Building inclusive financial system in Pakistan-I

Supported by high and sustainable economic growth during 2000-2007 Pakistan has made key inroads: poverty incidence has reduced by 10% down to 24%, per capita income doubled to $925, and there has been steady progress in other Millennium Development Goals (MDGs).
Turnaround and transformation in banking sector, supported by privatisation and restructuring and market oriented policies, has already shown visible results in broadening, deepening and diversifying financial services in the country. However, the growth of financial sector has, as yet, not penetrated across all segments of population and across different regions. This is not unique to Pakistan as most countries have had to adopt explicit financial policies and affirmative action to redress the inequities and deficiencies of financial system which tend to disproportionately serve businesses and individuals with appropriate net worth backed by assets and collateral or located in prosperous areas.
Recognising this, the central bank of Pakistan has launched a broad based strategy for enhancing access to development finance. In this paper, I propose to discuss the case for a holistic and broad based strategy for financial inclusion in Pakistan to achieve desired scale and sustainability.
IN DOING SO, I INTEND TO FIRST OUTLINE:
(i) Impact of financial sector reforms in deepening access to finance;
(ii) Identifying nature and intensity of financial exclusion; and finally
(iii) Discuss the key objectives, goals and principles and major elements of financial inclusion strategy - The strategy is anchored on developing financial and socially sustainable mechanism of credit delivery with particular focus on financially excluded population and regions.
The central bank of Pakistan (the State Bank of Pakistan (SBP)) has now assumed a coordinating and supportive role with the alliance of Government, private sector and partnership with development assistance to evolve and implement the financial inclusion strategy.
IMPACT OF FINANCIAL SECTOR REFORMS IN DEEPENING ACCESS TO FINANCE:
Over the last seven years, Pakistan's banking sector landscape has changed drastically. Principally both ownership and management changed. Financial markets have been fully deregulated. Together these measures resulted in remarkable quantitative and qualitative change. Growth in bank assets, deposits and advances has been unprecedented. Profitability is high, and nonperforming loans are at the lowest etc.
MOST NOTABLE HAS BEEN:
-- Rise in private sector credit from Rs18 billion in FY00 to over Rs 400 billion in FY06
-- SMEs accounted for 17.4% of the total outstanding advances by December 2006
-- Consumer credit accounted for 12% of the total outstanding advances by December 2006 from virtually negligible levels
-- Rise in agriculture credit from under Rs40 billion in FY00 to Rs 168 billion in FY07
-- Housing loans rose from negligible levels to Rs70 billion by December 2006
-- Microfinance loans increased from about Rs3 billion in 2003 to over Rs 10 billion by December 2006
-- Aggregate number of borrowers has risen from 2.7 million borrowers in 2003 to about 5.5 million by December 2006.
Also, now banks are extending their business focus from corporate to household sector. About half of the borrowers have tapped consumer financing which is changing lives of low and middle income households that can now access credit (Table 1).
Thus far, 37% of the adults have bank accounts; the number of borrowers, at 5.5 million, constitutes only 3.5% of the population; there are only 171 deposit accounts per 1000 people and 30 loan accounts per 1000 people. Agriculture and SME credit reaches only to 1.5 and 0.16 million borrowers, respectively. Furthermore, outreach of documented microfinance sector is 1.13 million as of March 2007.
Financial exclusion exists in all economies and markets, whether developed or developing. However, the level and degree of financial exclusion is far more in developing and large countries as both population and size of country introduces their own constraints and challenges (Table 3).
IN PAKISTAN FINANCIAL EXCLUSION MANIFESTS ITSELF IN DIFFERENT FORMS:
(i) Exclusion because of geographical constraints since a large proportion of population eg almost 67% lives in rural areas and there are pockets of population residing in difficult remote and disadvantaged terrain such as barani and arid areas and tribal areas;
(ii) Exclusion because of lack of enabling environment at provincial level. For instance, banks find it difficult to intermediate agriculture credit in provinces where there are problems such as lack of suitable land records and weak law and order enforcement. Similarly, these problems hinder other sectors including microfinance institutions to increase their penetration which is highly desirable due to prevalence of high headcount poverty.
(iii) Exclusion because of banking behaviour and practices either because they are not servicing a large segment of population or they rely on traditional modes of lending which require collateral or documentary requirements or they impose prohibitive transaction costs etc;
(iv) Exclusion because of poverty or illiteracy or cultural and language barriers as a result of which population generally lacks awareness and understanding of financial services and products;
(v) Exclusion because of lack suitability of products like current accounts, which do not offer an overdraft and an easy route to borrowings; and
(vi) Exclusion because of regulatory barriers, such as the money laundering guidelines requiring proof of identification which many poor and vulnerable people find difficult to provide.
Financial inclusiveness is critical as 42% of Pakistan's population is under 15 years of age and about 24% of the population lives below poverty line, both these segments can benefit from economic empowerment. Apart from banks' loan pricing policy and lack of easy availability, financial institutions are reluctant to venture into new areas as they do not have the capacity to assess the demand and deliver their financial services. The lack of availability of the faith based system of financial services, lack of alternate delivery channels and financial innovation, inadequate database and information on borrowers, and weak enforcement of contract etc are some of the main stumbling blocks that prevent inclusiveness of financial sector.
PAKISTAN - FINANCIAL INCLUSIVE STRATEGY:
OBJECTIVES, GOALS AND PRINCIPLES: Recognising the overwhelming size and intensity of financial exclusion in Pakistan, SBP in designing the second generation reforms for financial services industry is placing high priority on developing and implementing an effective strategy for financial inclusion. This section offers some perspectives on this strategy.
A key objective of the financial inclusion strategy of Pakistan is to support the Government's target for halving the income poverty headcount by 2015 and to reduce eventually poverty to a single digit. To realise this objective, the Government and the SBP has for sometime been creating conducive policy, legal and regulatory framework across the board, while adopting multiple approaches and modalities to extend its net of financial services to larger segment of population.
Keeping these perspectives in mind, Pakistan has adopted a holistic strategy for empowering and enhancing the capacity of poor to contribute and participate in economic growth. On one hand, the Government is focusing on enhancing public investment in education and health and a wide variety of poverty alleviation programs. On the other hand, the central bank has been steering a broad-based policy framework for promoting inclusive financial development.
The principle thrust of the approaches and programs designed has been to shift emphasis from directed and subsidised credit to adopting best practices and market based approaches to promoting private sector in financial inclusion. Meanwhile, public expenditure is supporting selective and targeted interventions to stimulate and catalyse action and nurture institutions which leverage public: private partnerships to improve access to financial services for poor.
Most prominent eg is the support for the Pakistan Poverty Alleviation Fund (PPAF) and the National Rural Support Program and the recent President's Rozgar Scheme that offers credit to nations young and unemployed.
The PPAF is sponsored by the Government of Pakistan and funded by the World Bank and other leading donors. The PPAF follows a model of public private partnership through lending of wholesale funds to civil society organisations committed to community outreach programs for enhancing income and economic welfare of the disadvantaged people. Specifically, the PPAF provides funding for projects that help generate income, improve physical, social infrastructure, and skills of the vulnerable. On February 28, 2007 the PPAF had a resource base of US $826.17 million (Rs 49,560.2 million).
The NRSP is the largest Rural Support Programme in the country in terms of its outreach, staff and development activities. It is a not-for-profit organisation with a mandate to alleviate poverty by helping people to harness their potential and undertake development activities in Pakistan. It has presence in all the four Provinces including Azad Jammu and Kashmir. The NRSP, with more than half a million poor households organised into a network of about 29,000 Community Organisations (COs), manages one of the largest micro-credit portfolios in Pakistan, with 282,421 active loans as of March 2007; it holds 25% of the microfinance market. The NRSP provides various financial services to the members of COs in rural areas to help them implement their Micro Investment Plans (MIPs), including Micro Credit, Micro Insurance and savings products.
The National Bank of Pakistan, largest nation-wide bank, is offering small loans to unemployed and poor to finance purchase of auto rickshaws, setting up utility stores under franchise of the Utility Corporation, and setting up public call office etc. Interest on these loans is fixed at 12%: 50% of interest charges are to be borne by the Government and the remaining 6% by the borrowers. The Government will pick up first 10% of all losses and share credit risk insurance. External and internal verification of borrowers, references and guarantees are handled by ICIL - a representative firm of Dun and Bradstreet. This scheme is anticipated to deliver over 5 years period about Rs105 billion (US $1.74 billion). Since its launch this year, the scheme has delivered Rs2 billion to about 22,136 borrowers.
Recognising Pakistan's context, and drawing from other country experiences, it has to be acknowledged upfront that financial exclusion can only be tackled effectively:
(i) If it is well conceptualised, well grounded and well integrated in the overall financial sector policy framework;
(ii) If it is backed by absolute political commitment and co-operative stance of the federal, provincial and local government and relevant sector agencies to create a healthy and conducive environment for financial intermediation at the lower end of population where risks are of different nature;
(iii) If financial institution recognise their corporate social responsibility and work towards financial deepening and credit diversification that is key to financial inclusion as well as to managing banks' health and its systemic risks;
(iv) If there is focus on provision of holistic financial services, whereby savings mobilisation is perceived critical and integral to establishing the client on a sound footing and clients have collateral free access to financing with adequate provision for risks mitigated through credit enhancement mechanism and insurance; and
(v) Facilitating reliable and secure payment between different parties.

