Shamshad Akhtar: Financial inclusion
Keynote address by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the
Expanding Access to Finance USAID and SHOREBANK INTERNATIONAL WHAM Project
2005-08, Islamabad, 28 March 2008.
* * *
1. Asia is home to nearly 650 million of poor (defined as 1 dollar a day1) representing
65% world poor. Population growth and economic cyclical factors however add annually to
the ranks of poor. Notwithstanding there has been a reduction in poverty incidence in Asia
from 27% in 1990 to 20% by 2006, though East Asia managed to achieve steeper and swifter
reduction in poverty relative to South Asia.2
East Asia lifted around 630 million people from
extreme poverty in under a quarter of a century and the region's share in total poverty
declined from 58% in 1981 to just 9% in 2004. In South Asia poverty fell from 52% in 1981 to
32% in 2004, but absolute number of poor has been high close to 470 million. Along with
poverty reduction, there has been a gradual move to attainment of Millennium Development
Goals (MDGs).
2. Several factors have contributed to improvements in these indicators ranging from
higher economic growth and liberalization to concrete affirmative and targeted anti-poverty
programs. Among these, Global microfinance campaign and domestic initiatives helped in
changing lives of poor and extended them finance that contributed to their economic
empowerment. In Asia, the number of microfinance beneficiaries has now reached 113
million: 74% of who were poor and 65% women. Including families of the beneficiary clients,
microfinance services reached close to 465 million across the world - almost 85% of these
are Asian clients. Dealing with "poverty" is complex given its dimensions and multiple
causative factors. Global and regional challenges of reducing poverty and MDGs are
daunting but attainable provided there is accelerated, aggressive, brutal and frontal attack
through well coordinated and cohesive economic and social policies.
3. Recognizing this dilemma, the evolution of financial inclusion that aims to broaden and
deepen access to development finance for all, of which microfinance is a subset, is timely.
Ultimately it is a well functioning and efficient financial market which can deal holistically with
provision of financial services to the economy and population. Building financial inclusive
system is, however, an integral and core pillar of financial sector reforms. As growth and
development of finance alone does not address question of "access." Direct intervention to
build financially inclusive system is critical as one recognizes fully (i) financial markets
failures and imperfections such as information asymmetries, lack of sensitivity to gender and
redistributive dimensions of resources and wealth and high transaction costs etc.; (ii) high
price and non-price barriers such as lack of credit history and collateral and connection; and
(iii) other constraints such as lack of literacy and entrepreneurial skills, etc.
4. Over the years, there has been substantive development in the architecture and
thinking on financial inclusion. While there is no "one-size fits all" financial inclusion strategy
or approach but it is important to recognize few core or necessary and sufficient conditions
that are needed to maximize the benefits derived from such strategy.
5. At the outset, it is critical to understand the size and dimension of financial exclusion.
Despite complexities of estimation, a recent study3 concluded that average level of financial
exclusion, as measured by the percentage of the adult population with access to an account
with a financial intermediary, in poor developing countries is as high as the level of financial
inclusion in advanced industrialized countries where it is rare not to have at least some
access to basic financial services in remote parts. In developing countries, level of financial
exclusion is steepest in Sub-Saharan Africa (a reflection of extreme poverty and difficult
economic condition). Situation in Asia, present a mixed picture. South Asia (average access
rate being 31 percent) lags behind in expanding financial access relative to South East Asia
(average access rate being 47 percent). Advanced transition economies of Central Europe
have progressed well in rebuilding access. There has been relatively little progress made in
Central and South America despite a relatively robust economic base, particularly among
larger countries.
6. To design strategy and policies, there is further need to understand what the reasons
for exclusion are? Is it voluntary or pure denial of services and what the barriers of access to
finance are? General evidence does suggest that in developing countries financial
penetration is quite low because of (i) geographical exclusion since physically banks
coverage of population is low (18,000 persons per bank branch in South Asia and 12,000 in
South East Asia), the limited reach in rural areas where larger proportion of population
resides, (ii) cash based economy given issues surrounding disclosure, identification, and
taxation etc., (iii) low financial literacy, and (iv) lack of collateral and credit history of micro
borrowers and micro-entrepreneurs.
