Pakistan’s Prime Minister, Mian Nawaz Sharif, launched the Youth Business Loan Scheme earlier this week. The 100 billion rupees Scheme will give out 100,000 loans to young entrepreneurs to launch small businesses. The loans will range from 100,000 rupees to a maximum of two million rupees. The borrower will pay an 8 per cent annual interest rate, whereas the lending institutions will charge approximately 15 per cent in annual interest. The government will subsidize the loans by covering the borrowing cost for the difference between the rates charged by lenders and 8 per cent paid by the borrower. The Scheme will be run by the Prime Minister’s daughter, Maryam Nawaz Sharif.
Pakistan is suffering from widespread under- and unemployment resulting in the youth being readily recruited by religious and other extremist groups. In such dire circumstances, any scheme that engages the youth in commerce and productive activities must be a step in the right direction. However, despite the good intentions, the Scheme appears to be flawed and ill-conceived. Furthermore, the claims that the Scheme will be free of corruption and nepotism fly in the face of the Prime Minister’s decision to put his daughter in charge of a 100 billion Rupee lending program.
Successful entrepreneurs turn investment and opportunity into profits and prosperity. They are driven by the desire to create something new as they chase their dream in every living moment of their lives. Bill Gates, Michael Dell, Steve Jobs, Larry Page and Sergey Brin are all examples of entrepreneurs who launched small businesses and with passion and perseverance grew their small businesses into multi billion dollars corporations.
The fine distinction between a loan and an investment appears to be lost in the Prime Minister’s Youth Business Loan Scheme. Does Pakistan really have 100,000 entrepreneurs ready to turn opportunity and capital into profits and prosperity? Or will the nation end up with billions in loans extended to those who couldn’t even write or conceive a business plan.
Even if one were to assume that the 180 million Pakistanis are fortunate to have 100,000 budding entrepreneurs ready to make their mark, the very structure of the Scheme is riddled with constraints and contradictions that may take away the very incentive to put the borrowed funds to productive use.
For starters, consider that an applicant doesn’t need to submit a business plan with the application for the loan. SMEDA, a partner agency along with the State Bank of Pakistan, offers templates for how to develop a business plan on its website. However, the very first item in the template states the following: “A business plan is not required for PM’s youth business loan scheme.” How on earth will the lenders determine the feasibility of the proposed business?
Take the example of Canadian Youth Business Foundation that offers up to $45,000 in start-up financing to youth for new businesses. The program does not limit its role to extending credit, but instead it guides the engaged youth in developing business plans, arranging mentors, and making available other resources for a successful execution of their business plans. No one gets financing without a business plan in Canada!
I see the Prime Minister’s Scheme bearing the signs of sub-prime lending because many unsuspecting individuals will end up borrowing huge sums for projects they will not be able to plan or execute, thus resulting in defaults. Remember, if the prospective borrowers are not required to furnish a business plan, how will lenders differentiate entrepreneurs from subprime borrowers?
The two leading banks in the Prime Minister’s Scheme are the National Bank and the First Women Bank. The lenders have set the lending (interest) rate at KIBOR plus 500 basis points. Since the base rate in Pakistan is hovering around 10 per cent, the lenders are adding 500 basis points on top of it to end up with an interest rate of 15 per cent. However, if the base rate fluctuates, as it has done in the past, the cost of borrowing can change as well. This can play havoc with the balance sheets of even well-planned businesses who may have naively assumed that they were protected from fluctuations in interest rates.
Notice that inter-bank interest rates in Pakistan were as high as 14 per cent in 2011. What if the 8 per cent mark-up or interest rate advertised by the Prime Minister’s office end up being a teaser rate? The odds of that happening are high and the borrowers under this Scheme will be at the mercy of lenders, especially if the government withdraws its subsidy and sovereign guarantee during the 8-year life of the loan. Clause 8 under Terms and Conditions of the loans states explicitly that if the current or any future government were to withdraw the subsidy for any reason, the borrower agrees to pay against the revised interest rate set by either the National Bank or the First Women Bank.
The 2007-08 global recession was brought about by similar lending practices in the United States where sub-prime mortgages were offered to un-creditworthy borrowers who were enticed by very low mortgage rates that lasted for only a short while. As soon as the higher mortgage rates kicked in, borrowers lacking a stable source of income ended up defaulting on their mortgages resulting in a global crisis because the sub-prime mortgages were bundled as mispriced derivatives that concealed the inherent risks in those investments. Could Pakistan be next with its 100 billion Rupee toxic debt?
If the partner Banks are correct in pricing the debt at 15 per cent, these loans may create a secondary debt market managed by those who would like to benefit from the opportunity for arbitrage, i.e., borrowing two million rupees at 8 per cent and lending it at 15 per cent, thus avoiding the need to start a business and create employment opportunities for others. These borrowers may end up becoming shark investors themselves as they loan funds to the financially disenfranchised in their communities. This will generate a source of revenue for some, but will defeat the very purpose of the Scheme that aspires to start an entrepreneurial revolution in Pakistan.
And what about the notion of Islamic banking? Remember that the Muslim League has always pandered to the religious right who have shun the very concept of ribaa (interest). These loans are structured as traditional debt where the borrowers are expected to return the principal and interest for a fixed interest rate of 8 per cent. The loan repayment schedule posted as Excel spreadsheets lay bare the structure of these loans. A video posted on the SMEDA website shows an individual who explains the details of the Scheme. Fast forward the video to eight minutes and 45 seconds to see the gentleman almost choking at the word interest and with some effort replacing it with profit margin.
Calling interest payments profit sharing is intellectual dishonesty. What business turns profit in the first month? Those familiar with the risk/venture capital know it takes years before the business turns profitable. Until that time the business merely services the debt. Also misleading is the claim that the Scheme offers the first year as a grace period. The loan repayment schedule illustrates that the borrowers have to make interest payments in the first year and are exempted only from repaying principal in the first year.
Details on what happens in the case of default are sketchy at best. The borrowers are expected to put only 10 per cent in collateral. In case of default and with a 10 per cent limited exposure, the borrower can simply walk away from liabilities, leaving the public sector to foot the cost of defaults.
Pakistan is not without the expertise to roll out such Schemes to meet their objectives. Organisations such as the National Rural Support Programme and Tameer Bank have significant experience in micro finance and operations in near and remote parts of Pakistan. Their decades of experience and demonstrated success is the competitive advantage that the Prime Minister could have tapped into. Instead, it appears that the 100 billion Rupees initiative is being used to bolster Maryam Nawaz Sharif’s claim to inherit the Muslim League’s throne against the rival bid by the Prime Minister’s nephew, Hamza Shahbaz Sharif.
A 100 billion rupees is too big an amount to settle a family dispute over succession.