How Should Donors Support Microfinance in Pakistan Post-Flood?
The floods have hit Pakistan hard. Over 2 million homes have been damaged or destroyed, and $1 billion is at risk of being lost by the financial sector in the region most affected. Behind these figures are the lives of 17 million people who have lost their homes and livelihoods. An estimated 1,800 have died and over 3.5 million children are now at risk of infectious diseases in the flood affected areas.
This type of tragedy is unfortunately a common occurrence as climate change continues to bring about drastic weather conditions to places that are often ill prepared. Just this year, the world has seen massive natural disasters in Haiti, China, and Pakistan. It is often the poor that bear the brunt of these natural disasters as they live in more precarious homes and have few coping mechanisms to handle this level of destruction.
In this environment where the needs are great and the resources are limited, what can governments and donors do to maximize the impact of their response?
Focus on Livelihoods
There is no question that the lives and livelihoods of those most affected is the immediate priority in this post-disaster phase. Those affected need shelter, food and water. They also need to rebuild their lives and livelihoods. Relief assistance is needed to help them recover, but the way this relief is distributed can influence the future economic viability of the region affected.
The history books are replete with examples of relief operations gone awry. A notable example comes from Sri Lanka where after the tsunami many relief organizations began cash for work programs to inject liquidity into the markets. They set wage rates above comparable rates in agriculture and other sectors. To capture this short-term bounty, laborers switched from agriculture to cash for work projects. Large farms mechanized their cultivation to deal with the labor shortage and reduced their demand for farm labor. (Parker, 2008) Unfortunately, this scenario is not unique.
Fortunately there are some successes from which there are emerging best practices. Examples from the floods in Mozambique in 2000, as well as more recent experiences after the tsunami have shown that grant programs can be linked with financial services as a way to address the underlying livelihoods of the poor while also ensuring financial access well beyond the “CNN period.” Donors and policymakers need to design their programs carefully and they should look for ways that enhance long-term access to finance, rather than undermine it. Relief and development organizations have developed a set of minimum standards that apply to crisis environments to help minimize market distortions and enhance economic recovery.
Strengthen Financial Institutions Serving the Poor
Institutions that serve the poor are an important part of the post-disaster response. But financial institutions have also been impacted. In Pakistan, 86 branches of microfinance institutions have been damaged or destroyed. An estimated Rs. 2.7 billion (US $ 31.7 million) or 34% of total outstanding portfolios are at risk of being lost.
Any subsidy, whether to individuals or institutions, requires caution. MFIs in Pakistan have received substantial donor assistance in the past but outreach is still less than 2 million clients. For a county of 180 million people, 20% of which live below the poverty line, this outreach is still very low. How can funders support MFIs on their path to independence while bridging this difficult period?
Several proposals are currently on the table including interest rate subsidies, a risk mitigation fund, an emergency liquidity facility and access to liquidity from the Central Bank. Several of these proposals can help build a resilient industry in the future. The emergency liquidity facility, for example, was something first tried in Latin America and the Caribbean and has been considered a success. The facility is only open to eligible MFIs that meet stringent risk management and financial criteria (such as 3 years of profits and emergency preparedness plans). Other proposals may distort incentives and have the potential to harm progress. For example, the interest rate subsidy to clients could potentially confuse borrowers and reduce credit discipline. This was a problem in Sri Lanka after the tsunami when the subsidies there were announced by the government without clarity on duration and scope.
Address Liquidity Needs with Caution
Some of the liquidity projections may be exaggerated. The Pakistan Microfinance Network estimates that MFIs will need $31 million in fresh capital to compensate for losses and finance new demand, but there are a few things to consider. First, losses are not yet clear. Until each and every MFI has assessed each client, it is too early to know which loans will be written off and which will be restructured or refinanced. Second, with the many livelihoods programs that will soon be unleashed, borrowers may choose to pay off loans and obtain new ones rather than tarnish their credit worthiness. In Mozambique, for example, several MFIs were able to partner with livelihood providers to sequence support, preventing clients from defaulting on their debt while still meeting their immediate cash and livelihood needs (Nagarajan 2001). Finally, demand for credit is not always as high as MFIs expect. For example, with the proposed housing grant that the government is planning, it is unlikely that clients would choose to borrow for housing instead of availing of this opportunity. In the next 6 to 12 month period, demand is likely to increase as businesses slowly recover.
In the immediate term, MFIs may want to explore expanding the services that are often most in demand immediately after a disaster, savings and remittances. Such services allow MFIs to meet the needs of clients while also enabling them to expand outreach and improve their financial positions. Donors should work with MFIs to help them build capacity to deliver these kinds of services, rather than merely writing checks for liquidity.
One of the things that donors need to be careful about is Pakistani MFIs hiding their poor lending practices and weak portfolios behind the devastation of the flood. Meaning, most MFIs were suffering from low portfolio quality and huge recovery problems even before the floods; a fact they have successfully hidden from donors.
Donors should now actually look at new and innovative business models. Setting criteria for track record and outstanding portfolio only creates monopolies and barriers to entry for new MFIs. Something like the Islamic MF Challenge by CGAP can be a great way to find innovative and viable MF models that would not only rehabilitate the flood victims, but also create strong MFIs. The key, however, would be to encourage new entrants rather than pump more money into the poorly performing monopolies.