7. Conceptually, financial inclusion should focus on
•
Provision of full range of financial services i.e. going beyond credit to deposit and
payment services;
•
Meet requirements of individuals ranging from consumption to basic education,
health and other services,
•
Cater to the requirements of small and new firms, and
•
Markets excluded by gender or remoteness
8. Evidence confirms that degree of financial inclusiveness is high where there is high
degree of competition in the financial system that encourages financial institutions to go
beyond the saturated and right in the corner markets to the excluded and far flung markets
and offers appropriate products to clients with different requirements.
9. Commercialization of microfinance business has a massive impact on enhancing scale
of outreach. For instance, in Latin America, the Non-Governmental Organizations (NGOs)
opted to transform themselves into licensed financial institutions, together with specially
licensed financial institutions that they were able to provide almost 45% of the microfinance
services.
10. Donor support can be useful provided it paves the way for commercialization and
private sector involvement in microfinance, either alone or as part of private-public sector
consortiums, by brokering new banking relationships, by offering incentives for the entry of
commercial institutions, by taking equity positions in MFIs, by providing credit enhancement
on capital market transactions and by promoting international investment funds.
11. Financial inclusion based on private sector involvement and solutions for extending
reach to poor yields better and sustainable results. In the UK, South Africa and other
Commonwealth countries, private sector with supportive government environment, played an
instrumental role in promoting financial inclusion. Government or donor sponsored
subsidized or directed lending programs have now proven to limit growth and encourage
dependency since they induce price distortions that deter effective competition.
12. Subsidies can work for microfinance borrowers and institutions in certain
circumstances. For example, subsidies may be necessary during the start-up stage of an
MFI, but they are best used to cover operating costs and to build MFI systems and staff
capacity. It can take some years for an MFI to reach the scale and efficiency needed to cover
its costs from interest income. During this period donors can support to build the capital base
of efficient MFIs, enabling them to grow more quickly, increase their leverage, and serve
larger numbers of clients on a sustainable basis. Subsidies may well be used to correct
market failures; such as, to increase efficiency, transparency in financial reporting, and
supporting industry infrastructure.
13. Within South Asia, Pakistan is actively pursuing a broad based financial inclusion
strategy in conformity with the best practices through a public-private partnership model. In
order to speed-up the process of financial inclusion, the State Bank of Pakistan has
developed an ambitious plan to scale up outreach of microfinance services to 3.0 million
users by the end of 2010, scale number of small agriculture borrowers to 2.0 million and
SME borrowers 300,000 by 2010. The DFID, and other donors, will be providing substantial
financial and technical support to Pakistan's financial inclusion programs.
14. Based on experience and research, critical conditions for financial sustainability of
financial inclusion programs are:
(i) Economies of scale: Given direct relationship between profitability and scale of
operations, larger banks/MFIs are able to evolve business models and growth
strategies to reach out to poor clients on a sustainable basis. Such institutions have
inherent ability to spread fixed cost over more transactions, promote multiple sales
points, adopt innovation and technology which together offer ease and efficiency in
service delivery. These factors enhance ability of firms to expand and compete to
stay in power.
(ii) Proper Funding Mechanism: Sustainability requires that MFIs largely rely on deposit
mobilization to finance their businesses. In initial stages of development however
MFIs end up developing alliances with the commercial financial institutions. These
arrangements offer opportunities for foreign and/or local currency funds. Setting
aside moral hazard of generating protracted dependency, foreign exchange risks in
absence of the natural hedge raises the end pricing to clients that inadvertently
results in dampening demand or magnifies probability of defaults. It is usually easier
for MFIs to successfully borrow from a bank than to sell a bond which involves
disclosure of information to produce adequate confidence in the borrower. However,
profitable MFI have successfully issued bonds sparking interest in financial markets
such as Compartamos bond issue in Mexico. Alternatively, a number of instruments
and relationships can enhance the ability of MFIs to access financial markets. For
example, use of guarantee funds and other guarantee mechanisms can correct
"market failure," such as inaccurate market evaluation of risk, as a means of
bolstering access of MFIs to capital markets. Proper structuring of guarantee
schemes, however, require minimizing misperceived risks in lending without
undermining the risk management of the lending institutions.
