From Kashf Foundation to Kashf Microfinance Bank—Changing Organizational Identities

Abstract

This case documents the challenges faced by the Kashf Microfinance Bank (KMFB) in 2012, when it was a relatively new entrant in a financial industry established by the 2001 Microfinance Institutions Ordinance. The case documents the difficulties KMFB faced in establishing itself as a microfinance bank, moved away from the unregulated NGO sector where its parent company, Kashf Foundation, was situated. As a microfinance bank KMFB faced the simultaneous challenge of surviving the start-up stage and adapting to the stringent banking regulations placed on it by the State Bank of Pakistan (SBP). The latter required learning to strike a balance between the sometimes conflicting banking and development institutional logics, a typical problem for hybrid institutions with a social mission. As KFMB grappled with trying to meet the SBP’s requirements on capital adequacy, it faced a repayment crisis originating from its parent company, wiping out a significant portion of its equity. The case focus is on a decision KMFB’s board must take, regarding whether or not to invite a new majority shareholder to bring the Bank out of the red. This includes the decision criteria for choosing a shareholder that will uphold KMFB’s mission of financial inclusion.

Keywords

Microfinance NGOs Banks Financial Inclusion Organizational Change Institutional Logic Hybrids

Discussion Questions

Analyze the difficulties institutions like Kashf Microfinance Bank face in moving from the NGO realm to the banking realm, while maintaining their social mission.

What steps can Kashf Bank take in order to strengthen its organizational capability after moving from an NGO to a banking status?

Evaluate Kashf Microfinance Bank’s position in light of its external environment and consider whether it could have steered its organizational course any differently to avoid the situation it found itself in late 2012.

What are the factors Mudassar Aqil, the CEO of Kashf Mirofinance Bank, should consider in choosing between the investors the Bank has been approached by? What should be his final recommendation to the Board?

On a wintry evening in late 2012, Mudassar Aqil sat in his office reading yet another State Bank of Pakistan (SBP) inquiry directed at Kashf Microfinance Bank, the institution for which he was the CEO. The bank had been established in 2008 with an initial paid up capital of PKR750 million provided by Kashf Foundation, an internationally celebrated NGO microfinance institution (MFI) with a strong brand presence in Pakistan. Aqil’s mind was increasingly occupied by thoughts of the bank’s current dismal financial statements (see Exhibits 1 and 2). He knew he had tough choices ahead as he prepared for a meeting with his board of directors.

In November 2010, the SBP had announced an increase in the minimum capital requirement (MCR) for microfinance banks (MFBs), from PKR500 million to PKR1 billion. All MFBs operating at the national level, such as Kashf Bank, had to comply with these regulations by December 2013. However, before reaching this target, the MFBs were expected to raise their capital in order to meet an annual target of PKR600 million by December 2011, PKR800 million by December 2012 and finally PKR1 billion by December 2013.

These regulations hit Kashf Bank hard, since two-thirds of its initial equity of PKR750 million had already been wiped out in the years since it began operations in 2008. As a direct result of this, the country’s premier credit rating agency had just intimated Kashf Bank that it was dangerously close to being downgraded to non-investment grade. For a deposit taking entity, this could well be the final nail in the coffin.

In 2012, Kashf Bank was barely four years old, and was trying its best to stay afloat in an industry created by the Microfinance Institutions Ordinance just eleven years ago. How would the bank recover from its balance sheet crisis, with the State Bank demanding answers on one hand and its own shareholders raising alarm about the looming threat of a possible downgrade on the other? Were there any realistic options for a fresh injection of equity that would maintain the original board of directors’ hold over the bank and Aqil’s own position as its chief executive officer? Or would there have to be a sell-out?

The bank had been approached by a few interested buyers who were attracted by Kashf’s brand name and who wanted to acquire a majority shareholding. One of these was a telecommunications company that wanted to explore branchless banking opportunities by taking over a local MFB. Another was a consortium of local investors. In purely financial terms, both offers would substantially improve the bank’s balance sheet and pull it out of the red. There was also the international microfinance foundation, that is, Foundation for International Community Assistance (FINCA). Although as an unfamiliar name in the Pakistani market, it possessed solid credentials and was a widely respected brand in the international community.

Kashf Bank’s board of directors had to decide how to balance financial considerations with the social and development mission of their institution when choosing between these investors—if they decided to go the buyout route to bolster the bank’s equity position. This was a constant tension in double bottom-line institutions like Kashf Bank, which had to maintain their financially viable commercial status while meeting the industry’s development mission of providing access to finance to the country’s unbanked population of more than 150 million.

The Microfinance Landscape and the Embeddedness of Informal Finance

Microcredit was popularized by Muhammad Yunus in the 1970s as a tool to alleviate poverty and expand access to credit in Bangladesh. By the 1980s, microcredit had garnered worldwide support. The United Nations, recognizing its potential for energizing developing economies, declared 2005 as the year of microcredit and Muhammad Yunus received the Nobel Peace Prize in 2006.

In Pakistan, microcredit was introduced in the 1980s by two NGOs—the Aga Khan Rural Support Programme (AKRSP) and the Orangi Pilot Project (OPP) (Hasan & Raza, 2011; Rauf & Mahmood, 2009). Following their success, several rural support programmes (RSPs) were established across the country, which offered microcredit to small farmers and owners of livestock (Rural Support Programme Network, 2011). In 1996, the Pakistan Poverty Alleviation Fund (PPAF) was established by the World Bank, as a wholesaler of funds on soft terms to such institutions.

Exhibit 3 depicts how the sector evolved in Pakistan. It shows a general move away from community development NGOs towards bank-led microcredit. Similarly, emphasis on poverty alleviation was replaced by a profit-oriented approach. Finally, specialized institutions had broadened their product portfolio by introducing micro-savings and micro-insurance, so now the intervention was referred to collectively as microfinance, rather than just microcredit.

