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EDITORIAL: According to a news report, there are delays and cost overruns in the State Bank of Pakistan’s (SBP’s) financing projects for Small and Medium Enterprises (SMEs) due to the Covid-19 lockdown and currency depreciation. But the finance ministry and SBP need to look at the broader issues which are actually hindering the SME financing in Pakistan. Unfortunately, such projects for financial inclusion are not focusing on the core of the problem. There is an urgent need to bring about a meaningful change in the country’s banking culture. A paradigm shift in the thought process of banks is required. Private credit is too low in Pakistan and within it the credit extended to SMEs is miniscule.

Private credit to GDP peaked to 27 percent in Pakistan in 2007 and at that time, the SME to private credit ratio was 15 percent – SME credit to GDP ratio was a mere 4.1 percent. Thereafter, the economic downturn resulted in high non-performing loans (NPLs), making banks shy away from private credit in general and the SME credit in particular. This situation further worsened because of successive governments’ growing needs to finance budget deficits which were met through borrowings from the domestic banking system. The overall private sector’s credit pie shrank to 16 percent of GDP in financial year 2020-21 while SMEs’ share plummeted to 6 percent in the same financial year from 15 percent 13 years ago. In terms of GDP, SME credit is now hardly 1 percent.

Statistics clearly show that no programme tailored for SMEs was cut right. SMEs have to rely on market credit and informal means for emergency purposes. Their working capital needs are usually met by suppliers in the value chains, but at much higher interest rates. These businesses lack long-term capital for expansions or modernization. This is hindering corporatization in the country.

Banks’ reluctance to lend to SMEs is due to the small tick size. When one customer (such as the government) is guzzling Rs12 trillion from banks’ credit pie; what juice would a bank see in the less than Rs500 billion SME market. The lending to private sector at Rs8 trillion is mainly for big corporates. Banks lend to names; not businesses. They see the profile of sponsors; not ideas or niches. Lesser known the name, higher is the personal guarantee or immovable collateral demand. SMEs usually don’t have that kind of assets to offer. Then banks tend to lend lower amounts relative to collateral. Moveable assets are not acceptable in most SME cases. Cash flow-based lending is close to none. The problem is two-fold. Banks are unable to assess the true cash flows as SMEs’ books are neither clean nor well managed nor audited. Businesses shy away from laborious documentation due to fear of the taxmen and multiplicity of reporting, tedious compliances, and payments.

If the number of registered employees crosses a certain level, Employees’ Old-age Benefits Institution (EOBI), social security and the Industrial Relations Ordinance kick in. Businesses tend to under-report their turnover and staff strength. Many companies have been forced by law to become withholding agents on behalf of buyers of their goods. That part of value chain is largely undocumented and these firms are not willing to pay tax or provide personal details. Banks have to work harder in assessing cash flows because of SMEs’ informal cash and reported payment system.

This incentive structure is misaligned. The puzzle can be solved by digitization of supply chain transactions. The government needs to lower tax rates on digital transactions to generate a quick pull. It should make compliance of reporting easy with little or no human interface. Banks earn from SMEs mainly on providing payment infrastructure in the form of fee and other incomes. They may lose that sweet making. Payment aggregators are a foray into the system. Banks may need to find a new avenue of incomes from SMEs – the cash flow assessment and credit risk scoring can be automated based on information by aggregators and credit rating agencies. Having said that, reduction of fiscal deficit is imperative for opening up of credit space. The big corporates need to graduate to raise debt capital through public offerings and private placements. Without the proper ecosystem and incentive structure, any government or donor-sponsored project envisaging credit guarantees would have a limited impact on SME financing.

Copyright Business Recorder, 2021