Interview with Mehr Shah, Director Knowledge Management, Karandaaz:

With Karandaaz hitting the right chords in financial inclusion discourse, BR Research decided to have a chat with its Director Knowledge Management, Mehr Shah, in Islamabad. Mehr has over fourteen years of experience in a wide range of local, regional and global development agendas. Previously she was associated with Pakistan Microfinance Network, Hagler Bailly (Pvt.) Ltd, and the World Bank in Pakistan and Afghanistan. In this discussion with Mehr we talk about SME finance, branchless banking, and warehouse receipt financing. Below are edited transcripts.

BR Research: What is the most recent estimate of SME finance?  

BRR: Most SME finance research look at supply side affairs. Considering for instance that many SMEs would rather borrow informally at higher rates than be a part of the formal system, what is your understanding of the demand side?

MS: You are absolutely right in the sense that the SME financing problem needs to be tackled from a number of different angles. Over the years, a multitude of projects have been spearheaded by the central bank and organizations such as SMEDA to develop enabling policies and regulations, build capacity and also introduce credit guarantee funds. Since its inception in 2014 Karandaaz has been working with multiple financial institutions to catalyze the flow of credit to SMEs.

However, a key challenge cited by the supply side is the undocumented nature of the SME segment, resulting in information asymmetries that form a significant bottleneck to financing. To facilitate informed decision making, Karandaaz is exploring the development of a data portal to collate all the information available on SME financing.

Similarly, to overcome the information asymmetry aspect, Karandaaz is exploring the development of credit rating models for SMEs. Other activities such as incentivizing SMEs to be documented, and an updated Census of Economic Establishments such as the one done in 2005 also need to be undertaken, but these are outside the purview of Karandaaz.

BRR: What are the key takeaways from Karandaaz’s work on SME finance in the last few years? Is there a new finding aside from the long list of already-known problems and solutions?

MS: I think what you said previously is very pertinent that there is a need to look more closely at the demand side of SME finance. For example, we need to break down the reasons why SMEs hesitate to access formal financing, and that includes the hesitation to access equity. Most SMEs are family-owned establishments, and there’s a real reluctance to bringing external shareholders on board. What are the primary reasons behind that resistance and how can it be overcome? Could awareness raising play a role, or is it a deeper issue connected to contract enforcement and thereby, needing a more expansive initiative.

BRR: Do you think now that the third generation is taking control of family-owned business, it might provide an opportunity to foray into SME reforms. If so then what specific activities could Karandaaz or other stakeholders could do, or what proposals you might have on the table?

MS: I think as economies evolve the complexity of the activities undertaken by organizations have an impact on their thinking. SMEs are characterized by family firms and at certain stages such as the startup and entrepreneurial stage, this form provides advantages over the non-family company. An example is that firms may face agency costs if the interests of owners and managers are not properly aligned but the costs can be avoided in family firms where the owner-manager is essentially the same person, or belonging to the same party.

However, there comes a time in the life of a firm when people begin to realise that external forces and resources can play a positive role. For example, specialized managers can bring a lot of strength to the table. And because they bring expertise, diversity of views and opinions and experiences, I think being open to formal financing, including outside equity investments, is going to be a natural progression for growth oriented firms.

Whether and how this evolution can be catalyzed is the question Karandaaz would be interested in exploring. The third generation, as you mentioned in your question, can potentially be a window of opportunity. There are indications of a highly educated new generation that has a global perspective and is technologically savvy and this could work to the advantage of SMEs.

BRR: One particular area which we are excited about is credit bureaus; credit history being one of the critical pieces of the puzzle so far as SME finance is concerned. The new law for private sector credit bureau has been passed, but the central bank says specific legislations have to be rolled out for recording a wide variety of credit history data - be it rental or utilities bill data. Given your vantage point, what specific legislations or regulations are required to give power to that over arching law and by which tier of government?

MS: That’s a very good question. I’ll speak to you from the perspective of the microfinance sector: all microfinance providers were mandated to check the credit history of credit applicants as part of their due diligence process. Prior to that, there was evidence suggesting that clients were simultaneously accessing credit from multiple providers leading to higher credit risk.

A study on the impact of credit bureaus on the lending patterns of microfinance institutions and clients is currently being carried out by the Pakistan Microfinance Network. The findings of this study will be important in learning from the benefits to microfinance and applying those learning to other sectors, inclusing the SME space.

BRR: But a few months ago, the SBP was on record with us that “no credit bureau has commenced business under the current regulatory framework for private sector bureau”. They have only issued license to one new firm, which they declined to name. Our market intelligence informs us that JCR-VIS is getting into that business. Plus, the banks offering branchless banking facility and the microfinance banks are already members of SBP’s e-CIB, whereas MFIs have also been recently granted permission by the SBP for membership to e-CIB.

MS:  You are right about the new regulation on credit bureaus. If my memory serves me correctly, there were three credit bureaus functioning in the country, including the e-CIB. At least one of them has been unable to raise the required amount of paid-up capital. Since these bureaus have considerable client data, it may be useful to evaluate the feasibility of allowing these entities to raise the required amount of paid up capital in a phased manner, but I would believe, the results of the study mentioned above will help determine the way ahead.