Despite these developments, the average Pakistani household remained excluded from the formal financial system—which primarily meant commercial banks—preferring to keep savings at home and borrowing from family or friends in times of need. According to the World Bank (2015), only 10 per cent of the population had a formal bank account and only 1.56 per cent took out commercial bank loans in a given year. In terms of the full range of financial services, only 14 per cent of Pakistanis could claim financial access, as opposed to 32 per cent of Bangladeshis, 48 per cent of Indians and 59 per cent of Sri Lankans (Nenova, Niang & Ahmad, 2009).

The gender gap in access to finance in Pakistan was the largest in South Asia, with 41 per cent of men but only 25 per cent of women owning a bank account (Demirguc-Kunt, Klapper & Singe, 2013). In Pakistan, the disparity was much worse, with 21.1 per cent of men and only 5.5 per cent of women having access to banking services. Despite its growing presence, the microfinance sector in 2012 barely served 10 per cent of the total population excluded from formal finance (MicroWatch, 2012), as opposed to more than a quarter of the population in other South Asian countries such as Bangladesh and India (Nenova et al., 2009). Additionally, most institutions, with the exception of the RSPs, chose to locate in urban areas because the cost of operations was lower there, leaving large swathes of the rural population without access to formal finance.

Access to finance remained a serious issue for the rural population, despite the fact that agriculture directly accounted for 21 per cent of the nation’s GDP, and also contributed indirectly by providing raw material to agro-based local businesses. Agriculture employed about 45 per cent of the nation’s total labour force. However, yields had been stagnating for the past few years and one reason for this was the unavailability of formal credit to rural areas. In 2011, lending to the agricultural sector made up only 10 per cent of the total banking loans. Given that by 2012 the penetration rate of microfinance was barely 10 per cent and the majority of institutions preferred to stick to urban markets, the only recourse for the farm community was informal credit.

Informal suppliers of credit were locally referred to as arthis. These were lenders deeply embedded within the agricultural supply chain, and had developed products tailored around the cash strapped needs of their clients. For instance, the life of the loan was designed around the crop cycle. In case of a crisis, the farmer was allowed to rollover the loan and loans were given out on personal guarantees, rather than collateral such as land title (which was what commercial banks relied on when extending farm loans). Unsurprisingly then, a recent rural survey indicated that small-and medium-sized farm owners preferred arthi loans to bank loans. Of course, while microfinance rates hovered in the mid-thirty range, the arthi charged rates of interest as high as 81 per cent per annum (see Exhibit 4 for a comparison) and imposed binding contracts on the farmer to sell produce through him, so that his cash flows remained under the arthi’s control (Haq et al., 2013).

The term arthi was an umbrella term that covered several different types of informal actors who provided credit and other services to the farmer. The first of these was the commission agent, known locally as the kaccha arthi, who acted as the farmer’s bank, providing credit for the purchase of inputs and other loans to help tide the farmer over dry periods. The second was the wholesaler, known as the pukka arthi. The third was the beopari or the village level trader who bought the produce from the kaccha arthi and sold to the pukka arthi and often provided credit for input purchase too. The fourth was the input dealer from whom the farmer may purchase seeds and fertilizer either with cash or credit. Each one of these actors played an important role in the agricultural landscape of rural Pakistan, particularly in the near complete absence of the state and the banking sector (Haq et al., 2013).

With this context in mind, we return our focus to Kashf.

Kashf Foundation—Pakistan’s First Dedicated Microfinance Institution

The establishment of Kashf Foundation was an important milestone in the history of Pakistan’s microfinance sector. It was set up in 1996 by Roshaneh Zafar and became the country’s first dedicated MFI. Zafar had received technical training to set up the institution from Muhammad Yunus himself at his institution, that is, Grameen Bank in Bangladesh.

Funding for the foundation came in the form of both equity and debt financing from various sources, such as the UK’s Department for International Development (DFID) and PPAF. As of December 2005, the institution’s total loan facilities were just over PKR577 million while equity was close to PKR734 million as detailed in Exhibit 5.

Zafar saw Kashf as a social enterprise, that is, an institution with a strong social mission but one where the business approach to management was applied. She and the institution’s board chose to hire senior management with demonstrated managerial skills that had served in the private sector. Exhibit 6 shows Kashf Foundation’s organizational structure. As a mission-driven organization, its primary focus was on providing access to finance to underserved women. In addition to microcredit, Kashf also had a social action programme under which households were trained, counselled, exposed to interactive street theatre and campaigns were conducted around women’s issues (Mahmood, 2007).

The principal product was microcredit, which was offered to groups of women who provided cross guarantees on each other’s loans. Every group had a leader and groups met with the foundation’s officers in regularly held group meetings in client homes. The foundation also added savings as a voluntary product and credit life insurance as a mandatory product for the life of the loan. The loan period was 12 months, with the loan being payable in equal monthly instalments. At the completion of each successive loan cycle, clients were offered a loan higher than the previous one by an amount of PKR4,000 or US $65 (Mahmood, 2007).

By the mid-2000s, Kashf Foundation had become an institution recognized nationally and internationally. In 2002, it received the Microfinance Excellence Award by the Grameen Foundation, USA. In 2003, Roshaneh Zafar was awarded the Geneva-based Schwab Foundation’s Social Entrepreneurship Award as well as the Tamgha-e-Imtiaz¹ from the President of Pakistan, for her pioneering efforts in microfinance.

In 2007, Kashf Foundation became the third largest MFI in the country with 20 per cent of the total market share. The dramatic growth in the institution’s client base, gross loan portfolio and net profit shown in Exhibit 7 can be attributed to the maturing of existing clients which allowed them to take on larger loans and an aggressive expansionary strategy that saw Kashf’s outreach spread to the entire Punjab, Pakistan’s largest province. Karachi, the country’s port city and commercial hub, was added as a new market for Kashf during this time. These developments helped the institution go from earning a net loss to a net operating profit for the first time in 2003. But the fast-paced expansion led to the use of outreach methods that caused an unprecedented number of multiple borrowings by borrowers. This involved institutional practices at the loan officer level that ended up affecting its loan portfolio badly, leading to a massive repayment crisis in 2008, as described in a later section (Burki, 2009).

