MICROFINANCE SECTOR - PACRA · The Pakistan Credit Rating Agency Limited MICROFINANCE SECTOR...

MARCH 2013

The Pakistan Credit Rating Agency Limited

MICROFINANCE SECTOR


MICROFINANCE

March 2013 www.pacra.com

CONTENTS PAGE 1. Snapshot

1

2. Microfinance: The concept 2

3. Microfinance around the globe 3

4. Supply – demand dynamics in Pakistan 5

5. Regulatory Framework 6

6. Pakistan’s Microfinance Sector: Performance and Key trends 8

7. Risk Management 10

8. Outlook 13

ANNEXURE

Key Regulations for MFIs | Regional Comparison I

Key Indicators | Pakistan, Bangladesh, and India II

MICROFINANCE SECTOR


SNAP SHOT - MICROFINANCE

PACRA has used due care in preparation of this document. Our information has been obtained from sources we consider to be reliable but its accuracy or completeness is not guaranteed. PACRA shall owe no liability whatsoever to any loss or damage caused by or resulting from any error in such information. None of the information in this document may be copied or otherwise reproduced, stored or disseminated in whole or in part in any form or by any means whatsoever by any person without PACRA’s written consent. Our reports and ratings constitute opinions, not recommendations to buy or to sell. Tel: 92 (42) 35869504 Fax: 92 (042) 35830425 www.pacra.com

Potential Microfinance Market

Active Borrowers

Penetration Rate

Province No. in mln No. in mln %

Balochistan 1.7 0.0 1.0 KP 4.1 0.1 1.8 Punjab 15.2 1.6 10.7 Sindh 6.4 0.6 9.2 Others 0.1 0.0 6.0

27.4 2.4 8.6

* Source: Microwatch, Issue 26 (Oct-Dec2012)

MICROFINANCE - AN OVERVIEW (JUNE 2013)

ANALYSTS

Humza Hussain [email protected]

Naureen Hyat [email protected]

Samiya Mukhtar [email protected]

Rana M. Nadeem [email protected]

Type of Microfinance Institutions (Dec 2012)

No.

Microfinance Banks 10 Microfinance Institutions 12 Rural Support Programs 6 Others 7 Total 35 Source: Microwatch

Brief Overview: The microfinance sector in Pakistan is being developed to financially facilitate the underprivileged, while replicating success of similar institutions from other parts of the world. Initially, these institutions were mostly funded by multilaterals and international NGOs which were spearheading poverty eradication projects within the country. However, recently the sector has evolved into a more sustainable business model, performing functions similar to a commercial bank, while staying true to its mandate of providing financial assistance to the poor. However, these hybrid institutions remain highly susceptible to the changing business environment, due to high correlation of the borrowers with changes in the operating environment.

Demand for Microfinance: Pakistan is a developing economy with growing per capita income (US$1,205) and population. It has sizeable potential market for microfinance. The services offered by MFPs1 address common man economic/financial activities – income smoothing (immediate need for money for consumption), desire to save for unexpected events and for future requirements, starting a small business, send and/or receive cash from one place to another, deposit utility bills. These requirement particularly credit and savings are fulfilled through informal ways; borrowing from worthy landlords, neighbors, or individuals at a very high rate. Savings are done through committees2 and/or buying gold jewelry. Since the quantum of money involved in very small in all these activities and few of these poor/low income people engage in these transactions through formal market, microfinance services are the best mode of financial inclusion of un-served population. With a penetration rate of 8.6%, the potential market for microfinance is estimated to be around 27mln individuals at end Dec-12.

Performance and Efficiency: MFPs have to operate at retail and micro level. All the costs associated with operations of MFPs have to be recovered to make them financially viable. Financial institutions also need comfort as to debt repayment ability of FIs. Meanwhile adequate returns need to be generated to make microfinance industry a good business case for shareholders. Profitability and key performance indicators of the industry have remained weak due to high operating costs.

Key Developments and Future Outlook: Microfinance sector is young and growing. With a high level of untapped potential, there is a lot of room for growth of MFPs. The regulatory role for MFBs1 has been supportive till date. The biggest development of CY12 is launch of Microfinance-exclusive Credit Information Bureau (MF-CIB). This is expected to enable the industry players evaluate and monitor their risk exposure in better way. New players in MFB segment is a sign of good investment opportunities in the industry. Meanwhile, Branchless Banking is expected to play a more prominent role in expansion and profiling of MFBs.

The ownership and governance framework of MFPs needs strengthening. Although MFBs have an adequate level of ownership and governance structure owing to direct supervision by SBP, other MFIs lack on these areas. Bringing professional board members and management is expected to play a direct role in improvement of internal controls, policies, and infrastructure.

The industry has yet to achieve cost efficiencies and required profitability to augment its risk absorption capacity. Funding constrains remain there particularly for those MFPs which are heavily reliant on donors’ funds. The industry needs to build a sustainable retail deposit base to pursue growth and sustainability.

1 MFP (Microfinance Provider), MFI (Microfinance Institution), MFB (Microfinance Bank) 2 Method of saving wherein group of people pool their money

Dec-08 Dec-09 Dec-10 Dec-11 Dec-12GLP 20,001 16,758 20,296 24,903 38,238 Growth 57% -16% 21% 23% 54%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

PKR

in m

ln

Gross Loan Portfolio | Growth Trend


MICROFINANCE SECTOR

MICROFINANCE Page 2 of 13March 2013 www.pacra.com

1. MICROFINANCE: THE CONCEPT

1.1 Microfinance: “Microfinance” primarily refers to provision of financial services to cater to saving, consumption, investment/entrepreneurial and transactional needs of low income or poor segments, of an economy. The objective of microfinance is to promote financial inclusion of these poor segments which otherwise remain un-served by conventional financial institutions. The desired outcome of these services is poverty alleviation. Microfinance is globally accepted means of addressing poverty. Thus, microfinance services are different from traditional financing as that these involve relatively lower quantum of money in an average transaction. 1.2 The clientele to microfinance services are individuals/families particularly women having a household income level below a specified benchmark - poverty line. Poverty level is defined as income level of below US$1.25 per day1 as defined by World Bank and accepted globally. However, each nation’s definition of poverty line may vary from global poverty line; depending on the living standard of each economy. 1.3 “Poor Persons” as defined under “Microfinance Institutions Ordinance 2001” 2 of Pakistan refer to persons who have meager means of subsistence and whose total income during a year is less than minimum limit as the State Bank of Pakistan (SBP) may, from time to time, prescribe. The maximum household annual income eligible for a microfinance loan is PKR 600,000 (PKR 1,644 per day) as specified under “Prudential Regulations for Microfinance Banks” 1.4 Microfinance Providers: Microfinance services are offered by Microfinance providers (MFPs), which can have a profit (commercially operated) or non-profit agenda. The scope of services and applicable legislative framework defines the placement of an MFP in its respective post. MFPs can fall under any of the following categories: Microfinance Institutions, Non-Profit Organizations (NPOs), Microfinance banks, Rural Banks, Commercial Banks, Non Governmental Organizations, Trusts, Foundations, Non-Banking Financial Institutions, Credit Union, Saving and Credit Co-operatives. 1.5 Microfinance products: Microfinance products are offered in the form of microcredit, micro insurance, and other alternative delivery channels mainly through branchless banking. In order to promote savings among low-income clientele and to build a key source of funding, MFIs also offer deposit products with varying rates and maturities. 1.5.1 Microcredit: Owing to small monetary values per transaction involved in microfinance, the loans granted by MFPs are known as microcredit loans. The amount of loans outstanding at any given point in time is known as Gross Loan Portfolio (GLP). 1.5.2 Micro insurance: MFPs also act as an intermediary between insurance companies and microfinance clients. Insurance products with lower premiums and lower coverage are offered in collaboration with an insurance company. MFPs receive a percentage of premiums3 as commission fees. 1.5.3 Alternate Delivery Channels: Branchless Banking: High costs related to infrastructure development to increase financial outreach led the development of alternate delivery channels i.e. other than physical branches for provision of financial services. Branchless banking is a young but growing segment of microfinance industry.

