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In July 2013 the Pakistani microfinance sector held its Annual Microfinance Summit. One of the main conference panels was titled “The grand debate in microfinance: whether growth in microfinance should focus towards poverty reduction or access to finance”. The title, which speaks for itself, symbolizes the confusion facing microfinance practitioners, policymakers and donors.

The lack of clarity stems at the policy level, as is evidenced by a study of Pakistan’s Poverty Reduction Strategy Paper (PRSP). The PRSP approach, initiated by the World Bank and the International Monetary Fund (IMF) in 1999, forms the basis of a

countrywide comprehensive poverty reduction strategy, for each country the IFIs lend assistance to (IMF, 2013). Pakistan’s first PRSP, PRSP-I, was developed in 2003 and the second, PRSP-II, in 2009 (Government of Pakistan, 2012).

PRSP-I constitutes a four-part poverty reduction strategy, which includes policies to accelerate economic growth, develop mechanisms to improve governance and devolution, invest in human capital, and target the poor and vulnerable with direct

transfers. Microfinance features prominently in the last category, that is, direct targets for the poor and vulnerable. The PRSP describes microfinance as a “viable tool” that has the potential to reduce poverty and empower women, but cautions that it must be scaled up in a sustainable fashion. Free markets and private capital investments in microfinance are described as the mechanisms that would enable the sector to achieve financial

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The PRSP also predicts that as microfinance expands its outreach in the country, social mobilization and participatory development will become a dynamic process. Thus, it is clear that the PRSP presumes that private investment and private actors will work through the market to reduce poverty. This market-driven ideology is not new to Pakistan, as detailed in chapter 4.

In PRSP-II, published in 2009, there is a distinct change in tone and content, at least with regard to microfinance. Microfinance features in the second and eighth pillars of the nine- pillar poverty reduction strategy of PRSP-II. The second pillar, titled “protecting the poor and the vulnerable”, corresponds to the fourth pillar of PRSP-I. Microcredit is included here as part of a broader social protection strategy for the “poorest and most vulnerable segments of society”. The most recent PRSP monitoring report, which provides data for the first quarter of fiscal year 2011-12, includes microloans worth Rs. 8,360 million in the “direct transfers to the poor and vulnerable” category. This is in reference to microcredit disbursements made through Khushhali Bank, the only quasi-public sector MFB in the country at the time. At the same time, the categorization of microcredit as a “direct transfer” is problematic since these loans have to be repaid with interest.

Nevertheless, most of the discussion on microfinance in PRSP-II has moved to the eighth pillar, titled “capital and financial development”, where it is incorporated within a wider financial inclusion strategy. The document lauds the SBP’s efforts in promoting

commercialization in the microfinance industry. PRSP-II also stipulates that the SBP should continue encouraging MFIs to develop commercially sustainable operations and eventually to enter the financial mainstream by transforming into MFBs. The shift in the

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narrative regarding microfinance between the two PRSPs mirrors the shift in the global narrative on microfinance, as described in Section I above.

It is also obvious that there is a clear policy preference towards MFBs, which may have already resulted in the neglect of MFIs. A major manifestation of this is that since 2000 the largest MFIs have been compelled to spin off their portfolios, either in part or in entirety, into independent MFBs. Three of the 11 MFBs in the sector are MFI spin-offs and others may soon join the group.

MFIs have several incentives for transforming into MFBs. First of all, transformed MFBs receive a 5-year tax holiday. Secondly, while commercial banks are reluctant to lend to most MFIs, the SBP’s partial risk guarantee to commercial banks on MFB loans makes commercial bank loans more easily available for MFBs.

Another incentive is the SBP’s regulation on deposits, which prevents MFIs to use deposits to fund operations. Deposit mobilization, on the other hand, is an important, low-cost source of funding for MFBs. This serves to attract large MFIs, such as the NRSP, to the MFB sector. In the first quarter of 2011, the NRSP mobilized more than 51 percent of total active savers for the microfinance sector (Pakistan Microfinance Network database, 2011). When NRSP spun-off part of its portfolio to the newly created NRSP Bank, which became operational in 2011, the savings were taken up in part by NRSP Bank and were used for the first time to fund microfinance operations.

The SBP regulates MFBs through the Prudential Regulations2 for Microfinance Banks, which have been fashioned out of the Prudential Regulations for Banks, but especially

2_{A legal framework instituted by a country’s central bank in order to regulate all banking activity}

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relaxed in order to promote the MFB sector. As of December 31, 2012, the minimum capital requirement for a regular commercial bank was Rs.19 billion (US$190 million3), but for an MFB operating at the national level it was only Rs.800 million (US$8 million). In addition, MFBs, as mentioned in Table 1, have access to special development funds. These funds include the Financial Inclusion Program, the Institutional Strengthening Fund and the Improving Access to Financial Services Fund. Grants for setting up all, except the last of these facilities come from the UK’s Department for International Development (DFID). The last was set up with a US$20 million endowment from the Asian Development Bank (Akhtar, 2008).

The SBP has also relaxed the prudential regulations to allow the MFBs to lend against gold jewelry as collateral, which the SBP defines as “zero risk lending”. Gold backed loans are now included in the portfolios of all major MFBs and this product has managed to overtake uncollateralized lending for the fastest growing MFBs.

Finally, a key incentive that has led to the setting up of two new MFBs in the last year alone is the SBP’s branchless banking initiative. Capitalizing on the global mobile banking movement, the SBP issued a branchless banking initiative in 2008 and revised it in 2011. It called for the setting up of mobile bank accounts, referred to as “mobile wallets”. The 2011 revised guidelines for branchless banking include waiving all

paperwork requirements for setting up electronic bank accounts, the removal of biometric information requirements for account opening and an upward revision on transaction limits (Pakistan Microfinance Review, 2011). The World Bank based Consultative Group to Assist the Poor (CGAP) has called Pakistan a regional leader in mobile banking, while

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the EIU includes Pakistan among the top five countries in the world for mobile banking (EIU, 2012: 12). In the quarter ending December 2012, 34.3 million transactions, worth US 879 million, were completed through the mobile banking network in the country (Chen, 2013). At the same time, the proliferation of mobile banking has so far only served a transactional purpose and neither credit nor savings products are as yet available through mobile banking facilities.

Overall, however, there is no doubt that these incentives and initiatives have helped the industry grow and in a country where investment rates have been falling for the past five years, it has brought badly needed local and foreign private investment into the sector. In June 2012, the country’ largest MFB, Khushhali Bank was bought out by a consortium of local and international investors. Similarly, in 2012 the SBP issued three MFB licenses and these went either to private mobile phone company operators or private investment companies.

Nevertheless, the pace of commercialization that has overtaken the industry has to be viewed from the point of view of the industry’s clients and those that get left behind due to the increased emphasis on low-risk, high return investments. This is the subject of the present inquiry, and in order to provide a frame for the discussion that is to follow in the next few chapters the following section provides an overview of the nature of poverty and underdevelopment in Pakistan.