From Kashf Foundation to Kashf Microfinance Bank

In 2001, the dynamics of the sector shifted in Pakistan with the passage of the Microfinance Institutions Ordinance, which led to the establishment of MFBs. The first to be established included Khushhali Bank, the First Microfinance Bank, and Tameer Bank. This ordinance and the Microfinance Prudential Regulations that followed it entrusted the country’s central bank, the SBP, with the development of the microfinance banking sector.

As described in Exhibit 8, there were important differences between the MFIs such as Kashf Foundation, AKRSP and OPP and these newly established MFBs. First of all, the MFIs were registered under various acts but the SBP was the sole regulator for all MFBs, making uniform regulatory oversight possible. Second, the MFBs could fund their operations through deposit mobilization, while the MFIs had to deposit all collected savings at scheduled commercial banks.

The MFBs were also granted access to concessional facilities and grants through the SBP (Haq & Ahmed, 2010). These facilities were funded by the UK’s Department for International Development (DFID) and the Asian Development Bank. Finally, the MFBs were provided with a five-year tax holiday (International Monetary Fund, 2010). Of course, it must also be noted that Kashf Foundation was the recipient of large international grants. Specifically, by the end of 2007, its equity of PKR1.5 billion was primarily supported by grants from DFID, as well as grants and concessional loans from the PPAF. Moreover, as a Section 42 company, its income was non-taxable.

Deposit mobilization was the most important advantage accruing to the MFBs. For a financial institution, deposits represented the most important source of funding. In the absence of the deposit mobilization option, the MFIs had to rely on donor funding and the PPAF for funding. While the PPAF provided MFIs with soft loans at 8 per cent, these rates would increase as the size of the organization grew, putting an effective cap on subsidized lending as the MFIs tried to expand their customer base.

Thus, the largest MFIs began to consider spinning off their portfolios to create standalone MFBs. The first of these was the Agha Khan Rural Support Programme (AKRSP), which established the First Microfinance Bank in 2002. Another one was the National Rural Support Programme (NRSP)—the largest MFI in the country. The NRSP Bank was incorporated in 2008.

Kashf Foundation also wanted to take advantage of deposit mobilization opportunities in order to grow its institutional network and also to provide its clients with an institutional savings mechanism. It decided to set up an MFB, but one that would balance the profit-making imperatives of a banking institution with Kashf Foundation’s social mission. Using its international and local network, and Roshaneh Zafar’s reputation as a microfinance pioneer, the foundation put together an impressive board of directors for the proposed bank. This included the International Finance Corporation (IFC), ShoreCap International, Women’s World Banking and Acumen Fund (refer to Exhibit 9 for a breakup of the initial shareholding). Both Women’s World Banking and Acumen Fund were for-profit social impact investors, with a large global presence, and a stated commitment to poverty alleviation and women empowerment.

In October 2008, Kashf Microfinance Bank was incorporated as a majority owned subsidiary of Kashf Holdings Private Limited (KHPL). The initial paid up capital was PKR750 million. The foundation spun off its high-end, individual loan portfolio to establish the bank. In other words, the smaller denomination group loans remained with the foundation, while the portfolio of higher denomination individual loans was transferred to Kashf Microfinance Bank. The inherited portfolio was 100 per cent urban (refer to Exhibit 10 for details on the portfolio breakup between Kashf Foundation and Kashf Bank at the time of the latter’s incorporation). The bank began operations with five branches in urban Punjab and one in Karachi.

The Challenge: Building a Hybrid Organization

Mudassar Aqil began his career at M&T Bank, New York after earning his MBA from the Perdue School of Business, Salisbury University in Maryland, USA. After working at M&T for nine years and moving up to the position of vice president, he returned to Lahore. He then joined Bank Alfalah, a multinational commercial bank, and quickly rose to the rank of general manager, a part of its executive management team and its central management committee.

In 2011, he left Bank Alfalah to join Kashf Microfinance Bank. Aside from the fact that Alfalah was an established multinational bank and Kashf Bank was a young, local institution, he knew he was taking a risk by moving from commercial banking to microfinance. Most people identified microfinance with NGOs, as MFBs were the youngest financial sector in the country. However, Aqil felt certain that MFBs were the financial institutions of the future for a country like Pakistan, where only 12 per cent of the people had access to formal financial services through commercial banks (Nenova et al., 2009). He was convinced that the MFBs would expand the reach of financial services to the underserved population of Pakistan, far quicker and much more efficiently than either commercial banksor the NGO MFIs. This was because commercial banks were reluctant to serve vulnerable populations, and the MFIs were dependent on subsidized funding and therefore, not sustainable in the long run.

Establishing a New Business Model

MFIs that employed the banking model were often called hybrids because in addition to their development mission, they must also keep a strong focus on their financial bottom-lines (Battilana & Dorado, 2010). In that sense, they were neither entirely like the NGOs nor completely like commercial banks, but a blend of the two.

As a new MFB, Kashf Bank was unlike other MFBs, for it did not have to build a brand image. Kashf was a nationally and internationally recognized brand and its founder, Roshaneh Zafar, was well regarded for having established the first specialized MFI in the country. Another advantage for Kashf Bank was that it had inherited an existing portfolio at its inception from Kashf Foundation. By the first quarter of 2009, Kashf Bank had acquired more than 17,000 of Kashf Foundation’s microcredit clients, with a combined gross loan portfolio of PKR460 million as shown in Exhibit 10. This included the foundation’s individual loans, which were also its higher end loans. In the words of a senior officer at the foundation:

The foundation is the nursery from where our clients graduate to become borrowers of the bank.

Kashf Bank was the seventh MFB to be established in Pakistan. Exhibit 11 provides an overview of the MFB sector, with each MFB’s loan, savings² and micro-insurance portfolio at the time when Kashf Bank started operations. It shows that Kashf Bank began with a microcredit portfolio taken over from Kashf Foundation but without a pre-existing savings or micro-insurance portfolio. The bank’s senior management was conscious that success as an MFB meant future growth not just in the credit portfolio but also in the savings portfolio, since long-term financial sustainability depended on deposit mobilization.