1PovcalNet – an analytical tool for measuring poverty developed by worldbankhttp://iresearch.worldbank.org/PovcalNet/index.htm?1) 2State Bank of Pakistan (SBP) website, ‘Microfinance Institutions Ordinance 2001’, Last Updated on 1st July 2007, Viewed on 2nd February 2013, http://www.sbp.org.pk/1_frame/MF_Inst_Ord_20001.pdf 3Maximum amount to be paid to the policyholder, by the insurance company, in case of occurrence of event against which premiums (cost of insurance to policy holder) have been paid.


MICROFINANCE SECTOR


2. MICROFINANCE AROUND THE GLOBE

2.1 Microfinance has been in play around the globe for centuries in one form or the other (mainly credit and saving groups). However the history of formal microcredit organization can be traced backed to early 1700s when a loan fund system was established by a famous Irish author4 that provided small loans to poor people without collateral. The major growth in microcredit was witnessed in 1990s and during this period the term microcredit was replaced with microfinance that included additional services to the poor segment of societies. Currently microfinance industry is much bigger and active around the globe. Asia is considered one of the biggest markets in the world. According to different estimates and surveys, around 23%5 of the world’s population (~1.6bln people) is poor (Less than US$1.25 per day) with ~66% 6 residing in Asia. 2.2 Microfinance industry has its outreach in 107 countries7 (total countries: 1458) with ~95mln customers through different MFPs. Amongst MFPs, NGOs have the highest physical presence, followed by NBFI, Banks, Credit Unions, and others. However, financial institutions (non-bank and bank) combined, dominate global microfinance sector. Microfinance banks (MFBs) – the most regulated MFPs – on a standalone basis, have the highest system share (67%). 2.3 Microfinance industry during last few years has witnessed decent growth as reflected in five year CAGR of 20%. World GLP stood at US$88bln at end Dec-11. The funding structure of is tilted towards deposits (56%), followed by borrowings and other liabilities (29%), and shareholder’s capital (15%).

4http://www.globalenvision.org/library/4/1051 5Human Development Report 2011 - Sustainability and Equity: A Better Future for All, HDR_2011_Statistical Tables 6State of microcredit Summit Campaign Report 2012, Note 45 , Further referenced to : http://iresearch.worldbank.org/PovcalNet/povDuplic.html) 7MIX market data , cross market analysis report : 2011, last viewed in Mar-13 8US Department of State, http://www.state.gov/s/inr/rls/4250.htm, last viewed in Mar-13.

No. of MFPs % No. of Offices/Branches %NGO 488 35% 20,040 38%NBFI 433 31% 18,138 34%Bank 147 11% 9,991 19%Credit Union / Cooperative 233 17% 3,554 7%Rural Bank 54 4% 875 2%Other 36 3% 453 1%Total* 1,391 53,051

Type of Microfinance Institutions as on Dec-11

*There is slight variation in reported number of regionwise and legalstatuswise MFIs in MIX market data

System Share as on Dec-11 Assets Gross Loan Portfolio (GLP) Deposits Equity

Bank 67% 63% 77% 49%Credit Union / Cooperative 18% 21% 12% 26%NBFI 7% 9% 2% 16%NGO 4% 5% 5% 5%Other 4% 3% 5% 2%Rural Bank 0% 0% 0% 1%Total (US$ in mln) 118,780 87,650 67,202 17,674

No. CountryGross Loan

Portfolio (US$ in mln) as on Dec-11

% GDP

1 China 13,293 0.2%2 Peru 8,768 5.0%3 Colombia 5,311 1.6%4 Vietnam 5,477 4.4%5 India 4,318 0.2%6 Bolivia 3,048 12.5%7 Bangladesh 2,819 2.5%8 South Africa 2,560 0.6%9 Kenya 1,719 5.1%

10 Mexico 1,986 0.2%36 Pakistan 232 0.1%


MICROFINANCE SECTOR


Africa9%

East Asia and the Pacific

36%

Eastern Europe and Central Asia

12%

Latin America and

The Caribbean

32%

Middle East and North

Africa1%

South Asia10%

World | Microcredit Pie

2007 2008 2009 2010 2011Total Assets 47,122 55,189 92,661 98,747 118,780Gross Loan Portfolio 38,279 44,871 75,336 90,113 87,650

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

US

$ i

n m

ln

World | Gross Loan Portdolio


MICROFINANCE SECTOR


* Bringing Finance to Pakistan’s Poor, Page 9, worldbank.org

Formally Included

Informally Served (Organized Sector)

Inf. Served (unorg- sector)

Financially Excluded

Financially Served Voluntarily Excluded

Involuntarily Excluded

0% 14.3% 45.5% 50.5% 81.4% 100%

Province No. in mln No. in mln %

Balochistan 1.7 0.0 1.0 KP 4.1 0.1 1.8 Punjab 15.2 1.6 10.7 Sindh 6.4 0.6 9.2 AJK - 0.0 - GB - 0.0 - ICT 0.1 0.0 6.0

27.4 2.4 8.6

* Source: Microwatch, Issue 26 (Oct-Dec2012)

Potential Microfinance Market

Penetration Rate

Active Borrowers

3. SUPPLY – DEMAND DYNAMICS IN PAKISTAN

3.1 Demand for Microfinance: Given developing status of the economy, lower per capita income (US$1,205) and growing population, Pakistan has sizeable potential market for microfinance. Of ~180mln individuals living in Pakistan, close to 56mln are part of employed labor force. That means 31% of total population is considered eligible to directly use the financial services. However, only 20% (number of depositors and borrowers combined) is part of Pakistan’s formal financial sector. According to a World Bank’s report9 ~50% of country’s population is excluded from financial services. The possible reasons for a high exclusion rate can be attributed to no/low awareness about financial services and related benefits, poverty, and/or religious reasons. 3.2 Potential market for microfinance: The services offered by MFPs address common man economic/financial activities – income smoothing (immediate need for money for consumption), desire to save for unexpected events and for future requirements, starting a small business, send and/or receive cash from one place to another, deposit utility bills. These requirement particularly credit and savings are fulfilled through informal ways; borrowing from worthy landlords, neighbors, or individuals at a very high rate. Savings are done through committees and/or buying gold jewelry. Since the quantum of money involved in very small in all these activities and few of these poor/low income people engage in these transactions through formal market, microfinance services are the best mode of financial inclusion of un-served population. The potential market for microfinance is estimated to be around 27mln10 individuals with a penetration rate of 8.6% at end Dec-12. 3.2.1 Potential market for branchless banking: Branchless Banking - a breakthrough in the technology oriented world - has given a new dimension to alternate delivery channels while opening a new

9 Bringing Finance to Pakistan’s poor, worldbank.org 10Microwatch Oct-Dec12

Total Banks/DFIs MFB/MFIsNumber of Depsoitors 32.0 27.7 4.31*No of Borrowers 5.71 3.5 2.2*

* Microwatch

Main Source: Inuagural Address by Deputy Govrener, SBP, 6th Pakistan Microfinance Country Forum, Dec-2012

Number of Borrowers and Depostors in Pakistan | At end Jun-12

Total % Working Age % Labor Force % Employed Labor ForceRural 113.2 63% 83.9 65% 41.2 69% 39.2 70%Urban 67.6 37% 46.0 35% 18.2 31% 16.6 30%

180.7 129.8 59.3 55.8

Nos. in mln

31%

Source: Economic Survey of Pakistan (2011-2012), Chapter 12, Table 12.9

Population expected to use financial services | Employed Labor Force


MICROFINANCE SECTOR


financial world for both existing banking customers and un-banked population. Considering the gap between count of 110mln mobile phone users and 38mln (depositors and borrowers combined), the potential of mobile banking, an important pillar of branchless banking, is also sizeable.

