SMALL and medium enterprises continue to confront poor access to bank finance and many businesses keep operating in their own way, outside the documented economy.

Hundreds of animal slaughter houses are operating in the informal sector, and tens of millions of rupees change hands daily at each one of them. They can enter into the formal sector with the help of bank loans — for which documentation is required — and thus form profitable trading SMEs, says Hasan Naqvi, a banker-turned-trader based in Karachi.

“Many wholesale and retail meat sellers are eager to organise their businesses and enter the booming export business. But they are compelled to put off their plans because banks don’t entertain them,” he added.

This is just one example of banks’ reluctance to reach out to new, potentially sound customers. There are many such thriving businesses that need some guidance and access to formal financing.

Instead of looking at just non-performing loans, people associated with SMEs propose that banks look at their ratio of defaults or loan losses, where, they claim, their performance is not as bad as that of other segments

“But banks don’t want to come out of their comfort zone. First, they don’t acknowledge the existence of a potential borrowers’ class. And when encouraged by the government or the State Bank of Pakistan, they do start lending to newer clients, but remain choosy for too long a time,” says a senior central banker while tracking the history of SME financing.

Lack of inputs, insufficient access to bank financing, and poor marketing opportunities have plagued the growth of the SME sector. The central bank has put in place not only elaborate prudential regulations, but also a complete guidebook for banks on SME financing. But only a couple of banks are seemingly interested in SME financing.

According to a latest SBP report, banks made net loans of just Rs6bn to SMEs in 2013, up 2.3pc from 2012. However, the share of SMEs in total bank lending was 6.5pc, down from 6.7pc a year earlier. Banks reached out to less than 5,000

new SMEs, which raised the number of all SMEs that have ever availed bank financing to about 137,000 in 2013.

The Union of Small and Medium Enterprises claims there are no less than 3.2m SMEs in the country. If this estimate is closer to reality, than less than 5pc of them have so far

benefited from bank financing. And even if banks reach out to about 5,000 new SMEs every year, there seems to be no way for them to raise this percentage significantly in the near future.

Like other developing countries, inadequate financing of SMEs in Pakistan has created disequilibrium in the SME credit market, says a SBP report. This implies that demand and supply of SME financing do not meet each other due to a mismatch of issues on both sides.

Banks remain reluctant to lend to SMEs because such enterprises’ greater sensitivity to economic fluctuations makes lending to them a bit riskier, and also because of lack of collateral and credible data on the market size.

Banks also shy away from SME lending because, according to a former SBP chief, the cost involved in searching creditworthy businesses, as well as that of processing SME loans, is quite high.

The high probability of SME loans going bad is evident from the fact that their non-performing loans, as of December 2013, were about 32pc of banks’ total financing to them, bankers point out.

But people associated with the SME sector say the composition and evolution of the segment is such that they cannot address all concerns of banks at once. They suggest that if banks lend to SMEs against their assets, instead of insisting on securing collateral, financing to these businesses can be increased significantly.

They point out that the real reason for banks’ reluctance to start asset-based lending to SMEs is that banks don’t have enough expertise to verify SMEs’ assets, and they have made no big investment in human resource to develop such expertise. They justify the high level of NPLs to higher uncertainty in SMEs’ cash flows, which leads to some of their loans getting classified as non-performing.

Instead of looking at just NPLs, which cover a broad range of loans that remain unpaid for more than three months, they propose that banks look at the ratio of defaults or loan losses. That is where SMEs’ performance is not as bad as that of other segments, they claim.

Executives of local private banks involved in SME financing point out that the bulk of these enterprises are too small in size, requiring limited management capabilities, and are not used to keeping business accounts in line with banks’ requirements.

But while bankers keep talking about these and other limitations in financing small- and medium-sized businesses, they conveniently ignore the amazing growth in demand for SME lending originating from growth in large-scale manufacturing and increased activity in the real estate sector.

Published in Dawn, Economic & Business, August 18th, 2014