MICROCAPITAL STORY: State Bank of Pakistan Issues New Microfinance Guidelines Including Allowing Microfinance Banks to Raise Tier-II Capital

The State Bank of Pakistan (SBP) released new guidelines for the capital requirements of microfinance institutions (MFIs). In particular, the SBP will require MFIs to maintain a capital adequacy ratio (CAR) of at least 15% of their risk-weighted assets. To meet this requirement, the central bank allows MFIs to raise tier-II capital and subordinated debt in local currency.

According to Investopedia.com, CAR is used to protect depositors and promote financial systems’ stability and efficiency; it is calculated as the sum of tier-I and tier-II capital over risk-weighted assets. Tier-I capital is core capital, which includes equity and disclosed reserves. Tier-II capital is secondary bank capital that includes undisclosed reserves, general loss reserves, subordinated term debt, and more. MFIs must also classify their capital as Core or Supplementary, with supplementary capital limited to 50 percent of core capital when calculating the CAR.

Subordinated debt in local currency can also be used to maintain minimum CAR, on a case-by-case basis and with SBP’s written approval. Furthermore, the loan should be unsecured, plain vanilla, with an original fixed term to maturity of at least 5 years, and subordinated in the payment of principal and profit to all other MFI debt including deposits. The SBP also stipulates that the loan not be repaid before the repayment date without SBP approval and that no payments should be made even at maturity if the payments would cause the MFI to fall below or stay below the minimum CAR.

The SBP also asked MFIs to maintain a minimum paid up capital, free of losses, at all times dependent on the area of their operations. Originally, all MFIs had to keep at least Rs 500 million (approximately USD 7.8 million) at the beginning of operation, which later could be excused in the case of losses. Now the SBP requires licensed MFIs operating in a specified district to keep Rs 100 million (USD 1.5 million); those operating in a specified region to keep Rs 150 million (USD 2.4 million); those operating in a specified province to keep Rs 250 million (USD 4.0 million); and those operating on a national level to maintain Rs 500 million as paid up capital. Finally, MFIs which do not meet the minimum requirement must make up the shortfall by December 31, 2008.

A Daily Times’ article quoted an MFI president saying that the SBP’s goal is to protect depositors by strengthening the regulatory framework. The president also felt that it would be difficult for MFIs to maintain these requirements given that most usually suffer losses in the early stages of operation. However, allowing tier-II capital will help MFIs maintain the paid up capital requirement.

by Jennifer Lee

Additional Resources:

State Bank of Pakistan: Home, Draft Guidelines for Microfinance

Bloomberg: Currency Calculator

Daily Times: “Microfinance Banks Allowed to Raise Tier-II Capital”, by Mushfiq Ahmad, March 21, 2008.

Investopedia.com: Home