3.3 Suppliers of Microfinance Services: In Pakistan, MFPs providing microfinance services can be classified into one of the three categories: Microfinance Institutions (including NGOs, NPOs), Microfinance Banks, and Rural Support Programs. These MFPs come under different legislative/regulatory frameworks. With the gradual evolution of regulatory framework for microfinance banks, tendency to convert to microfinance bank from an institution has increased. Meanwhile, new business opportunities particularly branchless banking, and access to commercial funding has led to creation of new microfinance banks. Nevertheless, excluding non-banking MFPs still control a sizeable pie of microfinance sector.

End-Feb13 2012 2011 Microfinance Banks 10 9 8 Microfinance Institutions 12 12 9 Rural Support Programs 6 6 5 Others 7 7 9Total 35 34 31 Source: Microwatch

4. REGULATORY FRAMEWORK

4.1 Parallel to microfinance industry in last few years, regulatory framework of microfinance industry has also evolved. Pakistan is recognized globally, as one of the top countries having a strong microfinance regulatory framework11. Currently MFPs fall under five different legislative/regulatory frameworks. A brief on type of regulatory framework and number of MFPs falling under each type is given below:-

Regulatory Framework12

Licensing Framework Scope Regulatory Authority

No.

MFI Ordinance 2001 Ordinance promulgated particular to regulate establishment and licensing of microfinance banks and to set criteria for conversion of MFI to MFB

State Bank of Pakistan

10

The Voluntary Social Welfare Agencies Ordinance, 1961 [ORDINANCE No. XLVI]

A voluntary social welfare agency means an organization, association, or undertaking established for the purpose of rendering welfare services in a wide range of activities including the fields of education, health, family planning, child welfare, etc. Organizations registered under this regulation are financially dependent on public subscriptions, donations, or Government aid

Provincial Government

2

Societies Registration Act [1860 Act XXI] (The “Societies Act”)

This Act requires the registration of literary, scientific, and charitable societies. The object of the Act as stated in the preamble is to make provisions for improving the legal condition of Societies established for the promotion of literature, science, or fine arts, or for the diffusion of useful knowledge, or for charitable purposes. Thus, under this Act microfinance is covered as a ‘charitable activity’


10

The Companies Ordinance 1984 : Section 42

As per Companies Ordinance, microfinance institutions can render assistance to microenterprises and provide microfinance

Securities and Exchange

12

11 Global microscope on the microfinance business environment 2012, Economic Intelligence Unit, The Economist 12 Reference: Regulating Pakistan’s Nonbank Microfinance Institutions, Micronote Dec11, PMN with further reference to www.amlaw.pk


MICROFINANCE SECTOR


services in a sustainable manner to poor persons, preferably poor women, with a view to alleviating poverty. In the case of for-profit and limited-by-guarantee companies, under the Ordinance such organizations can only offer one service i.e., microfinance, and cannot be an integrated entity offering multiple development services such as health and education, etc

Commission of Pakistan (SECP)

The Trust Act 1882 Under this Act a Trust may be created for any lawful purpose, including microfinance.


1

Total 35

4.2 State Bank of Pakistan (SBP) is responsible for supervising all deposit taking MFIs in Pakistan. Microfinance Institutions Ordinance 2001 addresses interalia, the requirements for setting up of microfinance banks including conversion of MFIs to MFBs. Prudential Regulations as laid down by SBP supplement the MFI Ordinance 2001. Few of the critical requirements addressed in MFI Ordinance are as under:-

Establishment and Winding upAllowed Function of MFBRestrictions [Creating of Floating Charge on assets without SBP permission]

Specified Area of operations• District • Regions (up

to 5 adjacent districts)

• Province• Whole of

Pakistan

Capitalization• Minimum

capital of the bank

• At least 51% of Paid-up Capital to be subscribed by sponsor

Licensing Requirement• Existing

MFIs• New

MFBs

Ongoing Regulation and Supervision• Management and

Administration• Accounts and Audit• Filing of Returns• Liquidity and Reserves• Depositors Protection Fund• Inspection• Powers to give directions ;

to remove BoD; to supersede BoD

4.3 Prudential Regulations (PRs): PRs apply to all microfinance banks. These regulations set prudent requirements and limits so that MFBs operate in operationally and financially stable condition. A brief synopsis of microfinance regulations of Peru (the top ranked country in microfinance business environment 2012 by EIU), Bangladesh, and India is enclosed as Annexure I. 4.3.1 Comparison of regulations with two neighboring countries, Bangladesh and India indicates Pakistan has relatively mature framework for regulating Microfinance Banks. Indian Cabinet approved Microfinance Bill in May-12 which has been pending approval since 2007. Moreover, the Andhra Pradesh Microfinance Crises13 led Indian legislative authorities re-think the regulatory frame. Under Microfinance bill 2012, Reserve Bank of India has become sole regulatory authority of NGOs-MFIs and informal self help groups (SHGs) with more than 20 members.

13 Andhra Pradesh is a state in Southern India and was considered the hub of microfinance till 2010. The expansion rate of microfinance had been quite high (growth in volume: 46%; Growth in loans: 26% during 2009 and 2010). In 2010, higher debt burden, social pressures, and coercive push by microfinance employees led to widespread suicide by women. Post such incidences, AP Act restricted all MFIs from collecting outstanding loans in the range of US$1bln-2bln while restricting MFI access to bank funding. (Reference: The Microfinance Crisis in Andhra Pradesh, India: A Window on Rural Distress? By Marcus Taylor)


MICROFINANCE SECTOR


Country %Bangladesh 39.7Peru 39.6India 7.3Pakistan 5.3

World Average (55 countries) 19.0>>Number of borrowers as % of poor poulation* Source: Microscope on Microfinance 2012: Index, EIU

Microfinance Pentration | Pakistan and others>> *

4.3.2 Bangladesh has various regulatory bodies; NGO-MFIs are regulated by a separate Microcredit Regulatory Authority. The banks are regulated by the central bank of Bangladesh –Bangladesh Bank. Meanwhile Grameen Bank - the largest MFI of Bangladesh operates under a separate law - Grameen Bank Ordinance 198314. The microfinance industry in Bangladesh has yet to establish a core funding mix. Currently, except Grameen, MFIs cannot mobilize deposits from public. Meanwhile no formal and integrated credit bureau exists in the industry to keep track of MFI borrowers. At the same time MFIs are not allowed to charge more that 27% on any loan. Pakistan has no cap on MFI lending rates. 4.3.3 Peru has the most competitive environment for microfinance industry players. The regulatory framework and transparency requirements for the industry participants. Meanwhile, deposit taking banks’ (the most regulated form of financial institutions) share in the industry is increasing.

