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Protecting consumers of microfinance in Pakistan

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In Brief

Low-income earners in Pakistan have been offered financing opportunities for the first time, thanks to a recent surge in the activity of microfinance institutions (MFIs).

Microfinance theoretically involves the provision of loans or other financial services to lower-income-bracket borrowers, with little or no collateral required. These borrowers are able to take out small loans from MFIs to improve their businesses or living conditions. In Pakistan alone, the potential market for microfinance is an astounding US$27 million, with active borrowers and national gross loan portfolio size increasing in every financial quarter.


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Despite the benefits that accompany the growth of MFIs, one aspect of microfinance lending that must be addressed is consumer protection, or the right of the consumer to make autonomous, well-informed decisions. In Pakistan, such protection is especially vital.

Not only does almost 56 per cent of the population have no access or experience with formal finance, but the majority of the individuals targeted by these institutions have extremely low literacy levels. The lower literacy factor, be it financial or otherwise, disadvantages most consumers by obstructing their understanding of the complexities of loan transactions. This lack of understanding can lead consumers to believe that access to finance is more essential than the appropriateness of the product’s costs or risks. This is sharpened by the fact that, for many lower-income people in Pakistan, microfinance is the only financing option available.

The MFI sector in Pakistan is highly differentiated and largely unregulated. Where some MFIs have a strictly non-profit social motive such as poverty alleviation or female empowerment, others may cater to slightly higher-income-bracket individuals and thus may become for-profit organisations.

The unregulated environment effectively means that MFIs do not have to observe adequate financial assessment before passing on a loan. In a poorly regulated developing nation, MFIs often justify higher costs by virtue of the added expense of providing individuals with basic levels of financial literacy, and the higher cost of enforcing compliance. This is often used as an excuse for not opting for responsible financial practices. For close-knit communities, such as those found in most rural areas of Pakistan, the ‘trust’ factor plays a major role in decision-making. A lack of alternatives causes lower-income-bracket individuals to rely faithfully on the MFIs for their financial needs. This should serve these institutions well, as often these individuals become long-term customers with the ability to make better financial decisions and fewer missteps in terms of unmanageable debt or repayment issues. This trust factor is a product of transparency in, and dependability on, the words and actions of the MFIs and cannot be stressed enough.

To achieve greater consumer protection within the MFI industry in Pakistan, there must be greater regulation. MFIs must develop transparent, unbiased, and nondiscriminatory ways of dealing with consumers.

While this need could be addressed by greater governmental regulation and policies, the adoption of self-regulatory methods by the MFI industry of Pakistan could better serve the institutions as well as the customers. Self-regulation means enforcing and adhering to self-proclaimed codes of ethics and practices and avoids the costs incurred due to governmental regulation—which ultimately makes credit more costly and limits the accessibility of microfinance. Ultimately, customers are more likely to use the financial services of a trustworthy institution, while the government is less likely to have to enforce regulation on a sector which adheres to general standards of customer protection.

Ayesha Zara Naeem recently graduated with a Bachelor of Science (Honours) in Economics from the Lahore University of Management Sciences.

This article is a finalist in the recent EAF Emerging Scholars competition.

6 responses to “Protecting consumers of microfinance in Pakistan”

  1. Pakistan needs microfinance, especially in these trying times where the Pakistani government is not focusing on any developmental projects. Pakistan can easily follow the model set by Grameen Bank in Bangladesh but over emphasis on regulation, especially on a sector which is still in its early phase, can add extra burden on MFIs. Plus the current regulatory model set in Pakistan with Microfinance Banks abiding my the regulatory laws, while the non profit MFIs enjoy greater freedom. But the microfinance industry as a whole should try to learn from mistakes made by other MFIs operating in difference part of the world so that customer’s trust and confidence could be maintained in this sector.

  2. A good articulation on the need for microfinance, however on the point of increased regulation I would like to disagree on the notion that with a weak legal framework in the country, more informal institutions would still tend to offer better access to financing. Again the challenge would remain on how to balance this access with greater fairness and equality. I believe the answer lies, for the short term, on increasing the number of even informal institutions which thru competetive forces would tend to offer better value for the end consumer.

  3. A very well researched article! Micro Finance has indeed established itself well in the distorted and highly dependent economies of the third world countries, especially those in South Asia. In a country such as Pakistan where although the majority may fall in the low income strata of the population, the author rightly discusses how their decision making with regards to availing the services offered by the micro finance industry is greatly effected by the low levels of literacy. And to address the issue of consumer protection, there is a need for greater regulatory laws not only be the government and also by the industry itself to ensure the well being and development of the consumers of Micro Finance. Also, working in tandem with other non governmental organizations that are working to alleviate illiteracy would also help the MFI industry to a great extent because the crux of the issue really is the low level of literacy in the country.

  4. An amazing insight into MFI. However,it is such irony that MFIs have performed brilliantly in Bangladesh and other developing countries but have failed in Pakistan. Huge conviction is required to tackle the issue and it is for our benefit to invest in such institutions, monetarily and policy wise.

  5. The author raises a very interesting aspect of microfinancing. While the government may be focusing less on regulation of the MFIs to encourage their presence in the country and lower income areas, the consumers of microfinance credit should not be ignored. Their protection, along with the protection of the MFIs, is essential to the success of these projects, as only then can their main goal of enhancing the lives of people of Pakistan be achieved.

  6. A well written and insightful article. You’ve certainly hit the nail on target in terms of highlighting the importance of micro-finance and the need for regulation to make the role of MFIs more effective via better consumer protection.

    Micro-finance has indeed emerged as a crucial financial tool for poverty alleviation in developing economies. However, the notion of regulation is not as simple as just a system of self-regulation. The multi-faceted problems facing MFIs in Pakistan point to the need for a similarly multi-layered solution. To begin with, MFIs lack the administrative and monetary resources, and incentive to self-regulate. Secondly, the informal sector cannot be relied upon to bring about any kind of overhauling change, whether in the short or long term. In this case a government’s role is necessitated. Intense structural change of the financial system and a conscious shift in government financial policy are needed to address the issue of MFIs effectiveness in the country.

    You’ve correctly pointed to social characteristics, such as lack of financial literacy, that hinder the progress of micro-finance. There is an overarching environment of socio-cultural distrust of financial institutions in the country. Approximately 80% of the population does not have a bank account or does not participate in the financial sector. Evidence shows that borrowers use loans to finance an increasing cycle of debt rather than economic activity that would mitigate their poverty. These are the kind of social realities that must be kept at the forefront when considering any kind of regulation mechanisms for MFIs.

    Though annual statistics show an expansion in the outreach and disbursement amount of MFIs, these do not reflect any real positive change. Serious regulation needs to be incorporated to bear the fruits of micro-finance such as those borne by the likes of Bangladesh.

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