(iii) Transformation of NGOs into MFIs: NGOs need to be encouraged to restructure into
themselves into legally established companies, licensed preferably by central bank,
so that they can operate under effective and transparent ownership with adequate
capital base. Backing such MFIs by supportive prudential regulatory framework
helps in proper leveraging funding, while providing comfort to depositors and
borrowers. To encourage transformation of NGOs into MFI, Pakistan in June 2007
allowed a five year income tax holiday to such institutions and now few large NGOs
(such as Kashf Foundation and the National Rural Support Program) are in process
of structuring their transformation.
(iv) Strategic Alliances of MFIs with financial markets: Developing strategic alliances
and other partnerships are increasingly becoming the ways in which MFIs can
engage with a wide variety of financial market participants. As these arrangements
capitalize on the comparative advantages of vastly different institutions, they can
take many different forms. Where MFI cannot achieve organic growth they have two
options: (i) these include "strategic alliances," mergers and acquisitions, joint
ventures and contractual arrangements, or (ii) alliance with commercial banks to set
up and launch MF operations.
Developing supportive infrastructure for nurturing financially healthy
(v) MFIs/MFBs: It is
critical that countries work towards developing proper rating agencies and credit
information bureaus to assess risks associated with microfinance operations and
their clients.
(vi) Greater diversification and sales volume: The economics of retail financial services
drives managers to evolve a set of standardized products and services to expand
the volume of sales and lower average costs.
(vii) Governance of financial institutions: Proper governance of banks/MFIs is essential
to safeguard stakeholder interest in particular depositor funds. The functions of a
board of directors and senior management with regard to setting policies,
implementing policies and monitoring compliance are key elements in the control
function of a financial institution. In addition, governing bodies play a critical role in
establishing the values and "culture" of an institution, including its ability to make
sound technical decisions on products and pricing, manage risk, innovate, adapt,
change and grow.
(viii) Role of small, locally-oriented financial service providers: The importance of small
organizations should not be minimized; they are often the most significant, if not the
only, financial service providers in many communities. Small financial service
providers can be expected to penetrate their markets, seeking alliances with others
and through networks to offer a greater range of products and services.
15. Though financial sustainability is essential for massive and swift expansion of services,
to maximize client-level benefits it is essential to ensure social sustainability of financial
inclusion programs. While intertwined with financial sustainability, social sustainability
demands that:
(i) Effective community and social mobilization is critical to success of financial
inclusion strategy. It involves using participatory process to raise awareness,
mobilize and involve local leadership, institutions and communities to organize for
collective action for common goals and objectives to reach poor, women and the
disadvantaged. Community Investment Fund (CIF) provides a useful tool to reach
the poorest decile of population. The experience of successful CIFs demonstrate
that savings-based and Self Help Groups (SHG) based CIFs are some of the most
successful models for achieving better social outcomes on sustainable basis.
Externally funded CIFs have lower odds of success as they have to swim against
the stream of natural incentives of group members. It is prudent for external funders
to provide support services to CIF instead of injecting loan capital.
(ii) Targeted support programs. Most pertinent in this context would be the Community
and Rural Support programs which catalyze employment opportunities. Whether
they are by way of subsidized lending program MFIs (or those who support them)
should be able to report on how (or whether) the stated goals they have promised
(i.e., improved earnings, reduced vulnerability, increased empowerment, etc.) are
being realized.
(iii) Properly structured credit enhancements: Design credit enhancement in a way that
MFIs use of the facility is subject to fulfilling social sustainability criteria to yield
better social outcomes.
(iv) Social performance demands keeping a close watch on the financial bottom line
through better retention of clients and reduction of costs, quality of services,
improvements in client lives through proper economic empowerment which could be
through business opportunities, education, health, or agricultural extension, with
additional appropriate funding.
16. In a nutshell, evidence suggests that poverty reduction strategies are successful if
countries adopt inclusive policies. Building inclusive financial systems that are both
financially and socially sustainable is a fundamental requirement of any poverty reduction
strategy.