Who will lend to the SMEs?

In a country, where the SMEs constitute about 90 percent of all private sector enterprises, employ about 78 percent of the non-agricultural labour force, contribute over 30 percent to the GDP, and generate a quarter of export earnings, the dull state of SME lending is a great cause of concern.
According to the central banks latest report on the development sector, total outstanding loans to SMEs eased by 4.1 percent on a year-on-year basis to Rs334 billion - representing just 9.6 percent of the total outstanding banking sector credit.
The quality of loans, measured by the ratio of non-performing loans, is not quite healthy. The report titled "Development Finance Review" shows that SME NPLs, in line with its persistent rise since December 2007, increased from Rs92 billion at the end of December 2009 to Rs96.5 billion at December 2010. This translates into an NPL ratio of about 29 percent from 9.5 percent at the end of December 2007.
In another indication of weakness, the report reveals that Trading and Services SMEs - whose borrowers cumulatively form about 82 percent of total SME borrowers - saw a rise of 3.8 percent and 0.2 percent, whereas Manufacturing SMEs witnessed a decline of 11.7 percent on year-on-year basis.
The report also reveals that almost 90 percent of borrowers borrow just for working capital purposes, with only 5.3 percent of the borrowers taking loans for making fixed capital expenditures.
The SBP attributes the rising NPLs and insipid SME lending to high interest rates, law and order situation and the banks reluctance to extend credit to this risky sector.
But if that is all there is, then incentives such as schemes for revival of SMEs & Agricultural activities, the introduction of refinancing for modernization of SME, and so forth, should be able to jack up SME lending to desirable levels.
To ensure that monetary incentives like these are fruitful, however, proper infrastructure must exist. With the SME NPLs rising manifold in the aftermath of the financial crisis, banks will naturally act as once bitten twice shy.
With cracks opening up, its time for the government to step up on ensuring property rights, recourse to law, and documentation of the economy amidst other measure. And since banks have been shying away from SME lending, perhaps the reinvigoration of the SME leasing industry should also be explored.