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Table 1. Distribution of Sector Lending

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Sectors                          31-12-2003                    31-12-2006                             % Growth

                                                                                            over Dec 03-Dec 06

                           Number         Amount         Number         Amount        Borrowers         Amount

                      of Borrowers in Million Rs    of Borrowers  in Million  Rs

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Corporate                   17,743        606,500         25,740     1,269,564               45            109

SMEs                        91,663        215,009        168,233       417,873               84             94

Agriculture              1,411,508        104,676      1,480,214       141,856                5             36

Consumer Finance           721,201         61,437      2,665,423       276,037              270            349

Mortgage Loans                  NA          4,114         24,313        49,134                -          1,094

Others                     135,561        169,035        122,190       246,289             (10)             46

Microfinance Loans         315,000          3,150        997,778        10,743              217            241

Total                    2,692,676      1,163,922      5,483,891     2,411,496              104            107

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Source: SBP except microfinance numbers are from Pakistan Microfinance Network.

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Table 3. Financial Penetration: Rural vs Urban

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                                              Rural        Urban        Total

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Population                                     67.0         33.0        100.0

Poverty Incidence (as estimated by GOP)        28.1         14.9         23.9

Bank Branches                                  33.0         67.0        100.0

Total population having bank accounts           6.0         37.0         17.0

Adult population (19+ years) having ban        14.0         75.0         37.0

accounts *

Deposits (number)                              25.0         75.0        100.0

Deposits (amount)                               9.9         90.1        100.0

Advances (number)                              17.0         83.0        100.0

Advances (amount)                               7.1         92.9        100.0

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