What are the options available for Small and Medium Sized Enterprises in smaller cities to obtain the funds necessary for business growth and expansion?

Apart from the parallel financing mechanism (community or family loans, etc), interest based costly loans from banks remain the only option available for getting funds in regional markets.

However, banks still allocate merely eight per cent of their private sector lending to SMEs as per the SBP’s Quarterly Report Ending June 2017. SMEs in Pakistan, especially in smaller cities, are unable to explore the other local sources of finance due to the lack of institutional mechanisms.

In the last decade, various innovative financial tools have been developed globally to address business challenges of micro-enterprises, innovators and entrepreneurs. The establishment of a local stock exchange is one such funding platform where local SMEs can offer shares to local investors in a particular region.

The growth of local stock exchanges is an emerging phenomenon in a world where big, traditional, investment firms and stock exchanges in the financial sector have brought multiple vulnerabilities.

The idea for local stock exchanges is also gaining momentum due to the ‘buy local’ campaign in Western countries, particularly the US, as empirical research has proven that the revenue generated by local businesses are reinvested into the local economy as compared to the large multinational businesses who tend to move profits overseas.

Historically, in Pakistan, SMEs have not fully explored the option for offering shares on the stock exchange as access to the capital market has been severally curtailed through procedural complexities.

Ideally, the emerging cities of Pakistan that include Faisalabad, Sialkot, Gujranwala, Multan, Peshawar, Quetta, Sukkur and Hyderabad should be considered for the establishment of regional stock exchanges to facilitate SMEs operating in these areas.

Such an initiative will open doors for enterprises operating in agricultural, industrial, trading and service sectors to access funds through institutional platforms at comparatively lower costs. Local investors will also get an opportunity to inject their funds in various manufacturing, trading and service-oriented businesses.

However, the financing needs and corporate governance pattern of the SME sector is different from the large size companies usually listed on traditional stock exchanges.

The benefits of local stock exchanges include geographic proximity which makes it convenient for both owners and investors to know each other and understand the nature of the business. Mutual trust level is higher in regional stock offerings and local financing needs are easily understood.

For execution, the development of stock exchanges at regional levels, particularly in the smaller cities of Pakistan, will require certain regularity and technical changes. The role of the SECP is of prime importance in creating regularity space for the regional trading platforms.

The existing red tape and higher costs of listing need to be rationalised in order to attract SMEs for offering shares. In the same manner, the role of regional chambers of commerce will be crucial as these trade bodies can significantly affect the listing decisions.

The role of provincial governments can also be explored as after the 18th amendment, the provinces have been granted enough administrative and financial autonomy to manage and facilitate the growth of small businesses.

On the technical sides, five interventions will be required for establishing the stock exchanges in the smaller cites: the creation of an efficient underwriting service to manage the process of offering and listing shares.

A transparent credit rating system to correctly value the business credentials of a firm. To ensure the participation of investors, tax credits should be extended to local investors.

Fourth, the limits on trading of shares by local investors should be placed to discourage speculation and fifth, flexible provisions of buy-back of shares and insolvency proceedings should be incorporated to make adjustments for changing business scenarios.

In sum, the development of businesses in small cities requires the introduction of a modern form of stock offering and trading that can provide a cost-effective funding option to the SMEs in Pakistan.

The SECP, provincial governments and regional chambers of commerce should facilitate the establishment of local stock exchanges in smaller cities.

Published in Dawn, The Business and Finance Weekly, October 16th, 2017