5. PAKISTAN’S MICROFINANCE SECTOR: PERFORMANCE AND KEY TRENDS

5.1 Penetration: Pakistan has a high level of untapped microfinance market which is eminent from low penetration rate compared to other countries. The penetration rate adjusted for potential market, though increasing (8.6% at end Dec-12; 7.6% at end Dec-11), also remains below world’s average penetration rate. 5.1.1 Punjab, the most populous city of Pakistan, has the highest penetration rate (11%), followed by Sindh (9%), ICT (6%), KP (2%) and Baluchistan (1%). 5.2 Asset Growth: The asset base of the sector, led by microcredit, expanded by a strong average growth rate of ~50% from 2000-2008. The decline in asset base during 2009 can be attributed to delinquency crises in Punjab. Since 2010, the growth has again picked up its pace with 54% increase in gross loan portfolio during CY12. The key reasons for this are i) growth in no. of active borrowers (2.4mln at end Dec-12; 2.1mln15 at end Dec-11), and ii) increase in average loan size (PKR 24,131 at end Dec-12, PKR 21,126). The credit disbursements also grew by 33% to PKR 55,163 during CY12.

Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

GLP 20,001 16,758 20,296 24,903 38,238 Growth 57% -16% 21% 23% 54%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

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5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

PK

R in

mln

Gross Loan Portfolio | Growth Trend

5.3 Market Share: Microfinance banks own the highest share in GLP pie, owing to higher average loan size compared to peers. In terms of number of active borrowers, the pie is fairly shared between MFBs, MFIs, and RSPs. Nevertheless the largest chunk still resides with MFBs. Additionally 65% of industry GLP is concentrated around 5 MFIs including two

14 Grameen Bank - Annual Report 2011 –Note 1.01 15 The no of active borrowers as reported in PMR 2011 is 1.7mln

Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 (P)

Total Assets 33,194 30,473 35,826 48,623 70,152 Growth 45% -8% 18% 36% 44%

-20%

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0%

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60%

70%

80%

(20,000)

(10,000)

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PKR

in m

ln

Pakistan | Microfinance Industry | Asset Growth


MICROFINANCE SECTOR


56%

22%

18%

5%

GLP | Market Share | At end Dec-12

MFBs MFIs RSPs Others

39%

30%

24%

7%

Market Share |Active Borrowers | At end Dec-12

MFBs MFIs RSPs Others

banks (Tameer: 18%; KB; 17%; NRSP:13%: FMFBL:9%:KASHF:9% at end Dec-12).

5.4 Funding Structure and deposit growth: MF industry has traditionally remained dependent on donor fund, grants, and other subsidized funding. However, with the emergence of MFBs as the major participants in the industry, the trend has been shifting towards commercial debt and deposits as source of funding. 5.4.1 Deposit Growth is primarily measured by growth in value of micro savings and micro savers. Considering the potential of the market, establishment of a sticky deposit base is critical. Pakistan Poverty Alleviation Fund is one of the key sources of funding for various MFPs. Major donors allocate funds to PPAF which are further lent to MFPs for disbursements as microcredit. Existing grants to PPAF will be maturing by end Dec-13. Therefore, MFPs which are highly dependent on PPAF may face funding constraints. Meanwhile SBP also offers few credit guarantee schemes in order to support MFBs in funding arrangements. Only MFFBs can avail these schemes. 5.4.2 During CY12, the value of savings has increased considerably (61%). Since the age of deposit accounts and deposit base is small, the retention of deposits and subsequent impact on MFPs cost of funds will be tested in the future.

Commercial / Subsidized Funding

Volume (USD in mln]

Tenor Key Donor

Grants Administered by Pakistan Poverty Alleviation Fund

PPAF 5.5 2009-2013 World Bank

PRISM [Institutional Strengthening Fund ]

0.5 2008-2013 IFAD

PRISM [Knowledge Management and Policy Support]

1.8 2008-2013 IFAD

Grants Administered by SBP

Volume (USD in mln]

Tenor Key Donor

Institutional Strengthening Fund

5.5 2008-2013 World Bank


MICROFINANCE SECTOR


Yield on GLP (%) MFIs MFBs RSPs Weighted Average

Nominal 37.5 33.5 32.0 35.2Real 23.6 20.0 18.7 21.6

Expenses as % GLP 30.8 39.1 39.4 37.5

Dec-07 Dec-08 Dec-09 Dec-10 Dec-11OSS 89% 81% 105% 100% 108%FSS 74% 71% 87% 82% 101%

0%

20%

40%

60%

80%

100%

120%Industry | Business Profile

Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

Savings 5,384 8,554 11,863 15,508 24,974 Growth 35% 59% 39% 31% 61%

0%

15%

30%

45%

60%

75%

-

5,000

10,000

15,000

20,000

25,000

PKR

in m

ln

Savings | Growth Trend

Equity17%

Debt41%

Commercial

Liabilities20%

Depsoits22%

Funding Structure

5.5 Efficiency and Profitability: MFPs have to operate at retail and micro level. All the costs associated with operations of MFPs have to be recovered to make them financially viable. Financial institutions also need comfort as to debt repayment ability of FIs. Meanwhile adequate returns need to be generated to make microfinance industry a good business case for shareholders. 5.5.1 Operational costs of MFPs are high so is the required return on loans. Globally Operational Self Sufficiency (OSS) – Ratio of all expenses to before tax profit – is a widely accepted measure to evaluate profitability of the bank. MFIs having ratio of 100% are considered operationally self

sufficient. Adjusted for certain expenses, another ratio –Financial Self Sufficiency is also used by the industry players. CY11 was the first year Pakistan’s microfinance industry achieved operational and financial self sufficiency. MFBs have yet to achieve financial self sufficiency. Meanwhile, the sustainability of this positive trend has yet to be tested. 5.5.2 Overall performance of the industry improved during CY11 as it booked consolidated profitability of PKR 665mln (CY10: Loss of PKR 16mln). This was mainly generated by RSPs (74%), followed by MFBs (14%), and MFIs (12%).

5.6 Branchless Banking is seen as an attractive avenue from both perspectives (demand side; ease of doing financial transaction, supply side; potential to earn revenue without brick and mortar model).

7. RISK ASSESSMENT

7.1 Credit Risk and Asset Quality: Microfinance industry entails different business models, each of them exposing the industry to credit risk with varied level of vulnerability. The borrowers of the industry are low-income individuals – male (42%), and females (58%). With 56% of total borrowers residing in rural areas, macro-economic factors - economic growth, inflation trends, natural calamities, and to some extend political environment - play a key role in repayment ability and willingness of the borrowers.