However, moving from the MFI to the MFB realm provided some challenges to the newly established bank. KHPL’s board, the bank’s first chief executive and branch-level officers who had moved from Kashf Foundation to Kashf Bank needed some time to shift gears from the NGO mode to the banking mode. While the foundation maintained a business approach in its strategic planning and implementation, it nevertheless did not have to deal with central bank reporting requirements, nor did it have to face competitive pressures from other MFBS on both the assets and liabilities side of its balance sheet.

Branch-level officers who had moved from the foundation to the bank had to be trained in individual lending, which required a skill set different from that employed in managing a group loan portfolio. The MFI approach to microcredit involved establishing a close relationship with clients. This was especially the case in group-lending where groups of women provided cross guarantees on each other’s loans. On the other hand, because of its individual loan portfolio, the bank had to focus much more on cash flow and repayment capacity of clients.

In addition, as an MFB, Kashf Bank now had the license to raise deposits; however, with that came the urgency to step up its efforts to achieve sustainability through deposit generation. Human resource turned out to be a key challenge for the organization, for most of the branch-level officers did not have a banking background and had to be taught to keep an eye on outreach³ numbers without losing sight of the institution’s access to finance mission.

As an NGO, Kashf Foundation’s mission was to correct gender disparities in access to finance for women. As part of this mission, it lent primarily to women, though there was also a small proportion of male borrowers. It also funded women’s empowerment campaigns and financial literacy trainings for its female clients. But as an MFB, Kashf Bank had to meet the stringent criteria stipulated under the prudential regulations for MFBs established by the SBP. This in effect meant targeting clients with the best risk-return profiles and keeping non-revenue generating activities to a minimum. To achieve this, the bank chose to focus on cash flow based loans to micro and small enterprises in urban areas. Most of these clients needed more money than the MFIs were able to lend to them. They also preferred individual loans to avoid the joint liability stipulation of group lending. This led to an overwhelmingly male borrower base, since male-run businesses, in Pakistan’s patriarchal setup, were larger and more profitable than female-run businesses. Research in other parts of the world, such as Africa, confirmed that this was a worldwide trend (De Mel, McKenzie & Woodruff, 2009; Fafchamps et al., 2011). Exhibit 12 shows the gender breakup of Kashf Bank’s portfolio in 2012.

This experience was not unique to Kashf Bank, but had been well documented in the microfinance literature. Battilana and Dorado (2010), for instance, described how Bolivian MFIs that evolved from NGOs to commercialized entities in the 1990s had to face the double challenge of surviving the start-up stage and simultaneously learning to strike a balance between the sometimes conflicting banking and development institutional logics.

By 2012, the bank continued to have only one lending product and that was its individual loan. It had also not introduced an insurance product. As a deposit taking institution, it worked hard to promote its savings product and offered returns at par with other banks and the leader of the MFB market, that is, Tameer Bank. Consequently, its deposit base rose within a few years of its operations to more than one and a half times its credit portfolio by 2012, as shown in Exhibit 12. By this time it had branches in three of the four main provinces, that is, Punjab, Sindh and Khyber Pakhtunkhwa (KPK). This included sixteen districts in Punjab, three districts in Sindh and three in KPK. Note that at this time the MFB with the largest footprint in Pakistan, Khushhali Bank, had a presence in seventy two districts; the First Microfinance Bank (FMFB) had fourty eight branches and Tameer Bank had thirty eight branches (MicroWatch, 2012). Comparative industry details as of September 2012 are provided in Exhibits 13 and 14.

Funding for continued expansion was restricted to equity sources and the bank’s deposit mobilization efforts, as commercial banks in the country were loath to lend to the MFBs, despite the fact that there was a partial risk guarantee in place backed by the central bank itself, in case of MFB default on commercial bank loans.

Unprecedented Crises

For Kashf Microfinance Bank, the ‘Kashf’ brand name soon turned out to be a very mixed blessing. In 2008, the same year in which the bank had been set up, the foundation was hit by an unprecedented crisis. The crisis came to public notice when a group of Kashf’s borrowers refused to repay their loans in a peri-urban area near Lahore, the city where both the foundation and bank were headquartered. There were conflicting reports about what actually led to the en masse default.

One factor that some have pointed towards was political interference, which was reminiscent of the 2010 microfinance crisis in the Indian state of Andhra Pradesh (Ross, 2010). In Kashf’s case, a member of the National Assembly was said to have convinced some borrowers that they did not need to repay their loans. This news spread rapidly through the borrowers’ social network, leading to a massive default (Chen, Rasmussen & Reille, 2010). Another version described how some borrowers were told that Roshaneh Zafar, Kashf’s founder, had died and on her death bed had expressed the desire to write-off all of Kashf’s loans. But a carefully documented study, published by the Pakistan Microfinance Network—the microfinance sector’s primary research centre—laid the blame on dubious practices of Kashf Foundation’s loan officers, who were under pressure to meet their quarterly outreach targets (Burki, 2009).

Whichever version was correct, the fact remained that the crisis brought the entire industry to its knees. It was similar in nature to the incidence of ‘unzipped’ group lending arrangements documented in India, Bangladesh and Uganda (Gine, Krishnaswamy & Ponce, 2011; Wright & Rippey, 2003). A report by the Consultative Group to Assist the Poor (CGAP) at the World Bank (Chen et al., 2010) highlighted the growing vulnerabilities of the MFIs globally. It presented case studies of loan delinquency crises in four countries, one of which was Pakistan’s 2008 repayment crisis. It found three factors responsible for the delinquencies in all four countries: multiple borrowings, overstretched institutional controls and an erosion of lending discipline.

