Helping SMEs grow

Last year, loans to the SME sector in China exceeded those to large enterprises, thanks to government efforts to encourage SME financing. The efforts of the Chinese seem sound, especially considering that SMEs are the real engines of economic growth. This is a lesson for Pakistan, where the government seems to be more concerned about its own borrowing than that of the private sector, especially the SMEs, which are being elbowed out by the governments fiscal financing. "It is a source of concern that the (quarterly) decline in the number of SME borrowers is significantly higher than the overall reduction...in the number of borrowers of total banking industry," said the Development Finance Review for 3QFY11 released by the SBP. The report also showed that SME credit for the quarter ending March 2011 was over nine percent less than the previous quarter and over six percent relative to the same period last year. While government borrowing resulting in SME sector crowding out is one reason for lower credit outlay to the sector, another critical factor on the supply is the increasing NPLs of SMEs, which have been rising consistently since March 2007. However, the growth in SME NPLs has been slower than that of the overall banking sector. On the demand side, the current stream of high interest rates over the past few months curbed demand for loans, while the overall slow economic growth in the country with the persistent energy crisis reduced investment and business appetite. Interestingly, the major chunk of outstanding SME financing was short-term; facilitating tenures of only up to one year. This shows that majority of SME financing is fulfilling working capital and operational needs rather than fueling further growth and development. The report verifies this by further explaining, "The share of working capital in outstanding SME was 77.6 percent," at the end of March 2011, with the remaining financing allocated for fixed investment and trade purposes. The greater share of short-term loans over consecutive quarters shows that this trend of borrowing for working capital needs is a rather persistent one. In order to encourage SMEs to borrow for sustainable growth and investment and not merely operational needs, the government needs to come up with incentives encouraging long-term loans - for both the lender and borrower - especially for fixed investment purposes. Similarly, a glance at the SME loan size break up reveals that majority of the loans are concentrated in the over Rs5 million category, and in that too, the over Rs20 million category gets the biggest slice of the cake. While greater amount of funds in the larger loan-size category is also attributable to the larger per borrower amount in the over Rs5 million category, the lower proportion of loans allocated to the under Rs5 million category also reflects that banks efforts are still concentrated on the big borrowers rather than small ones. Sultan Allana, Chairman HBL - the bank with the highest share of total SME financing among private banks - told BR Research in an earlier interview that; "To be able to cover the entire spectrum, we have to also cover the lower side of the range." A look at SMEs outstanding advances in collateral versus clean lending may help explain this to an extent. Majority of the financing was for collateral-based loans against less than three percent for clean lending. Because smaller borrowers are less likely to be in possession of assets for collateral, they end up with lesser loans. In order to address this issue, the SBP indirectly suggests the creation of "innovative products and borrower evaluation techniques whereby borrowers repayment capacity is judged through business/ cash flows assessment instead of assets/collateral". Allana also suggested the creation of venture capital institutions to facilitate the lower-end of the SME sector. Ironically, DFIs, which should conventionally be aiding SME development by encouraging long-term, investment-based loans, contribute only 0.6 percent of their total outstanding advances towards SMEs, defying the word development in their nomenclature. Specific efforts such as incentives for investment-based loans and for loans to smaller SMEs, as well as the creation of special SME facilitating bodies such as venture capitalist institutions can offer some respite to the sector.

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Loan size-wise break of SME loans
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(Rs in bn)      Mar-11    % share
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20 mn           103.7         34
Total            303.2
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Source: SBP Development Finance Review March 2011