One thing is certain – as Pakistan begins to restore economic activities following months of lockdowns: micro credit will play a crucial role as consumers, at bottom of the pyramid, try to rebuild their lives.
And in these unprecedented times, where the challenges are unpredictable, the common risks for borrowers may be intensified and newer risks may begin to surface. Nevertheless, the stage has been set up to deal with consumer protection challenges emerging from credit provisions.
Reflecting back on the havoc caused by lockdowns, a massive number of farms and businesses exhausted their savings and reserves including reaching out to their social networks. Without any working capital to procure materials or inventory, many may have even sold out their assets, simply to survive.
Hence, they will need to borrow, for basic needs, when all other options will run out. Although humanitarian aid and government funds were created to support these households in need, but, it only reaches a small fraction of the population. In the coming months, all these elements will further add to an extensive demand for credit.
By the end of April 2020, the trend was moving towards doubling for a 30 days portfolio at risk among the microfinance institutions, raised substantially at an average of 7.2%, though not to an extent of crisis, as yet.
As the financial service providers continue to be under stress, they are experiencing new challenges that reduce their liquidity and impact the revenue with loan suspensions and extensions, higher outstanding amounts, withdrawals by depositors and failure to conduct branch operations smoothly.
Although, the regulators and policy makers have been facilitating financial institutions with relief in the form of eased reserve, liquidity and provisioning facilities, but the non-regulated institutions often have little or no support especially when it’s a known fact that the lower income people and groups usually turn to these institutions for financial support.
Given these challenges, in a market like Pakistan with high demand for credit and financial service providers under stress – consumer protection glitches are bound to arise. We can foresee some credit related high risk scenarios, which are expected but are financial service providers ready for this? Can they plan ahead to address these challenges and manage to mitigate the risks?
Unsustainable debt burden of borrowers
Credit extensions offered during the initial lockdown period are expiring soon. Even though the borrowers may not have enough means to fulfil or comply with it, especially when the terms of the extensions were not compatible and favorable for them – financial service providers will still now start reaching out to their customers for repayment of lending / credit services.
The degree to which financial institutions were flexible to this arrangement and the impact it could have, varied greatly. However, lending institutions still maintained some degree of discretion in how to restructure the loan extension and when and who to extend this offer to.
For many microfinance institutions, the majority of their loan portfolio has been rescheduled, as it was a regulator’s mandate too, while allowing financial institutions to treat these loans as ‘still performing’ in their balance sheets.
While the non-regulated financial service providers were busy in determining how to respond to this problem, on their own. And consequently extended the offer to all its borrowers including the group loans; meanwhile the group meetings were suspended and repayment collections were stopped.
When loan term is not extended and when late fees are imposed, or if the due delayed principal amount is in lump sum – heavy debt burden falls on the borrowers.
As the outstanding amounts continue to rise, financial institutions are attempting to focus on and organize loan collection activities; as a result many microfinance loan officers are inclined to pressurize their borrowers for repayments. While financial service providers that rely on collection agencies are turning a blind eye to high pressure tactics.
Regardless of whatever the arrangements are, a huge number of borrowers will still be unable to resume their repayments when the grace period or extensions are lifted – which will again require to be rescheduled. And evidently, domestic workers are falling into a debt trap with some of these aggressive micro lenders.
How will microfinance institutions manage these cases on individual basis will then depend on their liquidity and financial muscle, under of course regulatory guidelines when it comes to provisioning governance rules.
For microfinance institutions, concerns have been raised by the credit bureaus, to submit the correct information regarding reporting borrowers in grace period as delinquent, while some have opted out to not use grace period in determining credit scores.
This may have an impact on borrowers’ ability to be eligible for new loans. However, it not yet clear how favorable treatment in credit bureaus will last when the extensions ends.
Inability of micro businesses to get loans
People who previously relied on their savings and social connections can no longer do so and as a result more and more people than usual will seek loans.
With no reserves left and no capital available, even many borrowers with good credit history will be unable to meet the standard criteria of creditworthiness and collateral requirements. Therefore, a fresh blend of micro credits can be critical to economic recovery.
While many microfinance institutions suspended their lending to new customers during the lockdown, many have been impacted with the arrears and losses and many are still having trouble raising capital. It is still not very clear how they will begin to restart. But as a consequence, they will tighten their lending criteria or will lend to only loyal and good customers.
All factors combined only point to a risk of credit crunch, heavily affecting those at the bottom of the pyramid and low income borrowers. At this point in time, it is more than important for regulators and policy makers to outline and define guidelines for underwriting in a responsible, more accountable way.
There are already reports of loans becoming less available. Fearing a credit squeeze, would it feasible to penalize the financial service providers that reject these loans on negative credit scores? One modification could suggest greater weight on a consumer’s repayment history, social and human capital – relative to collateral.
The last consequence is the flip side of the second and arises when regulated financial services providers and responsible ones are constrained. Some may be belligerent to sell high-interest lending facilities, targeting the vulnerable segment at a time when they are more desperate for money and less able to pay off their debt.
Deceptive lending is more likely to happen, especially among the non-regulated microfinance service providers which are commonly used by low income customers.
The credit facilities for low income customers is up for a difficult and perhaps a chaotic phase given these scenarios above, which are likely to appear soon. Not all financial service providers are regulated, and those who do not have categorical instructions will opt to treat consumers on an individual case-to-case basis.
This will more likely lead to inconsistencies in processes – making it slow, and in how they treat their customers. By anticipating what can possibly go wrong and communicating clear policies, FSPs, Regulators, Investors and Credit Bureaus can help ensure credit markets at the base of the pyramid treat borrowers fairly during these uncertain times.
Given the complexity of the situation, financial service providers will have to take some extraordinary decisions and initiatives, (anticipating what can go wrong) to communicate transparently and clearly with both, their staff and their customers.
Therefore, a need for clear guidance is crucial and less must be left to the discretion of financial service providers – regulators, investors and credit bureaus can help ensure sustainability of the credit market and fair treatment of borrowers in these uncertain times.
Or else, when the rules change as a consequence of evolving crisis situations, many financial service providers may have to leave their policies continually in flux and adapt on the fly – leaving them and their staff confused.
Suman Valeecha is a business graduate and a marketer. Currently working for the financial sector, she is also a faculty member at one of the leading business schools in Karachi. She has been a speaker at TEDx. She also run a social business that works for the rights of transgender community in Pakistan.