MICROFINANCE SECTOR


Trade, 30%

Agriculture, 22%

Livestock/Poultry, 16%

Manufacturing/Production, 9%

Services, 8%

Housing, 0%

Others, 15%

GLP | Sector wise Expsoure | at end Dec-12

Africa LAC* World ECA** EAP*Pakistan Asia MENA****

PAR > 30% 6.6 4.8 3.8 3.7 3.4 3.2 2.5 2.1Write-off to GLP 0.7 1.4 0.5 0.3 0.4 2.1 0 0.3

* Latin America and the Caribbean ** Eastern Europe and Central Asia

*** East Asia and the Pacific **** Middle East and North Africa

Asset Quality | Comparison with World | at end Dec-11

Types of Collateral used by 25 Microfinance Providers in Pakistan

1 2 3 4 5 6 7 8 9

#Category

8 6 8 4 7 7 3 2 2 1 9 6 5 5 2 - 1 - 1 - 3 3 2 1 1 - - 1 - - 5 4 3 3 2 - 3 1 - - 25 19 18 13 12 7 7 4 3 1

MFIsRSPs

Others

Microfinance Sector | Credit Risk Management

Asset Ownership

-

Compulsory Savings

Asset Leasing

Live Stock

MFBs

Group Guarent

ee

Personal Guarentee

Post Dated Cheks

Promisory Note Gold

7.1.1 Credit exposures can be on individuals or groups. Under group lending, a group of individuals undertake to repay the loan. This inculcates a joint responsibility to repay the availed loan and thus creates social pressure. In many countries, group lending has generated a recovery ratio of as high as 98%. However, this social pressure can be manipulated by the groups and can lead to heightened risk exposure leaving MFP with no physical security. Nevertheless, group based lending dominates the outstanding microcredit of the industry. Though group guarantees are accepted by MFBs, they tend to offer more products based on collateral other than group guarantee. There has been a slight increase in proportion of individual lending during 4QCY12. In terms of sector concentration, trade based and agricultural loans, combined, account for more than 50% of credit pie. 7.1.2 As per loan classification criteria laid down by SBP, portfolio overdue by 30 days would be classified as OAEM with subsequent downgrading of portfolio to substandard, doubtful, and loss at greater than 60, 90, and 180 days respectively. Provisioning for OEAM category is not required. However subsequent categories require 25%, 50%, and 100% provisioning respectively. Additionally MFBs are required to write-off loans after one month of classification in loss category. MFBs are also required to maintain general reserve of 1.5% of net advances.

7.1.3 Loan loss experience and provisioning: Overall asset quality of Pakistan’s microfinance sector is weak as compared to other countries in Asia. Including the write-off ratio, PAR is also greater than world’s PAR at end Dec-11. Coverage ratio remains strong: 79% at end Dec-11.

70% 69% 70% 68%

30% 31% 30% 32%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Mar-12 Jun-12 Sep-12 Dec-12

GLP | Lending Methodology

Group Individual


MICROFINANCE SECTOR


1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12Industry 4.2 3.7 3.0 3.3 3.9 3.8 3.1 1.4MFBs 4.9 4.6 3.0 3.3 4.7 5.0 3.5 1.1MFIs 2.6 2.1 1.2 1.5 2.1 1.9 2.3 2.1RSP 5.0 2.5 4.1 4.8 3.2 2.2 1.5 0.4Other MFPs 2.8 5.5 5.4 4.9 5.4 5.5 7.3 5.8

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

PAR

% G

LP

Portfolio at Risk | Quarterly Trend 7.1.4 An analysis of last eight quarters reveal that PAR follows a seasonal trend with highest level of PAR at the beginning of the years, gradually reducing to a low level towards the end of year. MFB’s on average maintained a higher PAR. During 4QCY12, PAR has reduced to a very low level. Although detailed data for PAR is not available, this decline in ratios can be attributed to any of the following two reasons i) all portfolio greater than 90 days crossing one month age; thus invoking write-offs, or ii) high recoveries. 7.1.5 Potential Credit Risk and Punjab Delinquency Case: During 2008-2009, certain group borrowers started to revolt against repayment of microfinance loans. These groups approached local man in political power to push respective MFP to write off their loans. This resulted in old clientele as well as new borrowers to willingly default on their loans. The crises highlighted the need for MFIs to revisit the governance framework, internal controls, and monitoring of operations. PAR increased from 1% to 20%. This crises led the identification of following gaps, still prevailing at few places, in business models and risk management of MFPs:-

MFPs following footsteps of others MFPs to extend outreach: this resulted in clustering of MFPs in same area

Few MFPs taking divergent view: this encouraged MFPs entering new untested areas More focus on expansion, compromising internal controls: this is the critical reason

behind crises: i) there was extended pressure on loan officers/staff to meet targets and increase outreach, ii) loan officers had multiple responsibilities, iii) incentive systems were not aligned, iv) internal monitoring was weak, v) same loan officers were working for multiple MFPs. Two examples of key practices which were being followed were: delegation of responsibilities (client selection and application verification) by loan officers to leaders of group borrowers or other local influential resident.

Manipulation of existing clientele/groups of other MFPs to shift to their own MF. This activity led potential borrowers to seek group leaders’ support in getting finances rather than MFPs employee

In the absence of any integrated information bureau, borrowers increasing their debt burden by availing multiple loans

Group leaders becoming commission agents for borrowers (to include them in group) and from MFP (availing commission against their service to support loan officers in client selection. Few times, these group leaders enter into unethical practices; availing debt against “dummy” borrowers

7.1.6 Certain indicators (qualitative and quantitative) are used to assess the quality of loan book: i) credit approval process, ii) credit verification, disbursements, and monitoring of credit process, iii) internal controls and MIS generated by MFP, iv) loan to value ratios (if secured against physical security), v) proportion of repeat and roll-over loans, vi) MFPs client assessment frequency and analysis of clients’ repayment behavior.


MICROFINANCE SECTOR


7.2 Financial Risk: MFBs are involved in mobilizing public money and thus have to maintain minimum liquidity. They are required to i) maintain at least 5% cash, an ii) 10% liquid reserves against deposits of less than one years. MFBs are also required to credit 5% of their profits to Depositor Protection Fund (DPF). The amount is allowed to be invested in government securities or to be deposited with SBP. The DPF will be used to make payments of up to PKR10,000 per depositors in case of bank’s liquidation. Currently all banks maintain strong liquidity positions owing to initial roll-out of business operations and fresh capital. 7.2.1 Minimum capital (PKR 300mln –PKR 1,000mln) and capital adequacy requirements (15%) are also laid by SBP. Currently one bank is non-compliant with minimum capital and CAR requirements.

8. OUTLOOK : STABLE

8.1 Microfinance sector is young and growing. With a high level of untapped potential, there is a lot of room for growth of MFPs. The regulatory role for MFBs has been supportive till date. The biggest development of CY12 is launch of Microfinance-exclusive Credit Information Bureau (MF-CIB). This is expected to enable the industry players evaluate and monitor their risk exposure in better way. New players in MFB segment is a sign of good investment opportunities in the industry. Meanwhile, BB is expected to play a more prominent role in expansion and profiling of MFBs. 8.2 The ownership and governance framework of MFPs needs strengthening. Although MFBs have an adequate level of ownership and governance structure owing to direct supervision by SBP, other MFIs lack on these areas. Bringing professional board members and management is expected to play a direct role in improvement of internal controls, policies, and infrastructure. 8.3 The industry has yet to achieve cost efficiencies and required profitability to augment its risk absorption capacity. Funding constrains remain there particularly for those MFPs which are heavily reliant on donors’ funds. The industry needs to build a sustainable retail deposit base to pursue growth and sustainability.

Analysts Rana Muhammad Nadeem [email protected]

Samiya Mukhtar [email protected]

Naureen Hyat [email protected]

Humza Hussain [email protected]

Disclaimer:

PACRA has used due care in preparation of this document. Our information has been obtained from sources we consider to be reliable but itsaccuracy or completeness is not guaranteed. PACRA shall owe no liability whatsoever to any loss or damage caused by or resulting from anyerror in such information. None of the information in this document may be copied or otherwise reproduced, stored or disseminated in whole orin part in any form or by any means whatsoever by any person without PACRA’s written consent. Our reports and ratings constitute opinions,not recom m endations to buy or to sell.

