KARACHI, Aug 30: Banks lend money on past and future trend of cash flows of borrowing companies and try to secure their facilities by collateral. In exceptional cases for nominal amounts, the requirement of tangible security is waived.

The lending pattern would undergo some change for small and medium-sized enterprises when the State Bank enforces prudential regulations on SMEs in about a month. The banks would be allowed cash flow-based lending, secured solely by personal guarantees of borrowing entity’s directors up to Rs1 million. Now, the banks lend up to Rs0.1 million against cash flows.

As a large number of SMEs may not be able to prepare future cash flows due to lack of sophistication and financial expertise, the banks would be required to assist borrowers in obtaining the required information. No SME shall be declined access to credit merely on this ground. The commercial banks have so far moved at a snail’s pace to provide credit to SMEs because the latter’s lack of professional skills.

For greenfield project, where both the entrepreneur and the project are in an new business area, the risk for the lender is high. It is venture capital. In case of a greenfield project in a known sector of industry, the risk is comparatively lower. Hence, cash flow lending would depend on the nature of the risk, says a banker.

Economists assert that in developed markets, banks lend money against cash flows rather than collaterals because it is the entrepreneurial skill that is paramount in making any business a success. They say it is time to begin the transition from lending against tangible securities to providing facility against cash flows. And the State Bank recognizes this.

Small enterprises have practically very little access to bank credit. Normally, they do not have collaterals to offer. Credits offered to SMEs are at higher rates than availed by corporates. But the SMEs can leverage their businesses with bank credit. Their loan repayment performance is better than for big companies.

In its comments to the State Bank on the draft prudential regulations, Small and Medium Enterprises Association has suggested that the small enterprises should be allowed to take clean exposure up to Rs3 million for newly set up units and Rs5 million for enterprises with good business history over five years. For medium industries, it has suggested clean facility up to Rs5 and Rs10 million respectively.

According to the draft prudential regulations, banks would be required to identify the sources of repayment and assess the repayment capacity of the borrower on the basis of “asset conversion cycle and the future cash flows.”

The banks would also need to assess conditions in the particular sector\industry they are lending and its future prospects. They would have to identify the key drivers of their borrowers’ business, the key risks to their business and their risk mitigants. The lenders would also required to document the rationale and parameters used to project the future cash flows.

Currently, audited financial statements of borrowing entities are a major factor in assessment of their credit risk. In some cases, the bankers face the problem of verification of audited accounts. The Pak-Gulf Leasing Company sent two cases to the concern auditors to confirm whether these were the same accounts they had audited. The request was not acceded to. As no statutory requirement has been stipulated as yet, the auditors do not stamp the accounts they audit.

The managing director of the Pak-Gulf Leasing Company Mr A.B. Shahid took up the issue with the Institute of Chartered Accountants of Pakistan with the plea that the profession of accounting owes some moral responsibility as is the practice elsewhere to stakeholders than the company being audited.

ICAP responded by observing: Firstly, the responsibility for preparing the financial statements is solely that of the management and the auditor is only required to render an opinion thereon which is legally required to be annexed to such financial statements; secondly, if the management intends to mislead the lender or any other person even a stamp or an initial of the auditor on the financial statement may not deter it from doing so.