Tapping the digital banking potential

ARTICLE: Based on extrapolation from a 2005 SMEDA survey, and using commercial and industrial electricity connections as a proxy, Pakistan has five million MSMEs (micro, small and medium enterprises). Out of which 180,000 SMEs have access to lending by commercial banks while 195,000 micro enterprises have borrowed from microfinance lending institutions. Rest rely on shadow finance, including loan sharks.

Annual working capital need of MSMEs is estimated by SMEDA at Rs2.8 trillion - out of which less than Rs500 billion is served by formal banking channels, while the fixed investment credit requirement (estimated at Rs2.5-2.8 trillion) is largely unfulfilled by any segment. This, in essence, is the biggest hindrance to growth of firms in Pakistan.

SMEs' access to credit is plagued by both supply and demand-side challenges. Some SMEs do not want to document as they fear the taxman. Besides, they also face higher cost in meeting banks' requisite documentation. If anyone is still willing to avail financing, there are additional hurdles of collateral, as banks prefer immovable properties as security. This is compounded by issues of clean land titles and registry.

On the other hand, commercial banks find SMEs risky and time-consuming in terms of processing. Recently, some banks have taken only baby steps after being pushed by SBP. But they have many miles to cover. Meanwhile, microfinance institutions can only finance very small enterprises. Vibrant Non-Banking Finance Companies (NBFCs) and niche bank segments are missing in Pakistan.

SMEs are supposed to be the backbone of any economy, and many emerging economies have thrived on growth of SMEs. But for that to happen, credit availability is a must. It seems that conventional banking segment in Pakistan cannot cater to this segment at desired levels. The regulator is too prudent and banks have a plethora of less-risky assets to deploy their low cost-funds at decent margins. The central bank must think out of the box to resolve this challenge.

Commercial banking in Pakistan can only be done by giants. The paid-up capital requirement is at Rs10 billion. This capital requirement and higher compliance costs leave no place for smaller banks - whether regional, sector specific, or any other form of banks. Low paid-up capital requirement and less-stringent regulations can open conduit for banks that are SME focused. This can allow banks to innovate in terms of expanding clientele. This needs a different type of banking landscape. There are numerous examples in the world where small banks flourish.

In today's digital world, the model should be one that focuses on using digital tools to reduce intermediation cost and enhance penetration. Hence, smaller banks must emerge that concentrate in digital domain. The other element is to spur NBFCs by enhancing penetration using digital tools for credit assessments. The problem with NBFCs in Pakistan is that they have failed to evoke regulator's interest. The SBP is geared up to do so; but NBFCs are regulated by the SECP. In India, the central bank regulates NBFCs. Pakistan should explore this option. The SBP has capacity and handholding capabilities to take NBFCs to the next level.

Whatever the form or whoever is the regulator, the key issue is to reduce information asymmetry for formal lenders to penetrate SMEs and consumer segments. To that end, a data ecosystem must first be established. Pakistan has rich databases, albeit working in isolation. Data on about 96 percent of adult population exists with NADRA. As per the latest PTA data as of June 2020, there are 167 million cellular subscriptions, about half of which are mobile broadband subscriptions (3G/4G). There are around 25 million bank users, and 46 million plastic cards (including 1.5 million credit cards and 24 million debit cards). Add 19 million active mobile wallets and 200,000 active mobile banking agents in that segment. As one observer puts it, it is a perfect storm to catalyze digital financial services.

The key is to integrate and then share this data in usable form. There are some changes required in the law to ensure data privacy. The need is to build digital financial service providers with access to all datasets, and capacity to build algorithms that come in handy in making lending decisions. A firm called Infoline is doing so in India; DataCheck and Aequitas in Pakistan are based on a similar idea, but they have a long way to go.

The bottlenecks lenders face to extend credit to SMEs include inability to assess cash flows, to identify assets of borrowers and their behavior. Depending upon the lender's product need, a centralized data processer can provide customized data. This can revolutionize lending to SMEs and consumers in Pakistan and would go a long way towards financial inclusion.

Pakistan has a huge cash economy. The way forward is to replace cash with digital payments. Covid-19 presents a golden opportunity in this regard. Roughly 40 million people in Pakistan work on salary, majority of which is disbursed in cash form. If the payroll is disbursed into wallet or bank account, lending institutions can use the account activity such as spending pattern and behavioral data to make informed decision about extending credit to these wallet holders.

To tap Pakistan's consumers and SMEs potential, digital payment culture must develop. The SBP is working hard to reduce the frictions. For example, bank fees on IBFT transactions was reduced as part of SBP's initiatives to counter Covid-19 led slowdown in economic activity - this has increased daily transactions from 180,000 (pre-Covid) to 400,000 in less than four months. Electronic Money Institutions (EMI) licenses are being issued, and some license holders are working on pilot projects.

Specifically, for SMEs, digital supply-chain financing solutions are the way to go. Just like TReDS in India, a startup, Haball, is striving to become payment aggregator in Pakistan. It is digitizing payments and invoices in the SME supply chain - from vendor to manufacturer to distributor to retailer. For financing, it is partnering with Islamic banks. It is also tapping the FMCGs' supply chain. Partner banks have extended credit to distributors of FMCGs while the payment is made directly to the corporate entity. By monitoring the transaction behavior, banks can extend credit limits to distributors that maintain good performance.

There is another fintech (Finja) which is lending to small-size retailers in the value chain. Finja has two subsidiaries - one has an EMI license for digital payment platform and the other has an NBFC license for lending. One is complementing the other. Also note that the NBFC arm is extending clean lending based on its own data and what it gathers from FMCGs and distributors.

These two are workable examples of how digital data can be leveraged for lending to medium-sized enterprises (by Haball partner) and small-sized enterprises (by Finja). The potential is huge for microfinance, NBFCs, commercial banks, and for small banks to explore new lending avenues by rightfully using digital data. That's some food for thought for the proverbial policymaker.

Copyright Business Recorder, 2020