The aftereffects of the crisis hit Kashf Bank particularly hard. Suddenly, bearing the same name as the foundation became a double-edged sword for the newly established entity. According to senior management, the bank spent the next three years putting out the fires caused by the crisis and trying to regain its lost momentum. During this period, the bank’s portfolio-at-risk increased to 25 per cent. With a seriously impacted portfolio, a cap on further lending had to be put in place. Refer to Exhibit 15 to see the quarterly progression of the bank’s loan portfolio during these years. After three years of operations, the bank had only opened 17 branches, and the growth of its lending portfolio continued to be lacklustre. After writing off a large part of its overdue loans, without a commensurate increase in the loan portfolio, the bank suddenly faced large losses (see Exhibit 2).

On the deposit side, however, Exhibit 11 shows a healthy growth pattern. By the third quarter of 2010, deposits were already greater than the bank’s loan book. Nevertheless, this was just as much a result of active deposit mobilization as it was a symptom of a stagnant loan portfolio. Second, the growth in deposits was concentrated growth, that is, the bank’s deposit growth came at the back of a few high net worth depositors. This meant that even if a handful of these depositors took their money elsewhere, there would be a large drop in the bank’s deposit base.

When the SBP increased capital requirements for all the MFBs with national operations from PKR 500 million to PKR 1 billion, net of all losses, Kashf Bank was asked to submit a capital plan to the regulator describing how it would meet the new capital requirements, by the due date of 31 December 2013. With two-thirds of its equity gone and the daunting task of having to meet these increased capital requirements, the bank looked towards its shareholders to inject fresh equity. However, the majority shareholder in the bank was KHPL, which was already dealing with the aftermath of the repayment crisis in the foundation and was in no position to put new funds in the bank. With the majority shareholder in such a weak position, the minority shareholders also expressed their inability to raise fresh funds. Quite understandably too, for all of Kashf Bank’s shareholders had taken a big hit on their capital given the large losses the institution had sustained.

Key Considerations

While the bank’s equity position was certainly the most pressing problem at hand, Aqil also had to figure out how to build an institutional culture for the organization that blended the logic of financial sustainability with serving the financially underserved. For instance, should women continue to be side-lined by the bank’s lending operations because cost considerations required lending to larger businesses, which were usually associated with men? Second, should the bank continue to seek out large depositors, at the expense of micro savers, because the former led to relatively faster growth in the deposit base?

For the moment, however, the senior management was consumed with thoughts of a looming bankruptcy (see the bank’s deteriorating financials in Exhibits 1 and 2). Aqil and his team prepared a strategic plan to take the institution out of the red by 2013 and shared it with the board of directors. Unfortunately, the board remained unconvinced and no new equity was promised. The shareholders understood that without a fresh injection of capital, the bank’s financial condition would continue to worsen. But it wasn’t clear where that capital would come from. The minority shareholders were unwilling to take on this burden. After taking substantial losses on their initial outlay, further investment without a clear exit option would have been a poor business case for them to take back to their respective investment committees.

The only option that remained was to look for a new source of capital—a new majority shareholder. If the bank could find an investor that would turn its balance sheet around and with a single capital injection allow it to meet the SBP’s capital requirements, it would grant Aqil and his team room to breathe and put the strategic plan into action to achieve breakeven by 2013. There was no time to lose, and Aqil knew he had to stop the hemorrhaging as soon as possible.

This wasn’t necessarily an ideal solution though, because a new majority shareholder would considerably dilute the equity of the existing shareholders. It would, first of all, reduce KHPL to a minority shareholder. Second, it would shave off several of the existing minority shareholders’ share to less than 10 per cent, at which point they would lose their seat on the board.

Aqil knew there were no easy answers. As the CEO of Kashf Bank, he had two primary responsibilities. The first was a fiduciary responsibility to his creditors and depositors, which meant that he had to ensure the financial health of the institution. The second was to the existing shareholders, who constituted the current board of directors. This put him in a bind. If he suggested to the board to take on a new majority shareholder, he was fulfilling his fiduciary responsibility, but that would likely result in a dilution of their shareholding and place on the board.

Aqil also faced a private conflict. If the bank sank, so would his reputation and future career prospects, given that he was at the helm of affairs at this crucial point in the institution’s history. On the other hand, he realized that he had been hired by the original board of directors and may no longer have a place in the organization if the new majority shareholder decided to replace Aqil and his team with fresh management. This would be a serious blow to a man who had arrived in Kashf Bank after taking two successive leaps of faith—the first was leaving New York at the peak of his banking career to return to his homeland, and the second was leaving a stable job at a commercial bank to lead Kashf Bank.

The best case scenario would be an investor who chose to inject capital but allowed the current majority shareholder and management team to stay at the helm of affairs, recognizing KHPL’s demonstrated commitment to microfinance. This would allow KHPL to maintain management control and recoup its losses down the road from future profits. The remaining shareholders could choose to maintain their shareholding in such a scenario by injecting fresh equity when there were clear signs of a turnaround. For Aqil, this would mean that he would not need to feel conflicted over his fiduciary responsibility and the responsibility to the board. His personal conflicts would also dissipate in the process.

The worst case would be an investor that took control over the bank, retooled its mission to make it a completely commercialized entity and got rid of the entire management team. Keeping in mind that the latter was a more distinct possibility than the former, the search for a possible investor began at Kashf Bank.

As the news spread, Kashf Bank began to receive a few offers from local and international institutions. Kashf after all was a well-known brand in the microfinance sector. Most interested parties were local financial institutions or consortiums of financial institutions. Khushhali Bank, Pakistan’s largest MFB, had just been sold to such a consortium led by the United Bank, one of Pakistan’s largest commercial banks. However, Kashf’s board and senior management were expressly clear that they would consider not just the financial capacity of a prospective buyer but also its commitment to Kashf’s social mission of financial inclusion. Among the international institutions that approached Kashf Microfinance Bank, one was the internationally renowned Foundation for International Community Assistance (FINCA).

FINCA International

FINCA’s origins could be traced to 1984, when it began offering microcredit loans to low-income farmers in Bolivia using what FINCA called the ‘village banking approach’. Village banking referred to group loans that had cross guarantees between groups of borrowers that served as collateral in these otherwise uncollateralized lending arrangements.

