The gathering storm over the country’s microfinance industry that serves about 7.3 million poor households and micro-enterprises with a gross loan portfolio of over Rs300 billion appears to be dissipating slowly. The economy is reopening amid a flattening Covid-19 curve, but not without hurting both borrowers and creditors.

The long-term impact of the health crisis on the microfinance sector that has helped millions of poor people access formal credit will become clearer within a year.

The microfinance industry, which consists of microfinance banks (MFBs) and not-for-profit microfinance institutions (MFIs), had already seen its “loans in arrears” for 30 days — the most common indicator used to see how the sector is performing — increase from 5.8 per cent in 2018 to 6.1pc in 2019 because of a challenging and uncertain macroeconomic environment and runaway inflation.

It is hard to say how fast, and to what extent, the sector’s “portfolio at risk” will increase because of Covid-19. At the moment, a sizeable rescheduling of debt through debt restructuring schemes is underway to help mitigate the effects of the health crisis on micro- and small businesses. But few doubt the default rate is going to rise once deferred payments become due. Nobody is certain how these loans will perform.

‘Borrowers are neither signing up for (debt) relief nor repaying their loans’

Mudassar Aqil, CEO of Telenor Microfinance Bank and Easypaisa, argues that the “accounting relief” provided by the State Bank of Pakistan (SBP) through its debt deferment scheme has helped prevent the erosion MFBs’ capital but, at the same time, shifted the problem (of default) to the next year.

In certain cases, repayments were deferred because of the lockdown restrictions that prevented the MFIs from collecting cash from borrowers. In a few cases, lenders voluntarily deferred payment recovery as a majority of borrowers found their household incomes collapse and their meagre emergency savings wiped out when they were forced to temporarily shut down their businesses.

The exact size of the restructured loans is not clear as yet. But a microfinance banker claimed it could have been anywhere in the range of Rs50bn and Rs75bn. He conceded the creditors were extending the facility only in extreme situations where they were sure of significant losses in the repayment capacity of their borrowers. But others said it was premature to give any estimate of the loans put on hold at this stage.

A Pakistan Microfinance Network (PMN) survey on the impact of the Covid-19 outbreak on borrowers in May showed 82pc of the respondents said their businesses had been negatively affected. About 85pc of the respondents reported a significant or somewhat decrease in their household incomes, squeezing their repayment capacity. Some 40pc borrowers thought that they could sustain themselves for less than a month. Only a small proportion of clients (6pc) were in a position to sustain themselves for up to six months. Around 58pc borrowers wanted repayments of their debts delayed because of the stress on their cash flows while 20pc respondents wanted their liabilities to be written off completely.

Before the health crisis reached Pakistan, microfinance borrowers had proved themselves to be a good risk for the lenders with up to 99pc repayment recovery. But it is no longer the case as the spectre of defaults hovers on the horizon. “The banks will be able to maintain clean balance sheets this year, thanks to the SBP scheme. But it has also created a question mark on the credit culture in the microfinance market. Many borrowers are neither signing up for relief nor repaying their loans,” says Mr Aqil.

Read: Microfinance crisis

The possible change in the repayment behaviour of his borrowers is also worrying Farid Ahmed Khan, CEO of Finca Microfinance Bank. “The change in the borrowers’ behaviour is a big unknown at the moment. When you get your debt rescheduled, your repayment habits also change. Therefore, the possibility of future defaults can’t be ruled out. There’s a big question mark on loans that are yet not due for repayment.”

Factors like an increased risk of defaults as a consequence of the potential change in the repayment behaviour as well as a drop in liquidity owing to substantial loan restructuring have made microfinance banks more conservative. Mr Aqil says the banks are not giving loans to new borrowers, but continue to serve the existing ones. “Disbursements have dramatically decreased. No one is going out to find new borrowers.”

Mr Khan, who points out 30-35pc borrowers had got their loans restructured for three to six months, endorses this view. He said his bank’s lending has reduced to 50-60pc of what it used to be prior to the disease outbreak. “We want the SBP to address our liquidity issue by relaxing the capital adequacy ratio requirement or through Tier-2 Capital so that we can keep lending. Besides, the government could underwrite our risk so that we can help low-income, unbanked households and micro-businesses that depend on micro-credit to meet their cash flow and expenditure needs, he added.

For people like Rizwan Sheikh, who heads corporate finance and investment banking at Pakistan Microfinance Investment Company, the Covid-19 crisis has brought out the best out of the microfinance industry. “When the crisis ensued, many had predicted the survival of the sector would become difficult. But surprisingly, the industry’s response has been quite different. It has quickly come out of the crisis, which underlines its resilience and maturity due to regulatory improvements over the last few years.”

According to him, loan recovery in March fell to 70pc and collapsed to zero in the next month as lockdown curbs were enforced. In May, it showed some growth and rose to 20pc and bounced back to 60-65pc in June. By July, it had increased to 80-90pc.

He says the hefty balance sheets of the not-for-profit, rural-based MFIs — which maintain closer, more personalised relationships with their clients — had helped them absorb the shock in a better way than expected. “However, commercial and urban-based MFBs with weaker ties with their customers are facing problems in recovering their loans. But they are also coming back… though they will struggle for a while.”

Published in Dawn, The Business and Finance Weekly, September 1st, 2020