such high fees that it becomes prohibitive for people to perform a small transaction. We are working with the SBP on this issue.

Concluded