From Bolivia, FINCA quickly expanded to other Latin American countries such as Mexico, El Salvador and Honduras. In 1992, FINCA reached Africa and opened its first branch in Uganda. Three years later FINCA’s outreach spread to yet another continent when it opened a branch in Kyrgyzstan, and from there it added several other countries in Eurasia. In 2003, FINCA’s first branch in South Asia opened in Afghanistan. By 2012, FINCA had a presence in twenty one different countries across five continents.

Throughout these years of expansion, FINCA had instituted policies that were designed to maintain its commitment to financial inclusion, poverty alleviation, asset building and job creation.

In 2010, it changed its business model by establishing FINCA Microfinance Holding Company LLC (FMH). FMH was established to allow FINCA access to capital markets in order to continue its expansion into new markets and to strengthen its presence in existing ones. Exhibit 16 shows the breakup of the capital injection by the investors FINCA partnered with to establish FMH. Through this partnership, FMH raised US $74 million in funds with FINCA International retaining 66 per cent of the ownership in the holding company, as well as a veto vote on strategic decisions taken by the FMH board.

A key component of FINCA’s international growth strategy was to support local institutions in transforming from microfinance NGOs into double bottom-line licensed financial institutions. Battilana and Dorado (2010) had defined double bottom-line institutions as organizations that maintained equal emphasis on their financial bottom-line and social mission.

FINCA’s line of control ran from its head office in Washington DC to its four regional directors, and from there to each individual country subsidiary. FINCA ensured consistency across its various sub-sidiaries by placing officers from different subsidiaries in different countries for a few years at a time, ensuring that its higher management got adequate global experience in managing MFIs.

The Decision

In November 2012, Mudassar Aqil sat in his office evaluating the offers that lay before him. Should he convince his board of directors to invite a local institution to buy KHPL’s majority shareholding in Kashf Bank? This would allow Kashf to keep its brand name, which by now had been cleared of all the negativity that had come with the rumour incident and was once again recognized as a trustworthy name across Pakistan and beyond. One of these institutions was a local telecommunications company that wanted the opportunity to explore branchless banking by taking over a local MFB. Another option was a consortium of local investors that wanted to exploit Kashf’s brand name. In purely financial terms, both offers would substantially improve the bank’s balance sheet and pull it out of the red.

Then there was FINCA, an unfamiliar name in the Pakistani market, but a widely respected brand in the international community with solid credentials. FINCA also had a strong commitment to the goal of financial inclusion. Through its long association with hybrid MFIs in Latin America, FINCA was an expert in managing double bottom-line institutions. But there was a catch: FINCA had asked for 90-day exclusivity to conduct due diligence, and enter into negotiations with Kashf Bank’s shareholders to make an offer to acquire a majority shareholding. This posed the risk that at the end of the 90-day period, FINCA may walk away without making an offer. Granting exclusivity would mean that the bank could not discuss the potential transaction with any other suitor during this period.

Exhibit 1.

Capital Injection into FINCA Management Holding Company—2012

IFC	$35 million
KfW	$15 million
FMO	$14 million
Resp	$5 million
Triodos	$5 million
Total	$74 million

Source: FINCA (2012).

Exhibit 2.

Kashf Bank Balance Sheet Data

Balance Sheet Data	2012 (PKR 000)	2011 (PKR 000)	2010 (PKR 000)
ASSETS
Cash balances with SBP and NBP	135,014	86,311	87,648
Balances with financial institutions/NBFIs	403,525	293,881	400,875
Lending to financial institutions	–	–	–
Net investments	142,781	72,673	28,767
Net advances	1,140,998	692,494	430,382
Operating fixed assets	200,220	218,774	223,538
Other assets	49,016	51,035	34,670
Deferred tax assets	46,275	36,989	22,460
Total assets	3,978,864	1,452,157	1,228,339
Liabilities
Deposits and other accounts	1,727,060	1,141,614	776,401
Borrowings	–	–	–
Subordinated debt	–	–	–
Other liabilities	106,128	61,987	49,659
Deferred tax liabilities	–	–	–
Total liabilities	1,833,188	1,203,601	826,060
Net assets	284,641	248,556	402,279
Represented by
Share capital	1,620,000	750,000	750,000
Discount on issue of shares	669,900	–	–
Statutory reserve	–	–	–
Depositor’s protection fund	–	–	–
Accumulated loss	(681,342)	(544,940)	(399,457)
Deferred grants	15,883	43,496	51,736
Total capital	284,641	248,556	402,279

Source: Kashf Bank Audited Financial Statements 2011 and 2012.

Exhibit 3.

Source: Hussein (2009).

Exhibit 4.

Interest Rate Comparison

	Interest Rate Range
Arthi	61–81 per cent
Microfinance institutions and microfinance banks	24–43 per cent

Sources: ShoreBank International-Pakistan (2011); Haq et al. (2013).

Exhibit 5.

Kashf Foundation—Debt and Equity Position (As of 31 December 31 2005)

Funding Source	PKR (Million)
Loan Facilities
Pakistan Poverty Alleviation Fund (PPAF)	374.68
Grameen Foundation USA	21.20
Acumen Fund	8.92
Muslim Commercial Bank (MCB)	172.32
Total	577.13
Equity
UK’s Department for International Development (DFID)	254.23
Aga Khan Foundation	39.53
Consultative Group to Assist the Poor	36.49
Others	45.61
Total Grants	375.87
Retained Earnings	357.62
Total Equity	733.47

Source: Mahmood (2007).

Exhibit 6.

Source: Kashf Foundation, 2005 Annual Report.

Exhibit 7.

Kashf Foundation Financial Performance

	1999	2000	2001	2002	2003	2004	2005	2006	2007
No. of active clients	913	3,406	7,221	15,706	45,331	67,552	72,507	133,363	282,396
Gross loan portfolio (PKR million)			18.52	32.64	207.49	467.12	758.36	1,339	2,536
Net operating profit (PKR million)	N/A	N/A	(5.29)	(4.76)	4.48	74.03	107.01	111.57	429.40

Source: Mahmood (2007).