Source of Exchange Rates: http://www.xe.com

ANNEXURE I

COUNTRY-WISE COMPARISON OF REGULATIONS PARTICULARS PAKISTAN PERU BANGLADESH INDIA Name Of Regulation [Last Updated]

Prudential Regulations For Microfinance Banks [16th March, 2012]1 Microfinance Institutions Ordinance 2001 [1st July 2007]2

General Law Of The Financial And Insurance Systems And Organic Law Of The Superintendency Of Banking And Insurance [17th January 2013]3

Microcredit Regulatory Authority Rules, 2010

Non-Banking Financial Company-Microfinance Institutions (Reserve Bank) Directions, 2011

Regulatory Body

State Bank of Pakistan (SBP) Superintendencia de Banca, Seguros (SBS) Microcredit Regulatory Authority (MRA)

Department of Non-Banking Supervision, Reserve Bank of India (RBI)

Definition of Microfinance Loans

“Microfinance services” means the financial and other related services [specified in section 6 of The Microfinance Institutions Ordinance 2001], the value of which does not exceed such amount as the State Bank may, from time to time, determine; A microfinance institution shall, in accordance with prudential regulations and subject to the terms and conditions of the license issued by the State bank, render assistance to micro-enterprises and provide microfinance services in a sustainable manner to poor persons, preferably poor women, with a view to alleviating poverty.

“Micro Credit” means loan facilities offered by micro credit organization certified under MRA for poverty alleviation, employment generation and facilitate a small entrepreneur.

A loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not exceeding INR 60,000 or urban and semi-urban household income not exceeding INR 120,000. The loan does not exceed INR 35,000 in first cycle and INR 50,000 in subsequent cycles.

1State Bank Of Pakistan (SBP) Website, ‘Prudential Regulations For Microfinance Banks’, Last Updated on 16th March, 2012, Viewed on 1st February2013, http://www.sbp.org.pk/publications/prudential/SEP-16-2011.pdf 2State Bank Of Pakistan (SBP) Website, ‘Microfinance Institutions Ordinance 2001’, Last Updated on 1st July 2007, Viewed on 2nd February2013, http://www.sbp.org.pk/l_frame/MF_Inst_Ord_2001.pdf 3Superintendencia de Banca, Seguros (SBS) Website, ‘General Law Of The Financial And Insurance Systems And Organic Law Of The Superintendency Of Banking And Insurance ‘, 5th February 2013, Viewed on 6th February 2013, http://www.sbs.gob.pe/0/modulos/JER/JER_Interna.aspx?ARE=0&PFL=0&JER=106


Definition of Microenterprise

“Microenterprises” shall mean projects or businesses in trading /manufacturing /services /agriculture that lead to livelihood improvement and income generation. Moreover, these projects/businesses are undertaken by micro-entrepreneurs who are either self-employed or employ few individuals not exceeding 10 (excluding seasonal labor). In Pakistan, microenterprises operate in numerous forms including carpenters, electricians, food stalls, farmers, livestock, lathe machines, mechanics etc. and these have traditionally lacked access to formal financial services.

MSE should have the following characteristics occurring: Microenterprise: one (1) to ten (10) employees and annual sales including up to the maximum of 150 tax units (ITU). Small Business: one (1) to one hundred (100) employees and annual sales including up to the maximum of 1700 Tax Units (ITU). 4

Size of Enterprise

Employment Annual Sales

Micro 1-10 <150 Tax Units Small 1-100 <1700 Tax Units

Loan Limits Type of Loan Loan Limit Per Borrower

Borrower Eligibility Criteria

Total Limit

Housing Loans Rs.500,000 Household annual income of up to Rs.600,000

At least 60% of housing loan portfolio of an MFB should be within the loan limit of Rs.250,000 or below.

General Loans (Other than housing loans)

Rs.150,000 Household annual income (net of business expenses) up to Rs.300,000

-

Loans to Microenterprises *Only those MFBs that are fully compliant with minimum capital requirement (MCR) and capital adequacy ratio (CAR) shall be

Rs.500,000 Only in the name of micro-entrepreneur to ensure traceability and reduce the incidence of multiple borrowing.

The aggregate exposure against the enterprise loans in excess of Rs.150,000 shall not exceed 40% of the MFB’s

The companies of the financial system may not give to or for the account of a single natural or legal entity, whether directly or indirectly, credit, investment or contingency funds exceeding 10% of their effective equity. Can exceed upto 15%, 20% and 30% of equity in cases mentioned in the Law.

The Microcredit Organization will decide upon the amount of the credit to be extended to its client by taking into account the usage of fund by the Client, the ability to repay and the amount of loans taken from other sources by the Client

The total indebtness of the borrower does not exceed INR 50,000.

A borrower may borrow from 2 NBFC-MFIs. And the borrower can be a member of at most one Self Help Group (SHG) and Joint Liability Group (JLG).

4 “How Do Economies Define Micro, Small and Medium Enterprises (MSMEs)?”, pp 95, http://www1.ifc.org/wps/wcm/connect/624b8f804a17abc5b4acfddd29332b51/MSME-CI-Note.pdf?MOD=AJPERES&CACHEID=624b8f804a17abc5b4acfddd29332b51


eligible to undertake microenterprise lending.

gross loan portfolio

The maximum limits of the borrowers’ aggregate exposure from MFBs / MFIs / Other Financial Institutions / NGOs shall not exceed Rs.150,000 for general loans, Rs. 500,000/- for housing loans, and Rs.500,000 for microenterprise loans. The aggregate exposure of the borrowers who are eligible to avail both general and microenterprise loan shall not exceed Rs.500,000.

Interest Rate Cap

None

None: The state shall not participate in the financial system. The financial system companies may set freely the interest rates, commissions and expenses for their loan and deposit operations and services. Nevertheless, for setting interest rates, they should observe the limits that for the effect indicate the Central Bank, exceptionally, in accordance with the predicted in its organic law.

27%5

Interest on individual loans will not exceed 26% per annum Margin: 12%

Minimum Capital Requirements Category

Minimum Capital Requirements

[Minimum Paid Up Capital (Free Of

Losses)] Specified District PKR 300mln

USD 3.1mln Specified Region PKR 400mln

USD 4.1mln Specified Province PKR 500mln

USD 5.1mln National Level PKR 1bln

USD 10.2mln *The promoters or sponsor members shall subscribe at least 51% of the minimum capital and the shares subscribed to by the sponsors shall remain in the custody of CDC and shall not be transferable nor shall encumbrance of any kind be created thereon without prior permission in writing from SBP. Transition for Non-Compliant MFBs:

Category

Minimum Paid up capital (free of losses) required as of

December 31, 2011

December 31, 2012

December 31, 2013

MFB licensed to operate at

PKR 600mln USD 6.1mln

PKR 800mln USD

PKR 1bln USD 10.2mln

Type of Institution

Minimum Capital

Requirements [Capital Stock , Contributed in

Cash] Small Business and Micro-enterprise Development Companies - EDPYME

PEN 0.678mln USD 0.263mln

Savings and Credit Rural Institution


Savings and Credit Local Institution


Savings and Loan Associations authorized to take public deposits


Popular Credit Local Institution


5 Economist Intelligence Unit, ‘Global Microscope on The Microfinance Business Environment’, 2012, http://www1.ifc.org/wps/wcm/connect/467a47804ce326f793afd7f81ee631cc/EIU_MICROFINANCE_2012_PRINT.pdf?MOD=AJPERES


national level

8.2mln

MFB licensed to operate at district level




Banking Institution


Capital Adequacy Requirement

15% of Risk Weighted Assets The effective equity (sum of basic equity and the supplementary equity) of the companies should be at least 10% of the assets and contingent praised by total risk

All NBFC-MFIs shall maintain a capital adequacy ratio consisting of Tier I and Tier II Capitals which shall not be less than 15% of its aggregate risk weighted assets. The total of Tier II Capital at any point in time , shall not exceed 100% of Tier I Capital.


