Syed Mohsin Ahmed has been associated with the Pakistan Microfinance Network (PMN) in different roles during almost two decades now. Mohsin is a qualified management accountant, who has taken executive courses on leadership from the Harvard Business School, a Financial Risk Management course by the Citi Foundation and Women World Banking, and a diploma course on Microfinance at the Microfinance Training Program in Boulder, Colorado.

BR Research recently sat down with the PMN CEO in Islamabad and discussed the happenings within the microfinance sector and the roadmap ahead:

BR Research: It appears that "financial inclusion" is the new development fad. Digital payments are all the rage. And micro-credit is being less and less talked about. Is "microfinance" feeling left out?

Syed Mohsin Ahmed: In our view, microfinance plays a pivotal role in the financial inclusion space. And it is critical for the microfinance sector to use the Fintech innovations to better meet its mandate. At the end of the day, it has to be a collaborative effort between the two segments to do the great amount of work that needs to be done.

But fundamentally speaking, the microfinance definition from its early days in the 1990s is all about financial inclusion, providing formal financial services including credit, deposit, insurance, payments and remittances to the marginalized, low-income and unbanked people. The difference is that traditional microfinance relies on brick-and-mortar operations, but financial inclusion has Fintech as its dominant component. In other words, we can now call it by any name we like. But the essence is the same.

Secondly, Pakistan has a huge untapped market where only 23 percent of the population has access to financial services. And we feel that microfinance will always have a role to play in the development of the country as it supports 2.6 jobs per loan and provides access to financial services to all

BRR: Back in 2016, the microfinance sector was aiming to achieve 10 million active borrowers by 2020, in support of the national financial inclusion strategy of the time. What is the current state of coverage?

SMA: That's correct. We have reached close to 7.3 million active borrowers thus far. We were expecting more, as we ended up at 7.1 million at the close of last year. But the growth has plateaued off amid the current macroeconomic situation. We think that the consolidation phase will continue for at least six more months. By the middle of 2020, we should be ready for the next growth level. And by 2020 end, we hope to reach close to 8 million active borrowers. That is almost 80 percent of the target that we had set for ourselves.

Over the last two decades, the microfinance sector in Pakistan has grown from 60,000 to 7.3 million borrowers and is now offering diversified menu of products other than traditional credit. The PMN, which is the national association of retail players, has played the role of a catalyst in achieving this growth. However, PMN is absolutely clear that support from SBP, DFID and PPAF in its initial stages and now SECP and PMIC have been instrumental in the sector's achievements to date.

BRR: How does that coverage level correspond with the overall addressable market for microfinance borrowers?

SMA: We have estimated that the potential market is close to 40.9 million active borrowers and another 5.8 million micro enterprises; additionally, the potential market is 60.9 million for deposit clients, 96.8 million for insurance clients and 82.1 million for payment clients, all within the microfinance sector.

So the expected coverage, on the borrowing side, at the close of 2020 will be around 13 percent. But we really need to double, triple this density. The demand side is there, the supply side needs to pick up, with finance, technology and services moving in tandem.

BRR: You mentioned that the macroeconomic situation is affecting the microfinance sector. Can you explain in what ways has the sector been impacted? And is the impact seen in the ongoing cycle any different from the impact in the aftermath of the 2008-09 macroeconomic crises?

SMA: The last severe boom-bust cycle of 2008-09 had a considerable impact on the microfinance sector. The empirical research at the time showed that "inflation" did not have a significant impact on the sector, especially on the client's capacity to repay as they were passing on the inflationary impact without an impact on sales. Where the sector really suffered during those times was due to the severe energy crisis. That affected production, sales and business activities in general within the sector.

Coming to the current crisis, which is being responded with a high-intensity macroeconomic adjustment, we don't have an empirical analysis at this stage. But I would still say that the currency devaluation in the last fiscal year did not have a major impact on the sector. However, indirectly, inflation is building up the credit risk within the system. Also, high interest rates will reduce overall profitability of the industry as margins will thin.

On one level, profit margins among the microfinance providers have reduced due to the high discount rates. These high rates have increased the cost of deposits as well as commercial banks' financing for the sector players. On another level, slowdown in economic activities is leading to deterioration in repayment capacity for some microfinance borrowers. The non-performing loans have gone up from around 1.5 percent of the portfolio to close to 4.5 percent. That ratio is reasonable, but it still shows that the overall risk has gone up. Additionally, the infection is more profound for microfinance banks (MFBs) than the non-banking microfinance institutions (MFIs).

BRR: Essentially it becomes a question that how the demand at the base of the pyramid is being affected by the macroeconomic fallout?

SMA: The last crisis did not seriously affect the demand at the base. This time around, our members are telling us that the purchasing power of the low-income segment has come down.

BRR: You said the sector's profitability is down. Can you explain a little?

SMA: The interest rate spread has come down for the microfinance players, thanks to higher discount rate and limits on raising lending rates in the sector. There is a social ceiling on raising the lending rates. We are already pressed because the microfinance lending rates are deemed high, so we cannot raise the rates. We have to absorb the effects of this cycle. Some analysts have suggested that interest rates will decline in 2020 by about 200 basis points. Let's see if the next year offers any respite on this front.

BRR: Recent sector data from PMN shows that the growth in micro-savings is far more than the corresponding growth on the micro-credit side. Who are these tens of millions of people saving with the microfinance providers?

SMA: The micro-savers belong to a mix of segments, both in terms of traditional savings as well as mobile-wallet-based savings. A significant number of savers are also clients of the BISP. Similarly, many m-wallet customers are also counted among savers.

