SME financing: mountain or a molehill?

The latest SME financing review published by the SBP (for CY16) shows improvement on several fronts. There is an increase in lending to SMEs, growing by 31 percent in Dec-16 year on year to Rs401 billion. The share of SME financing in total private sector credit has grown from 7.5 percent to 9.2 percent, meanwhile the SME NPL ratio has dropped to 20 percent from 25 percent in Dec-15 (See table for statistics).

The SBP-DFID collaborated Credit Guarantee Scheme (CGS) to SMEs and rural enterprises is being utilized with total borrowers reaching 25,860 since the scheme was launched in 2011. The report also shows that banks are meeting the SME lending targets set forth by the SBP.

On the outset, these are signs that bank ability of SMEs may be on the rise. Whereas the CGS scheme is reaching out to SMEs, mobility in overall SME lending should be taken with a profound grain of salt.

First: SME financing may have grown but it has not even come close to the peak of 2005-2007 when SME share used to be 17 percent of bank credit to the private sector. Interestingly, of Rs401billion, around Rs44-45billion increase comes due to the change in the definition of SMEs in 2016 which brought in the lower chunk of corporate under the SME portfolio.

Secondly, the average size of the loan is paltry for SMEs and has remained between Rs2-2.5million (Rs2.3million in Dec-16). More than a quarter of the loans are for less than Rs5 million whereas 65 percent of all loans lie between Rs5 million to Rs30 million loan size. This is an unfortunate clubbing of loans, because it is unclear how many of these loans are near the Rs30 million loan-size mark and how many toward the lower category. Intuitively, it is much more likely that a majority of these loans are closer to Rs5 million than they are to Rs30 million.

Moreover, mid-sized loans i.e. Rs30 million to Rs50 million constituted only 13 percent of all SME loans. The SBP June 2015 Development Finance report shows that loans up to Rs3 million covered 89 percent of total SME borrowers, out of which, a major number of SME borrowers availed loans of up to Rs0.5 million.

More importantly, bank wise distribution of these loan sizes demonstrates that banks are catering to a basket of very small loans. Public sector banks took on nearly half of the total borrowers with an average loan size of merely Rs1 million, constituting only a quarter of the total SME financing. Comparatively, DFIs took on less borrowers (around 700) but with a much bigger average loan size of Rs63 million.

There are other stray observations as well. The report mentions the export refinancing scheme but offers no data unlike previous years. This is likely because even though ERF rates have been brought down by this government in subsequent steps from 8 percent to 3 percent; ERF to SMEs in particular has remained only 2-3 percent. The facility overall remains largely underutilized. There are also no targeted incentives to facilitate exporters, and most SMEs don’t know of the facilities that exist. (Read our full story “SMEs: Walk the talk” on the problem with subsequent SME incentives).

The targets set forth by SBP (not part of the Prudential Regulations) for banks are based on size of banks as well as “capacity to achieve target” which are extremely vague parameters and are a stone’s throw from actual outstanding loans for banks in the past. Public sector banks show they outperformed their SBP-target but in fact, the increase in lending comes at the back of Bank of Punjab’s government supported Apna Rozgar Scheme. Overall, these targets do not indicate any evolution of banks moving toward improving their lending models for SMEs.

The most critical achievement at this point for the central bank would be to push for the collateral registry for which the Secured Transactions Law has already been passed. This will substantially reduce the risk-factor of SMEs who have issues arranging for property-based collateral. Moreover, the SBP should build on the current exposure of the CGS which is the one scheme that seems to be working.