Liquidity Requirements

Cash Reserve Requirement (CRR) At least 5% of its Deposits (including demand deposits and time deposits with tenor of less than 1 year) Time Deposits with tenor of 1 year and above will not require any Cash Reserve.

Statutory Liquidity Requirement (SLR) At least 10% of its total demand liabilities and time liabilities with tenor of less than 1 year, in the form of liquid assets i.e. cash, gold and unencumbered approved securities. Time liabilities with tenor of 1 year and above will not require any SLR. For SLR calculation, the approved securities mean Treasury Bills and Pakistan Investment Bonds.

Liquidity Ratio Local Currency Ratio: Minimum 8% Foreign Currency Ratio: Minimum 20%

Every Microcredit Organization must maintain 15% liquidity fund of its entire deposit funds. Liquidity fund maybe maintained in the form of minimum in 5% cash and the remaining portion as fixed deposit.

Fund Requirements And Client Protection

Statutory Reserve Fund At least 20% of its annual profits after taxes till such time the reserve fund equals the paid-up capital of the MFB. Thereafter a sum not less than 5% of its annual profit after taxes.

Depositors’ Protection Fund For the purpose of mitigating risk of its depositors Not less than 5% of annual profit after taxes. Note: The Khushhali Bank shall continue to contribute 10% and 5% of its annual after tax profit to Microfinance Social Development Fund & Depositors Protection Fund respectively.

Legal Reserve At least 35% of the capital stock. The reserve in mention is constituted transferri.ng yearly not less than 10% of the utilities after taxes. Thereafter 9% of the total obligations subject to reserve

Optional Reserves

To be created after complying with the Legal Reserve requirement Deposit Insurance Fund

Special private legal entity governed by the Law To provide coverage todepositors The amount of premiums to be paid in by members shall be determined on the basis of the risk ratingfrom a base of 1.65% and a differential between categories of 0.20%. Thesefactors may be changed by the SBS. The Fund shall only back nominal deposits of any type, made by individuals and non-profit organizations; any interest accrued by the deposits cited, and site deposits of all other legal companies. The maximum amount of coverage shall be PEN 62,000 (USD 24,000) per person, including interest.

Client Protection/ Transparency/ Disclosure6 SBS holds the power to measure the overall indebtedness of

individuals by requesting credit checks from companies of the financial system.

Every six months, all companies of the financial system accepting deposits from the public must receive a rating from at least two rating agencies.

Every Microcredit Organization will create a reserve fund using 10% of its total income surplus. Only MFI’s with equity of USD 7mln can offer savings. The Depositors’ Safety Fund for the Microfinance sector is called “Microfinance Deposit Trust Fund” and is governed by TRUSTEE board at MRA. MDTF covers all types of deposit accounts per client per MFI up to USD 44 which meets the threshold covering 80% of depositors fully.8

6Unregulated MFIs share their information on a voluntary basis with the Consortium for Private Organizations Promoting the Development of Small and Medium Enterprises, known by the Spanish acronym COPEME. Laws for consumer protection comprise Consumer Protection Law for Financial Service Clients, its Complementary Law, and The Data Protection Law of Peru, 8MRA, NGO-MFI – A Statistical Publication, (2011)


Companies, directors and employees of the financial system are prohibited from sharing any information with respect to client deposits without the written authorization of the client.

All financial institutions report their clients to SBS, which

consolidates and shares the information with all financial institutions through its Credit Bureau7. Such a system ensures that loaning facilities will not put borrowers at significant risk of over-indebtedness. If computer systems are available, the information must be supplied daily.

Annual reports to be publishedin the Official Newspaper and in one ofextensive national circulation, at least four times a year, in the opportunities and with the detail thatestablishes the SBS.

All the companies of the financial system that collect public funds should include the classification of atleast two risk classifier companies, every six months. The lowest one would prevail.

On its part, the SBS shall rate the companies of the financial system in accordance withgenerally pre-established technical criteria and factors. These shall take into account, among otheraspects, risk measurement and management systems, the quality of credit and trading portfolios, equitysoundness, profitability level, financial and management efficiency and liquidity.

The SBS should diffuse, at least quarterly, the information on the main indicators of thesituation of the financial system companies.

Restricted Transactions

The MFB shall not: i. Allow any facility for speculative purposes; ii. Allow financing facilities and other Microfinance Services to

any of its sponsors, directors or employees including their spouses, parents, and children. The rule shall not apply on loans given to employees under staff loan policy of the MFB;

iii. Without the prior approval in writing of the State Bank, enter into leasing, renting and sale / purchase of any kind with its directors, officers, employees or persons who either individually or in concert with their family members, beneficially own 5% or more of the equity of the MFB;

iv. Hold, deal or trade in real estate except for use of MFB itself.

Companies of the financial system shall be subject to the following prohibitions:

i. To grant credits using their own shares as a guaranty; directly or indirectly used for the purchase of the company's own; to finance political activities;

ii. To accept any warranty, securitie or pledge furnished by their directors and personnel, in support ofloans granted to persons having business limits with said directors or personnel;

iii. To purchase shares of companies not forming part of the financial system and which, whether directlyor indirectly, are shareholders of the same company, unless they are listed in the stock exchange;

iv. To secure deposits on behalf of financial institutions not authorized to operate within the country;

v. Financial entities in Peru are prohibited from pledging their fixed assets.

7The SBS shall be responsible for a comprehensive system to handle a register of financial,credit, commercial and insurance risks, called "Credit Bureau". This system must have consolidated andclassified information with respect to debtors of companies. Any industry association having the required infrastructure may gain access to the Bureau, once it has subscribed the corresponding contract with the SBS. The Credit Bureau shall contain a record of risks assumed for financial indebtedness within the country, risks related to credit insurance and other insurance risks, within the limits prescribed by the SBS.


Classification of NPLs

Loan Classification

No. of Days Outstanding

OAEM 30-60 Days Sub-Standard 60-90 Days Doubtful 90-180 Days Loss >180 Days

*Written off 1 month after the loan is classified as “Loss”

Loan Classification

9


Normal 0-8 Days With Potential Problem (CPP)

9-30 Days

Deficient 31-60 Days Doubtful 61-120 Days Loss > 120 Days

Loan Classification


Regular N.A Watchful 0<31 Days Sub-Standard 30<181 Days Doubtful 180<366

Days Bad Loan >365 Days

Nonperforming Asset means an asset for which, interest/principal payment has remained over due for a period of 90 days or more.

Watchlist Accounts

Accounts overdue by 5 – 29 days. However, such accounts may not be treated as NPL for the purpose of Classification / Provisioning.

