MICROCAPITAL STORY: State Bank of Pakistan Adds Incentive to Micro Credit Guarantee Facility

The State Bank of Pakistan (SBP) has issued a new circular that it will provide a 25 percent first loss guarantee for loans under its Micro Credit Guarantee Facility (MCGF) to further encourage commercial banks to provide wholesale funds to microfinance institutions (MFIs). The Facility was introduced last December but was met with an unenthusiastic response by banks despite the SBP’s 40 percent principal guarantee on loans. According to the press release in the Daily Times of Pakistan, only one loan has been granted so far under the MCGF. Banks and development finance institutions (DFIs) now will have the option of choosing either the 40 percent principal guarantee (pari passu), or the 25 percent first loss guarantee. The first loss guarantee will cover gaps in repayment of a loan’s principal, up to 25 percent of the principal value of the loan, whereas the 40 percent principal guarantee will cover 40 percent of the actual loss incurred. In essence the first loss guarantee covers a bank’s smaller losses upfront completely, while the 40 percent principal guarantee would require the bank to share in the losses but covers a larger percentage of loss.

The MCGF was initially started with a GBP 10 million (USD 16.2 million) grant from the UK Department of International Development (DFID). The SBP’s intention is to use the facility to reduce risk for banks and DFIs lending to microfinance institutions and thereby increase the outreach of financial services to the poor. The partial guarantees will allow the SBP to leverage the initial grant amount up to four times. Also, because it has been observed that banks are reluctant to lend in local currency, the structure of the guarantees will allow MFIs to borrow in local currency. The amounts lent by banks to MFIs under the facility will be deductible from each bank’s Demand and Time Liabilities for purposes of the SBP’s statutory liquidity requirement (SLR) and cash reserve requirement (CRR) calculations – meaning the banks will not be required to set aside additional reserves for these loans. Guidelines for the MCGF have also been simplified and made more flexible, said the SBP.

According to the MCGF guidelines, the interest rate charged to MFIs is limited to 200 bps (2 percent) over the prevailing SBP policy discount rate. The SBP recently lowered its policy discount rate by 100 bps to 14 percent. At the time of the move, inflation had declined to a still significant 19.1 percent (year-on-year), from a high of 25.3 percent in August of 2008. The projection for average CPI inflation for fiscal year 2009 is 21 percent, with fourth quarter inflation falling to 14 percent. Consequently the SBP’s real rate is currently negative, and the real rate banks are limited to charging MFIs are also negative, counteracting the SBPs recent attempts to entice banks to use the facility. This latest amendment to the MCGF does compensate banks for charging a lower interest rate to MFIs, however given the large gap between inflation and the discount rate banks are likely to continue to be reluctant to lend until inflation falls significantly or the SBP removes, or raises, its interest rate restrictions.

The SBP has made several recent attempts to promote microfinance in Pakistan. MicroCapital reported on the SBPs move last month to require MFI shareholders to deposit their shares in blocked accounts of the Central Depository Company of Pakistan in an effort to ensure adequate capitalization of MFIs. Unfortunately, as with the SBP’s limitation on interest rates, not all political intervention has served to promote microfinance: for example local politicians in Punjab province were reportedly declaring general amnesty for micro-loans. More on this and Grameen Foundation’s and Women’s World Banking response can be read about in this MicroCapital report.

As reported in a MicroCapital paper wrap-up, currently only 14 percent of Pakistanis use savings, credit, insurance, payments and remittance services from the formal financial system versus 48 percent in India, 32 percent in Bangladesh, and 59 percent in Sri Lanka. According to the original paper entitled “Bringing Finance to Pakistan’s Poor” by the World Bank, financial institution willingness to expand access in Pakistan has been stinted by slow technological advances, weak legal foundations, unsuitable financial processes and products, and the difficulty local banks have had in serving SMEs profitably.

By Laura Anderson, Research Associate

Additional Resources:

The Daily Times of Pakistan: SBP adds incentive to Micro Credit Guarantee Facility

State Bank of Pakistan: Home

Micro Credit Guarantee Facility: Home

State Bank of Pakistan Circular: Amendments in Micro Credit Guarantee Facility (MCGF)

State Bank of Pakistan Circular: Maintenance of Cash Reserve Requirement (CRR) and Statutory Liquidity Requirement (SLR)

State Bank of Pakistan Press Release April 20, 2009: Salim Raza announces reduction in SBP policy rate to 14% on positive inflation outlook

UK Department for International Development (DFID): Home

MicroCapital Story: Grameen Foundation and Women’s World Banking Express Concern Over the Potential Crisis in Punjab, Pakistan’s Microfinance Sector

MicroCapital Story: State Bank of Pakistan Directs Shareholders of Microfinance Institutions to Deposit Their Shares in Blocked Accounts of the Central Depository Company of Pakistan

The World Bank: Home