AFTER a gap of six years, banks’ financing to small and medium enterprises rose in FY14. But the number of borrowers declined, indicating that additional lending didn’t contribute to financial inclusion.

Worse still, the share of SMEs in banks’ total financing also slipped from 5.99pc in FY13 to 5.61pc in FY14. This again shows that incremental bank financing to SMEs was slower than that for other borrowers.

Then, the banks preferred to finance SMEs involved in trading, or lent more for only short-term requirements, but they tended to ignore manufacturing.

Banks’ exposure to the SME sector grew 13.4pc to Rs264.8bn in FY14, from Rs233.5bn in FY13. But the number of SME borrowers fell 7pc to about 134,000, according to a SBP report. The authors of the report suspect that the volumetric rise in financing, without any increase in the number of borrowers, could be due to a rise in the lending limit for medium-sized enterprises.

Manufacturing SMEs need to be promoted to obtain higher production in the value-added agriculture and upstream and downstream industrial sub-sectors. This cannot happen if they don’t get enough bank financing

Before the start of FY14, the SBP had revised prudential regulations for SMEs and had set a higher ceiling of Rs400bn for banks’ financing to medium-sized enterprises.

But they say improved economic indicators could be another factor behind higher financing for SMEs.

Bankers say they have reduced the ratio of SME’s non-performing loans to total financing to about 34pc in FY14, from over 38pc in FY13 by improving recoveries and making prudent lending. They also point out that till FY14, SMEs operating with up to 10 employees had availed over 42pc of total SME financing. This means that banks’ lending to medium-sized enterprises has not been at the cost of small enterprises.

They, however, admit that most of the SME lending remains concentrated in units engaged in trading because their businesses are more documented than those in manufacturing and services. In FY14, banks’ lending to trading SMEs was over 44pc of total SME financing, up from 35pc in FY13, while the share of manufacturing and services SMEs stood at 39pc and 17pc respectively.

Manufacturing SMEs need to be promoted to obtain higher production in value-added agriculture and upstream and downstream industrial sub-sectors. This cannot happen if they don’t get enough bank financing.

Besides, unlike trading SMEs — a majority of whom operate from large urban centres — manufacturing SMEs are located in rural and semi-urban centres or in suburbs of large cities. Their cash flow cycle is also longer than that of trading SMEs. Thus, raising funds from informal sources is more difficult for them.

A vast majority of manufacturing SMEs either rely on costlier informal financing or defer their expansion and modernisation plans for want of funds. Thus, their optimal growth potential remains unexplored.

Bankers claim the recent rise in SME lending is a direct result of their strategic focus. Banks had started re-strategising towards SMEs in 2011, and an industry survey back then had found that 12 out of the 15 banks surveyed had been re-focusing on SMEs in light of their experiences, they added.

Most of these banks are now working more efficiently on customer segmentation, risk management, products and services, organisation and human resource, delivery channels and the use of information technology to improve their SME lending.

Bankers say work plans and operational frameworks developed jointly by the SBP-IFC and the SBP-DFID have also enabled some banks to offer quality advisory services to borrowers. This, in turn, is resulting in larger loan disbursements and better loan monitoring.

How fast banks would catch up with the growing credit requirements of the SMEs, however, would depend on how soon they develop expertise to effectively examine SMEs’ credit worthiness.

“Banks’ weakness in this regard, and SMEs’ non-serious attitude towards documentation, are two key obstacles to accelerating bank funding to small businesses,” says a former president of the state-run National Bank of Pakistan.

According to the most conservative estimate of IFC, more than 3m SMEs were operating across the country in 2011. Even if we assume that the number remains unchanged today, banks’ current financing to l34,000 SMEs means they are catering to less than half of the total market.

Mainstreaming undocumented SMEs into the supply chain of industrial sector (eligible for bank credit) through a credit guarantee scheme introduced by the SBP should encourage banks to lend more to SMEs.

But unless banks’ bias for short-term financing isn’t removed, little policy objectives would be served even through higher financing to the sector, central bankers say.

Banks’ financing to SMEs are heavily tilted towards providing working capital, which accounted for 74.5pc of their total exposure to SMEs. Lending for meeting medium-term trade finance and long-term fixed investment requirements of SMEs had much smaller shares —12.9pc and 12.6pc respectively.

Published in Dawn, Economic & Business, January 12th, 2015

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