Accounts overdue for less than 30days

Provisioning Requirements

General Provision 1% of the net outstanding advances (advances net of specific provisions). However, general provision shall not be required in cases wherein loans have been secured against gold or other cash collateral with appropriate margin. Specific Provision

Loan Classification

Provisioning % of Outstanding Principal Net of Cash Collaterals and

Gold OAEM Nil Sub-Standard 25% Doubtful 50% Loss 100%

Provision for Normal Category10 Varies between 0 to 1.5% depending on the type of loan. The loan portfolio is classified as retail borrowers and non-retail borrowers. Retail borrowers include individuals or companies holding direct and indirect credits classified as consumer (revolving and non-revolving), loans to micro enterprises, small enterprises or residential mortgage loans. Meanwhile, non-retail lenders are individuals or companies who hold direct or indirect credits awarded to corporations and large and medium-sized companies. Provision for CPP, Deficient, Doubtful and Loss Category

Risk Category

Unsecured Loans (CSG)

Loans with Preferred

Guarantees (CGP)

Loans with Preferred, Readily Liquid

Guarantees (CGPMRR)

Loans with Preferred

Self-Liquidating Guarantees

(CGPA) CPP 5% 2.5% 1.25% 1% Deficient 25% 12.5% 6.25% 1% Doubtful 60% 30% 15% 1% Loss 100% 60% 30% 1%

Loan Classification

% of Principal

Regular 1% Watchful 5% Sub-Standard 25% Doubtful 75% Bad Loan 100%

The aggregate loan provision to be maintained by NBFC-MFIs at any point of time shall not be higher of a) 1% of the outstanding loan portfolio or b) 50% of the aggregate loan installments which are overdue for more than 90 days and less than 180 days and 100% of the aggregate loan installments which are overdue for 180 days or more.

Allowed Investments

Government Securities ‘A’ rated debt securities like TFCs and units of those Mutual Funds which maintain their investment portfolio in fixed income securities or money market instruments Shares of any corporate, the objective of which is to provide microfinance services, technical, vocational, educational, business development and allied services to the poor and micro enterprises. The maximum investment in such a company or security shall not exceed 15% of paid-up share capital of that

All investments made must first be approved from MRA

9 Management’s Discussion And Analysis Of Financial Condition And Results Of Operations, March 2012, http://www.cofide.com.pe/inversionistas/archivos/ITrimestre2012/MD&A_Mar12_200812.pdf 10 Mibanco, ‘Annual Report 2011’, http://www.mibanco.com.pe/nucleo.aspx?nompag=comphtml/memoria.htm&tp=interno&id=es


company or 15% of MFB’s own equity free of losses

Governance Framework

Not more than 25% of the total directors can be paid executives of the MFB Fit & Proper Criteria to be met Unlisted MFBs: At least 5 directors; Listed MFBs: At least 7 directors Not more than 25% of the members shall be from the same family The directors of a MFB shall not be director of any other MFB or act as consultant, adviser or an employee of any other MFB.

At least 5 directors that gather conditions of moral and technical suitability, elected by the Shareholders General Meeting.

The companies will be able to appoint deputy directors, in accordance with the provisions of their bylaws.

Cannot perform management position in the same company. The directors of a financial institution shall not be workers of the

company (except theGeneral Manager), or its subsidiaries. The Board of Directors celebrates ordinary sessions at least once a

month. Quorum: Atleast Two thirds. The General Manager or his substitute, should inform the Board, at

least quarterly, on theeconomic progress of the company of the financial system, contrasting that report with thecorresponding one to the previous quarter and with the predicted goals for the period.

Every Microcredit Organization will have a Council of Director, with a minimum of 5 and a maximum of10 member, with at least 2 female members. The Council of Directors will be elected from the members of the General Body (shareholders). A person will not be able to hold position for more than 3 years.

Additional Guarantees

Microfinance Credit Guarantee Facility (MCGF) Issued By The SBP To Banks/DFIs To secure the bilateral facilities availed by MFBs/MFIs and Redeemable Capital issued by MFBs/MFIs First Loss Default Guarantee: 25% of (a) the Principal Amount disbursed or (b) Issue Amount

OR Partial Guarantee: 40% of (a) the principal amount payable by the MFBs/MFIs to the Bank/DFI upon default; or (b) the principal component of the Redemption Amount payable by the MFB / MFI to the Bond Holders, through the Trustee, upon default;

License Fee Application Processing Fee: PKR 1mln [USD 10,213] No. of

Borrowers

License Fee BDT

[USD]

Annual Fee BDT

[USD] >1 mln 500,000

[6,352] 25,000 [318]

0.1 > 1 mln

200,000 [2,541]

15,000 [191]

25,000>1 mln

25,000 [318]

10,000 [127]

< 25,000 10,000 [127]

5,000 [64]

Branchless Banking

Branchless Banking (BB) Regulations (Updated on June 20, 2011) Issued By SBP. Tameer Microfinance Bank Ltd. and Waseela Microfinance Bank Ltd. have been granted BB licenses while U Microfinance Bank (Formerly Rozgar Microfinance Bank Ltd.) intends to initiate BB.

The Bank of Bangladesh has published guidelines for on mobile financial services, however in practice, no MFI has been given allowed to offer money-transfer services through mobile phones.

Key Indicators Pakistan Peru Bangladesh India[MicroWatch] [MIX] [MIX] [MIX]

GDP (USD in bln) [2012E]¹ 176.9 111.9 1,729.0 GDP Growth [2012E]¹ 3.7% 6.0% 6.1% 4.9%Inflation [2012E]¹ 11.0% 3.7% 8.5% 10.2%Total Population (mln) 190.3 29.4 150.4 1,241.0 Total Population Under the Poverty Line (mln) 42.4 2 8.2 47.4 3 369.8 4

No. of MFIs/MFBs 35 60 576 112No. of Branches 1,918 1508 18,066 11,885 Total Assets (USD in mln) 408.6 10,820.7 1,556.1 3,455.9

AdvancesNo. of Active Borrowers (mln) 2.4 3.7 20.9 26.5 Gross Loan Portfolio (GLP) (USD in mln) 395.6 8,888.6 2,809.2 4,318.0 Portfolio at risk > 30 days 1.4% 6.0% 3.3% 6.0%Portfolio at risk > 90 days 0.5% 4.6% 2.6% 4.1%Number of Loans Outstanding (mln) 2.4 4.0 20.8 24.3 Average loan balance per borrower (USD) 165.2 2,344.0 130.0 162.0 WA Yield on Gross Portfolio 33.7% 26.9% 24.6% 18.4%Cost Per Loan (USD) 51 263 15 14% of Female Borrowers 57.0% 46.0% 94.2% 95.9%

DepositsNo. of Active Depositors (mln) 4.7 3.5 18.6 2.1 No. of Deposit Accounts 4.6 15.9 2.1 Total Deposits (USD in mln) 257.5 6,623.0 2,174.0 106.0 Average Deposit Account Balance (USD) 54.8 1,553.0 33.0 41.0

RatiosDeposits-To-Loans 65.1% 75.8% 77.7% 2.5%Deposits-To-Assets 63.0% 62.2% 59.3% 2.3%Provision for Loan impairment/ Assets 1.4% 3.8% 1.8% 25.3%Loan Loss Rate 5.4% 3.2% 5.0% 25.9%Write-off Ratio 6.1% 3.9% 5.2% 23.3%Profit Margin (Weighted Average) -8.4% 13.7% 12.3% -137.8%

2: 22.3% of Pakistan's Population lives under poverty according to Pakistans Integrated Household Survey, estimated for 2012

Figures from MIX Market as at end-Sep12

Figures from MicroWATCH are quoted as at end-Sep12

Annexure II

Figures from MIX Market are quoted as at end-FY11

4: This figure is estimated for 2011. 29.8% of the Population was living under the poverty line, according to an planning commisson. "Who are poor in India", (March, 2011)

Country-Wise Comparison Of Key Indicators

3: This figure is estimated for 2011. 31.5% of the Population was under the poverty line, according to the Bureau of Statistics Bangladesh.

1: Figures taken from World Economic Outlook 2012, International Monetary Fund, http://www.imf.org/external/pubs/ft/weo/2012/02/pdf/tables.pdf

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