One of the biggest challenges facing the small and medium enterprises sector is the lack of financing available to these firms. This was also the moaning of almost all stakeholders present at the “First National SME Conference: contribution, challenges and prospects of SME sector in Pakistan” organized by SMEDA and the University of Management and Technology last week.
What seems inequitable is why is lending constrained to the sector that potentially contributes 35 percent to national exports and is considered the backbone of the economic sector. This hurdle of financing precludes all other issues being faced by small and medium business owners. How can these small scale firms are expected to modernize, innovate and expand when they cannot access funds for these purposes.
It is the reluctance of banks to open their treasure hoards to small business owners that result in small business owners having to rely on relatives and trade creditors for borrowing funds. Since 2008, commercial bank credit to SMEs declined from 17% of the commercial banking portfolio to 6% in 2014. This proportion is indeed worrisome when 95 percent of enterprises in Pakistan are SME’s and an almost insignificant percentage has access to formal credit markets.
Access to finance is mostly constrained to short-term finance with heavy collateral requirements. Moreover, commercial banks lack effective credit models to finance SMEs. According to SBP figures the year-on-year change for SME lending in FY2015 recorded only a paltry increase of 3 percent.
The reasons are many with banks citing lack of collateral and credit history, informal financial reports and business plans. Although even a cursory look at the balance sheets of leading banks will reveal the majority of lending occurs to the corporate sector. Moreover, the unreasonably high weightage of government securities chokes off any credit supply to the credit starved informal sector.
However, the fact that SMEs are different from corporate borrowers should be appreciated by banks when making lending decisions. Although small business owners are good at operational aspects and running their business, when it comes to financial reporting and having proper business plans they are lacking in capacity. The dearth of innovative financial products also proves to be a big hindrance with high transactional costs of serving SMEs making banks reluctant to reduce margins.
The crux of the matter is banks have become complacent and too risk averse for their own good as well as for the financial ecosystem that our growing economy is in dire need of. Should they realise that these low profile small and medium enterprises have the potential to transform into internationally competitive firms, they would be more willing to open up their coffers to SMEs. This column will take up other issues pertaining to SME financing in the coming weeks.