BRR: What is the unique number of people who have been financially included, be it through micro-finance, branchless banking or Islamic banking? The emphasis is on ‘unique’ because that will separate myth from fact in this whole talk about financial inclusion.

MS: We can be confident in stating that financial inclusion in Pakistan has been on the rise but getting to an exact number is hard because financial inclusion has traditionally been measured with metrics such as the number of registered accounts and active accounts. This means that if a client has more than one account, he or she will be double or even triple counted. Despite this inconvenience, I think it is not incorrect to conclude that financial inclusion has been on the rise in Pakistan. If we look only at the microfinance industry, the number of microfinance clients has increased from approximately one million to more than five million in the last decade. Independent surveys such as the World Bank’s findex and the FII survey also show an upswing:

BRR: Fair enough! What about mobile wallets? Has the growth in mobile wallets superceded the growth in OTC?

 MS: OTC still comprises a large chunk of the digital finance space but mobile wallets are also picking up with 3 percent of adults reportedly having active mobile wallets in 2017, compared to less than 1 percent in 2014. Until recently, there was a real push by providers on adding more agents, but that has now slowed down following, firstly the biometric verification requirement which came into effect in July 2017 and secondly, a concerted push by providers to shift more clients to the mobile wallet.

BRR: Shouldn’t the industry be evolving towards G2P and B2P payments?

MS: True. G2P payments are a core area of focus for Karandaaz and our sponsors. The thinking is to enable the off-take of digital financial services, large payment flows such as BISP payments; pension payments, etc. need to be digitized. Last year Karandaaz also conducted a Global Landscape study on Digitizing P2G Payments. These include payments such as license fee, traffic fines, etc.

BRR: What about B2P? Large organisations often have a fairly big size of blue-collar staff whose salaries are within the limits of branchless banking regulations. Those payments could be made part of the system. Likewise, so many corporates buy farm produce – such as milk, red chillies, animals for slaughter etc.  Those can also be made part of the system.

MS: All initiatives are valuable. Some private sector corporations have moved in that direction but you will agree that when government takes even half a step, the scale is unmatched. This is why Karandaaz has a specific focus on digitizing P2G and G2P initiatives.

BRR: We agree with you on the scale that government brings to the table. But it’s usually the urban centres that are trend setters. Plus, it’s easier to nudge the MNCs and other local big corporates towards digital finance and then you can market success stories out of it while sweating it out to get the government into action.

MS: You are absolutely right. The success of digital finance depends upon the number and type of use cases out there. In simple terminology, by use cases I mean: how many transactions can digital payments be used to pay for? The more avenues available for digital payments, the more likely people are in retaining digital stored value. So it is not enough to put money into digital wallets, this must be supplemented with more use cases. The more use cases there are, the more successful will be at shifting from a cash based economy to a digital one.

BRR: Walk us through the warehouse receipt financing. Where do we stand at the moment?

MS: The basic concept in warehouse receipt financing is that a farmer can take his produce, the commodity, and deposit it in a warehouse. The warehouse assesses that commodity, grades it, weighs it, values it and accordingly issues a receipt to the farmer. The farmer can take that receipt to a bank and borrow against it, accessing financing for the next cropping cycle. By placing the commodity in a licensed warehouse, the farmer need not resort to emergency sale at low prices. With financing available against a receipt, the farmer can opt to sell the crop at a later time, when the market price improves.

The development of the architecture needed for WHR financing is being pushed by the highest levels of government, in collaboration with well-established financial institutions.

After the SBP guidelines were issued, the SECP has developed the Collateral Management and Warehousing (Establishment & Operations) Regulations which has also been approved by the federal cabinet in May 2017.

The primary legislation for warehouse receipt financing has thus been passed; the CDC is now conducting feasibility on setting up a collateral management company, a key part of the infrastructure needed for the successful working of warehouse receipt financing.

BRR: What ideas exist to beat the ‘arthis’ and to ensure that the farmer actually deposits with the warehouse?

MS: If a warehouse is located close to the farm, then a farmer can go and deposit the crop, take a receipt against it, and accordingly take the financing from a financial institution. If the warehouse is far, this will entail costs for the farmer. Ensuring that licensed warehouses are close to farms will be a key enabler. Agri warehousing as a service provision still needs to be developed in Pakistan, and that I think is a significant bottleneck.

BRR: What about the secondary legislation. Where does that stand? 

MS: The secondary legislation is also being developed. The Ministry of Law is working on the draft law which would give electronic warehouse receipts legal cover and make them directly negotiable instruments. As mentioned above, a key development at this point will be a demonstration effect as for warehouse receipt financing to work, a number of moving parts need to work together and in collaboration.

BRR: Are these provincial or federal affairs, because agriculture is a provincial subject?

MS: As per the recommendations in the study the federal and provincial governments through, their provincial food departments, are best poised to develop a network of warehouses that can cater to the country’s major crop producing areas. Public-private partnerships to expand the storage capacity and technically upgrade the operational mechanisms seems to be the most optimal path to achieve a viable storage infrastructure for WHR financing. The Punjab government has already started some initiatives along these lines.