THE stimulus provided by the federal budget FY15, followed by the central bank’s revised prudential regulations, will enable microfinance banks to expand their business in a more robust manner.

Microfinance banks (MFBs) can particularly take advantage of the credit guarantee scheme announced in the budget for small farmers, as its loan cap of Rs100,000 is well within their per-party general financing limit. More importantly, loss-coverage of 50pc for such loans should encourage them to entertain scheme-specific loan requests.

Similarly, crop loan insurance and livestock insurance schemes and the low-cost housing guarantee plan should also motivate MFBs, as these initiatives substantially protect potential lenders against loan defaults, while the loan limits are not beyond MFBs’ ceilings for aggregate financing.

Revised regulations require microfinance banks to implement a comprehensive anti-money laundering framework, envisage a mechanism for customer identification and verification, and enhance due diligence

Exactly one week after the announcement of the budget, the State Bank of Pakistan came up with revised regulations, laced with elaborate guidelines for MFBs’ operations, risk management, corporate governance and customer due diligence etc.

According to a central banker, “combining financial inclusion with banking prudence has been at the heart of these guidelines,” which seek to make MFBs more responsible, and, thus, create room for the more efficient among them to seize new opportunities.

“The federal budget provides some new opportunities, but a lot more will come their way as MFBs move forward under a more demanding but potentially growth-sustaining regulatory regime,” says another central banker.

Some of the areas where the revised regulations are quite testing include required reporting to the Credit Information Bureau, development of a fully-fledged complaint redressal cell for customers, and stricter monitoring of currency transactions to avoid the risk of money laundering.

This May, a few microfinance banks had qualified for receiving grants under the Financial Innovation Challenge Fund (FICF). These banks, along with some commercial banks and other financial institutions, would get grants from the Rs240million allocation made by the SBP under the FICF. They would use the grants for activities like agricultural value chain financing, warehouse receipt financing against agricultural commodities, use of ICT in farm loaning, and for Islamic agricultural financing etc.

With credit monitoring procedures introduced under the revised prudential regulations, MFBs will now have to improve their working to match the financial innovation challenges.

On the other hand, the revised regulations also stipulate that MFBs must seek the SBP’s clearance for receiving local or foreign grants — a prerequisite which throws light on the futuristic shape of microfinance institutions.

For the last few years, microfinance banks have been involved in the SBP’s agricultural credit scheme. Their lending under this scheme has been increasing and is now above Rs21bn or about 6pc of total agricultural lending by all participatory banks.

MFB executives say the FY15 budgetary impetus will further accelerate their pace of agricultural financing and enable them to serve many more small farmers.

But making it happen while they also strictly comply with the requirements of the revised regulations is the real challenge.

For example, under the revised regulations, MFBs are required to monitor the overall exposure of borrowers, so as to manage their own credit risk and to minimise borrowers’ over-indebtedness risk.

But compliance with this requirement in case of agricultural loans can be difficult “not only due to the inexperience of some MFBs, but also because of an aversion for documentation among small farm loan seekers,” says the head of the agriculture credit division of a commercial bank.

The overall exposure of borrowers is calculated while taking into account their borrowing under various heads not only from one MFB but also from other MFBs and microfinance institutions. MFBs’ lending to most small farmers come under their general financing, for which the per-party limit is Rs150,000.

One way of addressing this issue could be to find farm loan seekers that qualify as micro-enterprises, for whom the aggregate per-party limit is higher (Rs500,000).

This means MFBs will have to focus on small agricultural businesses as well.

The revised regulations for MFBs also define the role and responsibilities of their boards of directors and require the induction of two independent directors. They also prescribe a fit-and-proper test for the appointment of key executives.

These regulations also require MFBs to implement a comprehensive anti-money laundering framework, envisage a mechanism for customer identification and verification, enhance due diligence, and improve record retention and reporting of cash and banking transactions, which meet standards developed by the Financial Action Task Force.

Central bankers say as MFBs’ operations continue to expand, there is a need to help them evolve internal early-warning systems against money laundering. They add that requirements under the revised regulations meet this objective.

For the time being, no specific guidelines have been prescribed to rebalance the gender mix of MFBs’ clients, “but going forward, this area can also be covered,” remarks a senior central banker.

By the end of the last year, 74pc male and 26pc female borrowers were availing financing facilities from MFBs.

Male borrowers were getting 81pc and female borrowers 19pc of the total financing. Microfinance banking executives say they plan to rebalance it more in the favour of females this year with ongoing efforts to reach out to both rural and urban women engaged in micro-enterprises.

Published in Dawn, Economic & Business, June 30th, 2014