BRR: Beyond 2020, what are the plans to level up the penetration rate in the sector?

SMA: Quite a few things are under consideration. First, the synergy between Fintech and Microfinance has to happen. If we have to achieve majority of the targets that have been set under the latest NFIS, this convergence must take place soon. There is already work that is happening in this area. We, at PMN, are creating a digital platform that will aggregate all our microfinance institutions (MFIs) and then link them up with the local Fintech sector, especially with the branchless banking service providers.

In this regard, the signing up of the Micro Payment Gateway by SBP and Karandaaz during Her Majesty Queen Maxima's visit to Pakistan is a positive development towards financial inclusion. The PMN chairman is also trying to promote the idea of a Fintech association so that fintech players can collaborate like microfinance has done under the PMN umbrella. This can also provide the necessary linkage between microfinance and Fintech sectors.

Second, the microfinance sector will soon start lending to impact-oriented businesses and social enterprises. That can take the form of investment into low-cost private schools, low-cost housing, renewable-energy projects, agricultural value chains, micro-enterprise lending, Islamic microfinance, developing products for specialized segments, etc. So, in addition to simple lending that is currently underway, this approach will move the sector into specialized lending in certain sectors. But the essence of our target market will remain the same. In our view, both PMIC and Karandaaz are playing an important role through debt and equity investments in these segments.

The third major area is going into the down-market and graduating people from the bottommost of the poor all the way to microfinance-eligible clients. We will be looking at programs where specific donor funding is going to come in, so that clients can be graduated from social protection to asset transfers to interest-free loans and then finally on to microfinance programs. This is something that the Ehsaas Program is also discussing with the microfinance providers.

Another area of interest is skill development, where microfinance linkages need to be built with the likes of TEVTA. Right now there are people who are graduating out of these training institutes with skills, but they don't have adequate financing to start up their own small businesses. Moreover, there is also an opportunity to build linkages with informal lenders in peri-urban areas, where, for instance, electronics vendors are selling appliances on installments, and this is a big activity.

BRR: But microfinance is not for everyone. How will some of the new initiatives work?

SMA: Microfinance, by its inherent definition, is provision of credit, deposit, insurance and payment services. Payments will work at the bottom-most tier, as payments are essential for everyone, and it will be targeted through Fintech means. In the segment just above that, savings and insurance services can play an important role in shielding people from sudden shocks.

The idea is that you don't necessarily have to sell micro-credit to people at the bottom tiers - there are other products that make more sense for these segments. For instance, providing long-term insurance services that are backed by a saving mandate can play a very important role in eventual monetary asset creation.

Then there are cycles - sometimes people are cash-heavy, and then there are seasons when cash dries up for them. When people have a lot of cash, it is at that time that savings and insurance products can play a role in providing them coverage to manage future risks as well as cover life-cycle event costs.

As we see it, the SBP has played a very successful role in development of the microfinance and financial inclusion space. The thin line between a market developer and a regulator has been managed very intelligently. We are sure that as the overall space for financial inclusion grows and new regulators come in, they will learn to play this role and hence investment from donors into these regulators will become important, as indicated in the EIU 2019 report.

BRR: You mentioned the need for convergence between microfinance and Fintech. But the formal finance is risk-averse in nature and Fintech is about innovative disruption. Do you see the competing needs for financial-sector integrity and radical innovation meet somewhere in the middle?

SMA: You need to have a "regulatory sandbox approach" to solve that problem. The SECP has allowed the testing of this approach in Pakistan. Discussions are in advance stages at the SBP where they can provide the sector with guidelines for such a sandbox, especially on the Fintech side. The SBP also has challenge funds, which provide innovation capital to the interested players.

However, as indicated in the last EIU report for Pakistan, the availability of rules to get the sandbox approach really going in Pakistan can definitely help in promoting Fintech innovation. Similarly, donors like DFID, which has played a major role under the Financial Inclusion Program (FIP) to support microfinance, are geared to play an important role for Fintech development and linkages with microfinance. This is something they are already doing through support to the PMN Digital Services Platform initiative.

BRR: How the microfinance sector is well-capitalized for the next phase of growth?

SMA: For non-banking, non-profit microfinance entities, finding new capital is always a challenge as they build their growth out of their retained earnings. And in the current situation, the profit margins have come down and their leverage ratios are going up. But the microfinance banks and the for-profit microfinance entities have the capacity to raise equity. So equity, per se, is not a challenge for the sector until and unless the microfinance institutions themselves decide that they want to move out from non-profit mode to for-profit companies and then they start accessing equity from other sources.

It is on the debt side, however, where some pressure is building up due to the high cost of borrowing in the current macroeconomic climate. On this end, the sector's liability side includes three main sources of finance: customer deposits, commercial borrowing from banks and other financial institutions, and borrowing from the Pakistan Microfinance Investment Company,

BRR: Towards the end, are there any alternate lending methodologies currently operative in the sector?

SMA: The dominant mode of credit-check that is currently operational is to do it conventionally through inquiry-generation from the two private credit bureaus. Members report to both the bureaus - Data Check and Tasdeeq.

In terms of alternate lending methodologies, the use of big data is taking place. Some companies are using user data such as mobile top-ups, social media, etc. to offer loans to customers. These are loans of small amount and are meant for short-term or emergency consumption. But there is some debate as microfinance credit, in its essence, is supposed to be a "production loan" instead of a "consumption loan".