Exhibit 8.

Institutional Differences between MFBS and MFIS

	MFBs	MFIs
Institutional Form	Banking institutions	Usually non-governmental organizations
Regulation	Regulated by the State Bank of Pakistan (SBP) as per the Microfinance Institutions Ordinance	Can be registered under any of the following acts: Companies Act, Trust Act, Societies Registration Act or Voluntary Social Welfare Agencies Act
Funding	Deposits; credit from commercial banks; specialized grants through the SBP	Soft lending from the PPAF, grants and subsidies from other donors.The largest MFIs are sometimes able to get lines of credit from local commercial banks
Deposit mobilization	Yes	Savings collected must be deposited with licensed commercial banks and cannot be used as a funding source
Products and services	Microcredit; savings; life and health insurance	Microcredit; savings; life and health insurance
Target market	Earning less than taxable income, primarily male	Self-employed, at initial loan application living at or below $2 a day poverty line, primarily female

Source: Zulfiqar (2014).

Exhibit 9.

Kashf Microfinance Bank Initial Shareholding

Kashf Holdings Private Limited (KHPL)	51 per cent
International Finance Corporation	19 per cent
ShoreCap International	10 per cent
Women’s World Banking	10 per cent
Acumen Fund	10 per cent
TOTAL	100 per cent

Source: Kashf Microfinance Bank.

Exhibit 10.

Client and Portfolio Breakup at Start of Operations

	Kashf Foundation	Kashf Bank
Rural Clients
Before spinoff	30,506
After spinoff	54,834	–
Urban Clients
Before spinoff	301,859
After spinoff	245,864	17,271
Group Clients
Before spinoff	319,652
After spinoff	300,698	–
Individual Clients
Before spinoff	17,004
After spinoff	–	17,271
Total Clients
Before spinoff	336,652
After spinoff	319,381	17,271
Total Gross Loan Portfolio (In Millions of PKR)
Before spinoff	3,232
After spinoff	2,978	460

Source: Pakistan Microfinance Network.

Exhibit 11.

MFB Industry Profile in the Year of Kashf Bank’s Incorporation (as of December 2008)

Number of Clients
MFB	Microcredit	Savings	Micro-insurance
Kashf Bank	17,271	0	0
Khushhali Bank	366,714	0	366,714
First Microfinance Bank	171,795	144,898	171,795
Tameer Bank	43,816	76,133	43,816
Apna	2,557	1,434	0
NRSP Bank	0	0	0
Pak Oman	15,702	26,859	0
Portfolio Value (In Millions of PKR)
MFB	Microcredit	Savings	Micro-insurance
Kashf Bank	460	0	0
Khushhali Bank	3,397	0	3,397
First Microfinance Bank	2,136	3,317	2,136
Tameer Bank	908	642	908
Apna	73	45	0
NRSP Bank	0	0	0
Pak Oman	138	25	0

Source: Pakistan Microfinance Network.

Exhibit 12.

Kashf Microfinance Bank—Portfolio Details (as of September 2012)

	Male	Female	Total
Number of borrowers	21,841	793	22,634
Gross loan portfolio (PKR)	929,970,614	35,455,996	965,426,610
No. of active savers	147,530	9,550	157,080
Value of savings (PKR)	1,170,492,603	342,857,880	1,513,350,483

Source: Pakistan Microfinance Network.

Exhibit 13.

Microfinance Industry Statistics (as of September 2012)

Nationwide Industry Data
Number of branches	1,780
Number of districts covered	93
Penetration rate (coverage of population)	8.74%
Active borrowers	2,394,205
Gross loan portfolio	PKR 37,973 million
Average loan size	23,245
Number of savers	4,514,149
Value of savings	PKR 20,132 million
Average savings balance	PKR 4,460

Source: Pakistan Microfinance Network.

Exhibit 14.

MFB Industry Profile (as of September 2012)

Number of Clients
MFB	Microcredit	Savings	Micro-insurance
Kashf Bank	22,634	157,080	0
Khushhali Bank	468,484	385,791	367,154
First Microfinance Bank	166,563	246,554	196,876
Tameer Bank	152,297	942,186	79,093
Apna	1,454	18,213	0
NRSP Bank	177,576	55,199	177,576
Pak Oman	12,040	17,287	0
Portfolio Value (In Millions of PKR)
MFB	Microcredit	Savings	Micro-insurance
Kashf Bank	965	1,513	0
Khushhali Bank	5,897	2,270	5,198
First Microfinance Bank	3,698	6,220	4,064
Tameer Bank	6,670	6,777	1,035
Apna	59	523	0
NRSP Bank	3,729	1,025	2,664
Pak Oman	154	22	0

Source: Pakistan Microfinance Network.

Exhibit 15.

Kashf Microfinance Bank’s Loan and Savings Portfolio

Quarter	Gross Loan Portfolio(In Millions of PKR)	Total Savings (Value in Millions of PKR)
2009Q1	460
2009Q2	399	21
2009Q3	394	80
2009Q4	420	318
2010Q1	451	733
2010Q2	442	424
2010Q3	440	474
2010Q4	446	776
2011Q1	495	733
2011Q2	563	947
2011Q3	627	895
2011Q4	695	1,142
2012Q1	705	1,186
2012Q2	838	1,605
2012Q3	965	1,513

Percentage Change in Quarterly Growth in the Gross Loan Portfolio

Percentage Change in Quarterly Growth in Total Savings

Source: Pakistan Microfinance Network.

Exhibit 16.

