SME financing: engine for inclusive growth

With emerging economies eyeing financial tools to strengthen their competitiveness, financial inclusion has become the new buzzword in recent times.
The recognition that the availability of financial services to all segments of the economy, mainly small businesses, is vital to fuel the engine of any country, SME lending is gaining huge attention these days.
Realising this business potential, the banking sector has to play its part in advancing services to this less-served segment of the society. However, fears of mounting non-performing loans have been keeping lenders at bay.
The SME-sector NPLs surged from around Rs36 billion in 2006 to Rs96.5 billion in 2010, with the NPL ratio rising from nearly 8 to 29 percent in 2010. Deterred by this trend, bank lending to SME declined from Rs408 billion in 2006 to Rs334 billion by the year ending 2010.
Another major stumbling block is the low Forced Sales Value (FSV) benefit accruing to banks. In the backdrop, the SBP had completely removed the FSV benefit against NPLs in 2007, which was partially restored to around 30 percent at the start of 2009. The benefit was later increased by 10 percentage points to 40 percent in the second half of the same year.
Banks also remained conservative on SME lending because they were not satisfied with the Financial Institutions (Recovery of Finances) Ordinance 2001 and demanding amendments in the clauses that obstruct banks to recover loans easily.
A few proposals for the development of SME sectors that were presented in the budget of FY10 were not implemented. In that budget, it was proposed that a fund worth Rs10 billion for Credit Guarantees be established. The fund was supposed to be financed equally by the government and the private sector.
In addition, a venture capital funds was proposed to be setup with a provisioning of around Rs2.5 billion. The then Finance Minster, Shaukat Tareen had also recommended enhancing the role of SMEDA and to setup a separate banking ombudsman for the SMEs.
Given this scenario, to streamline the SME sector, it is pertinent to incentivise the banking sector by restoring full benefit of FSV and improving loan recovery procedures. On the other hand, it is vital to extend benefits to SMEs in the form of credit enhancements facility.
As the SME sector contributes around 30 percent to the GDP, according to various estimates, incentives to the banking sector will increase the size of the SME financing portfolio, which is currently hovering around just 10 percent of total banking advances.
Failure to facilitate banking penetration into the SME sector, will not only prevent the full realization of the SME business potential but it can also keep many businesses in the undocumented sector - both of which, Pakistan can ill-afford at the moment.