Apprehensions about microfinance institutions

Authorities in Pakistan are trying very hard to block all sources of money laundering (ML) and terror financing (TF). The Securities and Exchange Commission of Pakistan (SECP) has, of late, apprehended in a report that proscribed persons involved in terrorist financing activities may be involved in obtaining microcredit from microfinance companies and using it for illegal activities. As NBFCs and Modarabas offer lending products like loans/leases and deposit products, these could be used for ML purposes and TF. These are investment products and legal arrangements which have a medium to high level of vulnerability. Also, there are some NBFCs offering credit to meet working capital requirements where there is high risk of funds being used for TF. The SECP's report also highlights that microfinance institutions have outlets across Pakistan, especially in remote/rural areas alongside porous borders with Afghanistan which are inherently more vulnerable for ML/TF. Customers from such high risk areas may seek a business relationship with NBFCs/Modarabas in Pakistan to conduct/facilitate criminal activities in Pakistan. Most of the recovery of microcredit is also in the form of cash and, as such, the movement of funds may not be easily traceable. As far as Ijarah (Islamic leasing/Musharaka/Modaraba) are concerned, the SECP report indicated that they have a moderate level of risk. Leasing is often granted to finance purchase of plant, machinery and vehicles where the level of risk is almost nil but there are Modarabas which offer credit to meet working capital requirements and where the risk of funds being used for TF may not be ruled out. In case of foreign and non-resident clients, the customer identification and information about sources of funds is not easily verifiable and, therefore, it is difficult to ascertain if funds would be used for criminal activities or not.

We feel that the report prepared by the SECP highlights a problem that requires immediate attention of the authorities and needs to be tackled on an urgent basis since the world community has neither the patience to tolerate ML/TF in any form nor is it prepared to listen to excuses which may even be genuine. Besides, ML/TF activities are very harmful for Pakistan itself and, therefore, no stone should be left unturned to restrain elements that could finance and breed terrorism in the country. In fact, the country has probably been the biggest victim of terrorism in the world which has not only terrorised its population but resulted in migration of professionals and investors to other countries and undermined its economic growth prospects. As the financial institutions could facilitate terrorism in the country by moving funds from one party to another and also provide loans/credit to criminal parties as working capital or for other purposes, these institutions need to be regulated/disciplined in a way so that their activities could be confined strictly to meet only the genuine needs of the households and entrepreneurs as depositors or borrowers. It does not mean, however, that the authorities in Pakistan have so far done nothing to block various sources of ML and TF. The State Bank has initiated various regulatory changes to align Anti Money Laundering (AML) and Combating Financing of Terrorism (CFT) regulations with the Financial Action Task Force (FATF) recommendations. These include instructions to banks to conduct biometric verification of all account holders, strict identification and verification of customers and their beneficial owners, amendments in the existing AML/CFT regulations to cover potential risk areas and changes made in Fit and Proper Test (FPT) criteria for banks' sponsors/shareholders/directors/presidents and key executives. The SBP has also provided active guidance to microfinance banks to further strengthen their internal controls towards ML, TF and other unlawful activities but it seems that commercial banks have come under the microscope of the relevant authorities more than the microfinance institutions which could equally be used for criminal activities by the unscrupulous elements of society. The chances of these institutions being misused are higher because of close proximity of their branches with the border areas. The findings of SECP are all the more important because Pakistan is trying to do its best at present to meet the relevant guidelines and provisions of the FATF to make an exit from the grey list and it would help if microfinance institutions are also covered properly to ensure that no ML and TF takes place through facilitation by these institutions. However, while emphasizing the importance of these actions, it may be pointed out that no steps should be taken which are unnecessarily inconvenient for the ordinary clients and may discourage banking habit in the country.