Kashf Bank Income Statement Data

Statement of Income Data	2012(PKR 000)	2011(PKR 000)	2010(PKR 000)
Interest income	409,687	292,276	214,687
Interest expense	(127,978)	(70,563)	(65,786)
Net interest income	281,709	221,714	148,901
Provision for loan losses	(15,576)	(8,953)	(32,177)
Net interest income after provisions	266,133	212,761	116,724
Non-interest income
Fee, commission, brokerage	68,494	50,836	40,362
Other income	24,116	32,170	27,658
Total non-interest income	92,610	83,005	68,020
Non-interest expenses
Administrative expenses	(486,596)	(447,868)	(363,549)
Other charges	(14,547)	(4,808)	(6,950)
Total non-interest expenses	(501,143)	(425,675)	(370,499)
Loss before taxation	(142,400)	(156,909)	(185,755)
Taxation -current year	(3,468)	11,213	11,515
Taxation - deferred	9,350	0	0
Loss after taxation	(136,518)	(145,696)	(174, 240)
Total comprehensive loss	(136,402)	(145,696)	(174, 240)
Accumulated loss brought forward	(544,940)	(339,457)	(225,218)
Accumulated loss	(681,342)	(545,154)	(399,457)

Source: Kashf Bank Audited Financial Statements 2011 and 2012.

Just as FINCA made this conditional offer, another investment consortium, headed by a highly reputable global microfinance foundation, approached the bank but asked for a month to put a due diligence team together. This consortium had just lost its bid on another Pakistani MFB. The problem was that if Kashf Bank waited around for this new consortium to cobble together a team, it would lose out on FINCA’s offer, for FINCA had asked for immediate exclusivity. FINCA had also made it clear that if it were to take up a majority shareholding in the bank, it would rename Kashf Microfinance Bank as FINCA Microfinance Bank. Aqil and his senior management felt apprehensive replacing Kashf, a popular brand name, with a foreign and unfamiliar name. How would its borrowers and depositors react to this change? They had no way and time to find this out at the moment.

The pressure from the State Bank mounted on the management to present a plan to meet its MCRs and Capital Adequacy Ratio (CAR), and the threat of a credit rating downgrade loomed large. In these circumstances, what should Mudassar Aqil recommend to the board? Should he ask them to accept the offer from a local investor or should he recommend instead that they grant FINCA exclusivity to conduct due diligence with the intent to acquire a majority shareholding in Kashf Bank? Yet another option would be to wait for the other international consortium to put their due diligence team together.

Footnotes

Notes

References

Battilana

Julie

& Dorado

Silvia

. (2010). Building sustainable hybrid organisations: The case of commercial microfinance organisations. Academy of Management Journal, 53(6), 1419–1440.

Burki

Hussan B.

(2009). Unravelling the delinquency problem (2008/2009) in Punjab–Pakistan (MicroNote No.10). Islamabad: Pakistan Microfinance Network.

Chen

Greg

Rasmussen

Stephen

& Reille

Xavier

. (2010). Growth and vulnerabilities in microfinance (Focus Note No. 61). Washington DC: CGAP.

De Mel

Suresh

McKenzie

David

& Woodruff

Christopher

. (July 2009). Are women more credit constrained? Experimental evidence on gender and microenterprise returns. American Economic Journal: Applied Economics, 1(3), 1–32.

Demirguc-Kunt

Klapper Asli

Singer

D. Singe

. (2013). Financial Inclusion and Legal Discrimination Against Women: Evidence From Developing Countries. World Bank Policy Research, Working Paper 6416. Washington DC.

Fafchamps

Marcel

McKenzie

David

Quinn

Simon R.

& Woodruff

Christopher

. (2011). When is capital enough to get female microenterprises growing? Evidence from a randomized experiment in Ghana (NBER Working Paper No. 17207), Cambridge, USA.

FINCA. (2012). FINCA International 2012 Annual Report. Washington DC: FINCA.

Gine

Xavier

Krishnaswamy

Karuna

& Ponce

Alejandro

. (2011). Strategic default in joint liability groups: Evidence from a natural experiment in India. Washington DC: The World Bank.

Haq

Aban

Aslam

Amal

Chaudhry

Aqeel

Naseer

Asad

Muhammad

Kabeer

Mushtaq

Khalid

& Farooqi

Maheen

. (2013). Who is the ‘arthi’: Understanding the Commission Agent’s role in the agriculture supply chain. IGC Working Paper. Islamabad: Pakistan Microfinance Network and National Institute of Banking and Finance.

10.

Haq

Aban

& Ahmed

Syed Mohsin

. (2010). Significance of small deposits for microfinance providers. Islamabad: Pakistan Microfinance Network.

11.

Hasan

Arif

& Raza

Mansoor

. (2011). From micro-finance to the building of local institutions. Karachi: Oxford University Press.

12.

Hussein

Maliha H.

(2009). State of microfinance in Pakistan. Dhaka: Institute of Microfinance.

13.

Mahmood

Mahboob

. (2007). Kashf Foundation—A Pakistani microfinance organisation gears up for dramatic growth (Case No. 07/2007-5446). Paris: INSEAD Business School.

14.

MicroWatch. (2012). Pakistan Microfinance Network. MicroWatch Newsletter. Islamabad, Pakistan.

15.

Nenova

Tatiana

Niang

Cecile T.

& Ahmad

Anjum

. (2009). Bringing finance to Pakistan’s poor: A study on access to finance for the underserved and small enterprises. Washington DC: World Bank.

16.

Rauf

Shahnaz A.

& Mahmood

Tahir

. (2009). Growth and performance of microfinance in Pakistan. Pakistan Economic and Social Review, 47(1), 99–122.

17.

Ross, Peg. (2010). Learning from the Indian microfinance crisis. Washington DC: CGAP.

18.

Rural Support Programme Network. (2011). Our history. Retrieved from http://www.rspn.org/index.php/about-us/our-history

19.

ShoreBank International-Pakistan. (2011). Estimating micro-businesses’ ability to pay. Islamabad, Pakistan: Pakistan Microfinance Bank.

20.

World Bank. (2015). The Global Findex Database 2014 – Policy Research Working Paper 7255. Washington DC.

21.

Wright

Graham

& Rippey

Paul

. (2003). The competitive environment in Uganda: Implications for microfinance institutions and their clients. Uganda: UK’s Department for International Development (DFID) Financial Sector Deepening Project.

22.

Zulfiqar

Ghazal

. (2014). Microfinance: To what end? Findings from Pakistan. Economic and Political Weekly, 49(10), 63–67.