PROGRESSIVE governments the world over recognise the significance of Small and Medium Enterprises (SMEs) and encourage their formation.
In India all state governments and hundreds of ‘Chit Fund’ companies manage a system of formal associations called ‘committees’ (Rotating Savings and Credit Associations).
The 193 registered chit funds in Bangalore alone have an annual turnover of Rs40 billion while Shriram group, which has its origin in chit funds, has a customer base of 12 million and declared a net profit of Rs22bn in 2016.
Pakistan’s SMEs suffer from a lack of access to formal financing. While past governments launched schemes to promote this sector, these schemes merely expanded the sector instead of addressing core problems inherent therein.
A research carried out to study SME financing in Lahore showed that most SMEs in the city obtain their finances from committees.
Even assuming the average Pot size across Pakistan to be merely 10pc of that prevailing in Lahore the monthly rate of finance provided by Committees is Rs35bn
The volume of each committee’s financing (Pot) ranges from Rs20,000 in residential areas to over Rs30m or more than a kilogram of gold in some wholesale markets. The aggregate value of financing provided every month by committees to the researched population alone is well over Rs40m.
In every committee the first Pot of the cycle is retained by the president as a hedge against minor default. In about a third of the middle and higher value committees the second Pot also is retained by the president. Prior to collecting the Pot, the winner deposits a signed and dated cheque for every subscription that will be due till the end of the committee cycle.
More than 90pc of the surveyed enterprises announced their participation in committees. The actual rate is certainly higher. While most entrepreneurs retained membership in one committee at a time, many retained membership in up to six simultaneously. The average membership rate is 1.6 committees per SME.
The survey revealed that committees distribute Rs468m among the sampled population every month. If corrections are applied the volume of financing provided every month by committees to this population ranges between Rs37m to Rs75m. Projected over the 3.5m SMEs operating across the country the volume of this financing is Rs350bn.
Even assuming the average Pot size across Pakistan to be merely 10pc of that prevailing in Lahore the monthly rate of finance provided by committees is Rs35bn. This is a glimpse of the size of the market Pakistani banks have excluded themselves from.
During the research entrepreneurs expressed concerns regarding the possible failure of their committees. More than seven out of every eight entrepreneurs expressed a strong preference for bank managed committees on the premise that such committees will never fail.
However, committees are no-cost-no-profit operations. Banks are averse to managing them in the conventional form because not only do the committees not turn a profit, banks will incur a loss on account of management costs.
The author has developed an instrument for operating bank-managed committees. It is based on the bank creating a Float by retaining at least the first two pots of every committee it sponsors.
Ordinarily, the Float should reduce to zero at the end of the committee cycle if only one committee was being sponsored. However if even only one new committee is initiated every month, the Float will remain as long as the committees lasts.
The bank can profit by investing in this Float. If no extra charges are levied on the members and no Interest payments made to them, the instrument will be Shariah compliant. The SMEs will be able to participate in safe, cost-free and Shariah compliant bank-managed committees.
Table shows the size of Float accumulated when managing 10 and 20 member committees if the bank retains one and two Pots.
For banks to fully profit from managing committees, certain basic measures need to be implemented. These include providing legislative cover to banks and to reinforcing the procedure for managing dishonoured checks.
Almost 90 per cent of all enterprises operating in Pakistan are SMEs. Their contribution to the country’s GDP is around 40pc. Pakistan’s principal export industries are SME based which produce over 30pc of the country’s exports and provide employment to almost 80pc of the country’s non-agricultural labour force.
The multi-billion rupee SME finance market awaits penetration by banks. By providing Shariah compliant committee service to their clients, banks will be able to penetrate this market, mobilise a large reserve at no cost, and earn a substantial profit.
The writer is a visiting assistant professor at the Jacob School of Management, State University of New York, University at Buffalo
Published in Dawn, The Business and Finance Weekly, November 5th, 2018