RAWALPINDI, Dec 11: The Khushhali Bank needs to bridge its liquidity gap by 2009 to remain financially sustainable to undertake its mission through its operational outreach and the use of microfinance as a tool for poverty reduction.

The repayment of the credit line of $68 million by the bank to the Asian Development Bank will begin in 2009 and this will result in creation of a liquidity gap, which urgently needs to address the liability side of its balance sheet for its future sustainability as a viable microfinance bank.

The ADB has asked the Khushhali Bank’s 8-member-board to consider issuing on a one-time basis a seven-year certificate of deposit to bridge its expected next year’s liquidity gap, considering that it has thus far been unable to raise customers’ deposits. This proposed certificate issue will need to be underwritten by investment banks in Pakistan.

The State Bank has endorsed this recommendation, says ADB in its completion report on the project.

The Khushhali Bank was established by the government in 2000 as a vehicle for the country’s poverty reduction strategy and the Microfinance Sector Development Programme (MSDP). Both were developed with the assistance of the ADB.

To obtain such underwriting, the Kushhali Bank will have to improve significantly its corporate governance by holding meetings of its board’s committees, which according to the State Bank have not taken place in the past two years. The bank would also need to improve its international audit processes.

Apart from addressing its immediate liquidity needs, the certificate of deposit issue would help the KB by establishing a market benchmark for the bank in assessing its own credit-worthiness, which will determine its future ability to raise customers’ deposits and testing the market based on a future equity issue through an initial public offering (IPO).

Based on its experience with KB, the report recommended that in future microfinance credit lines in Pakistan, it is essential for ADB to assess carefully the financial viability and sustainability of the microfinance intermediary institution to be able to operate successfully and without subsidised funding during the project’s lifetime.

In its overall assessment, the ADB rated the project as ‘partly successful’ observing that the KB’s failure to generate customers’ deposits to fund its outreach after the loan is no longer available reduces significantly the sustainability of KB’s microfinance interventions.

The KB, through its outreach, was reasonably successful in addressing problems of poverty reduction and gender empowerment. However, it did not build adequate financial resources to be able to continue to do so sustainably after its access to subsidised funding from the loan ends.

The government’s implicit subsidy of bearing the exchange risk of the loan and not charging KB a risk premium further exacerbated KB’s complacency about funding its needs independently.

KB’s entire lending has been financed by the loan, the sub-borrowers’ equity, refinancing by State Bank, and borrowings from other banks. On average, only 24.5 per cent of KB’s sub-borrowers were women, against a target of 40 per cent. In addition, the percentage of women borrowers declined between 2001 and 2007.

The KB effected a change in its gender targeting policy in 2003, after which time only those women, who were the actual users of loan funds, would qualify for lending.

The realisation of the project’s expected social capital output has been mixed. Against an appraisal estimate of $23.2 million, this component’s actual cost was $9.35 million, reveals the report.

The KB signed a partnership agreement with an NGO service provider, the Family Planning Association of Pakistan, in May 2002 to build social capital in participating communities. More than 90,000 community organisations were formed, which exceeded the project’s target. The cost of forming community groups was lower than envisaged at appraisal due to the depreciation of the Pakistan rupee.

The business model adopted by KB was not sustainable over the long run. At appraisal, it was envisaged that KB would generate customers’ deposits to fund at least 20 per cent of its lending during the loan implementation period. Despite being in operation for 8 years, the KB has been unable to generate any customer deposits. It has instead relied on its access to subsidised funding from the loan to finance its lending.

State Bank’s observation of KB’s poor corporate governance may impinge on KB’s ability to raise independent funding to finance its outreach and render both the KB and its outreach efforts unsustainable. Its performance indicates that it is unsustainable even when judged by its operational self-sufficiency (OSS) ratio and financial self-sufficiency (FSS) ratio, typically used to measure the performance of microfinance institutions, when compared to those of First Microfinance Bank, its comparator.

The report says the project had a positive impact on the development of microfinance in Pakistan. According to an independent study, the project demonstrated positive impacts on its participants in terms of monetary and social indicators of welfare and employment.

The highest impact was noticed in the agricultural sector, where most outcome variables–assets, inputs, and sales -- were higher for those, who had more access to the programme.

In addition, the project had a positive impact by generating (family and non-family member) employment opportunities in all sectors, which was facilitated by the start-up of household enterprises. Microfinance borrowers demonstrated significantly higher sales and profits than non-participants. Socially, the poorest bottom quintile of the study’s sample, including women in this group, benefited significantly.