Pakistan is market with highest potential: ADB lists factors stifling ‘SCF’ growth

ISLAMABAD: Pakistan is the market with the highest potential in the region, however, several factors including legal framework as well as the current tax law restrict the full development of Supply Chain Finance (SCF), says Asian Development Bank (ADB).

The bank in its report, “Supply Chain Finance in Central Asia and Caucasus”, noted that Pakistan is the market with the highest potential in the region.

Pakistan’s GDP in 2022 was $376.5 billion. If factoring volume reached a penetration rate of 2.4 per cent (the average in similar markets), the potential factoring volume could be as high as $9 billion.

Several factors restrict the full development of SCF in this market. First, the legal framework needs to adapt to accelerate the use of e-invoicing and facilitate the various products of SCF.

Second, the current tax law requires payment to be made directly to the seller to obtain tax credits, which renders SCF product operations untenable.

Finally, the growing demand for Islamic banking products is also creating hurdles for the development of SCF, it added.

Despite encouragement from the government and the State Bank of Pakistan, the country’s banks are still cautious about offering SCF because of a lack of clarity in the regulations and low awareness of the nuances of SCF.

SCF platforms play a vital role in the adoption and scalability of SCF products. However, the market has seen very limited technology adoption, the report noted.

The Bank stated that as per the estimates of the Small and Medium Enterprise Development Authority, there are more than 5 million SMEs in Pakistan. SMEs contribute 40 per cent of the gross domestic product (GDP) of Pakistan and 25 per cent to its overall exports.

Therefore, the National Financial Inclusion Strategy in 2017 set out a plan for SME finance, which included SCF. The market for SCF in Pakistan is relatively new but has been growing gradually, largely because of strong government initiatives since 2017.

Banks and regulators have benefited from knowledge sessions and webinars on SCF done by multilateral development banks such as ADB. A few banks have started offering factoring and/or reverse factoring products, which were developed with the support of the International Finance Corporation (IFC).

The main SCF products currently offered in Pakistan are domestic factoring, known locally as “invoice discounting”; and reverse factoring, often referred to as “supply chain finance.”

Market volumes, especially for reverse factoring, are small but growing. There is high suppliers’ interest in these products mitigating challenges of supplier education. Notwithstanding that, significant challenges to accessing technology and enabling platforms, as well as fulfilling various compliance and know-your-customer requirements, persist in the market.

While there is no specific law covering SCF in Pakistan, the State Bank of Pakistan is developing a framework to cover SCF. The current regulations have few limitations on the adoption of factoring or reverse factoring, e.g., lack of legal structures around nonrecourse factoring and inability to use e-invoicing and others.

Factoring provided by companies or individuals is primarily unregulated and falls under the aegis of the Contract Act 1872 and the articles in the Civil Code. The proposed factoring framework will enable banks to approach the Banking Court for speedier resolution.

The State Bank of Pakistan’s electronic Credit Information Bureau has been established to provide credit information. The bank recommended action points which include, continue engagement with development banks and obtain support for training and education, and sharing of international best practices, adopt factoring regulation, providing clear guidelines on the various products so that more banks can design and offer the products, update and implement a legal framework for a Shariah-compliant factoring product and utilize technology to scale up and minimise operational risks.

Copyright Business Recorder, 2023