There has to be an appropriate classification of the entities

Special Correspondent
Aug 20 - 26, 2007

Small and Medium Enterprises (SMEs) play a pivotal role in giving necessary impetus to employment generation, GDP growth and poverty alleviation. These entities create and promote entrepreneurial culture that helps in transforming economies from low to middle income levels. Their size in each country differs depending upon the size of the economy. However, their contribution in the employment and innovation in the developed economies make them backbone of the economy.

SMEs have the potential to adapt quickly to changes and to identify market niches, apart from their innovative potential. SMEs have played key role in the development of economies such as Japan, China, Malaysia and India. They had also played a key role in providing impetus to the development of some of the world's largest economies i.e. USA, UK, Germany, Taiwan, Korea and Hong Kong etc.

In Pakistan, the growing focus of banks on SME, consumer finance and agriculture sectors reflect the desire for loans diversification as well as enhancing earning base, which has remained heavily dependent on financing to the corporate sector. The rising demand from SME sector has mainly contributed towards persistent and broad-based loan growth in last couple of years.

In terms of the banking sector exposure, SME sector emerges as the second largest after corporate sector. In absolute terms, the loans to SME sector have increased by Rs 47 billion to Rs 408 billion, witnessing a 13% annual growth during CY06. Since the growth in credit to other components of the private sector like consumer finance was at a rate faster than the growth in the lending to SMEs, this has resulted into a slight reduction in the share of SMEs' in bank credit from 17.7% to 17% in CY06.

The break up of financing to SMEs shows that about one third of the total credit has been extended under working capital loans. Trade finance, being the second largest comes to around 14% and the rest comes under fixed investment category. It is encouraging to note that the number of borrowers under SMEs has increased from around 67,000 in 2002 to 168,000. The growth in number of borrowers may seem significant but keeping in view the numbers of SMEs operating in the country the number is very low.

Although the performance of SME sector in Pakistan is quite encouraging, its access to credit from the formal sector has been inadequate due to some inherent and structural weaknesses and problems. These include lack of information and documentations and reluctance to disclose the financial position. Dependence on collateral based lending, lack of awareness programs for SMEs, complexity of lending procedures and process are some of the common reasons for this lack of access to finance.

In order to promote SME finance, banks need to focus on developing SME specific products, program based lending and to standardize and simplify the documentation for SME borrowers besides giving due attention to traditional relationship based banking. Since Credit Information Bureau (CIB) maintains borrowers' profile, it can play an important role in encouraging the banks to further penetrate this underserved but vital sector of the economy.

There is a dire need to improve delivery mechanisms and channels for SMEs' access to resources. They need attention for access to finance, business development services, qualified human resources and technology to improve their productivity and capacity for employment generation. Market driven support programs are important for attaining sustainability and minimizing distortions in the economy.

The government has formally launched the first-ever SME Policy. This will be implemented over a period of eight years (2007-15) and envisages spending Rs13.128 billion. This includes establishment of a credit guarantee agency with a fund of Rs 3 billion, an SME subcontracting exchange costing of about Rs 26 million, an SME development institute costing Rs116 million, an SME export house costing Rs 157 million and creation of an SME promotion council with a fund of Rs144 million. An amount of Rs 7.7 billion had been allocated for access to finances under the policy followed by Rs 5 billion as access to resources and services human resource development, technology market and industry information.

State Bank of Pakistan has not imposed any limit on banks for providing credit to the private sector including the SMEs. The banks were following prudential regulations for provision of loans to the SME sector. A SME consultative committee had been established in the central bank to facilitate the sector, which comprises of presidents of the banks. The credit enhancement to the SME sector would help reduce lending rates to the sector.

However, two issues need to be addressed on priority basis 1) classification of an SME and 2) mark up rate. Technically speaking there is no official classification of SME and entities up to Rs 10 million are termed SME. Similarly, lending rates are excessively high and on top of this additional guarantees are demanded by the financial institutions. Often SMEs are also merged with micro enterprises.

One of the complaints of the financial institutions is that borrowers often do not have profile (history of dealing with the financial institutions), which become a constraint in lending. However, borrowers say that despite having profile their request is turned down, mostly due to inability to provide collateral.

Therefore, appropriate amendments have to be made in the Prudential Regulations for facilitating collateral-free lending. Staff of the financial institutions has to be trained for collateral-free lending.