In the long list of dichotomies, anomalies and mismatches that exist in almost all the spheres of social and economic affairs of the country, the SME mismatch is surely amongst the top few.
The Small and Medium Enterprise sector constitutes nearly 90 percent of all the enterprises in Pakistan; it employs 80 percent of the non-agricultural labour force; and their share in the country's annual GDP is estimated to be around 40 percent, according to SMEDA. Yet, barely 10 percent of total advances given out by local banks find their way to the SME sector.
Are banks to be blamed for it? To an extent yes, but they cannot be blamed entirely.
By their very nature, SME businesses tend to be more susceptible to economic downturns than their larger counterparts; they are also widely dispersed, informal and undocumented, and lack sophistication of business.
According to the central bank data, total non-performing loans (NPLs) of the SME sector stood at Rs41.3 billion constituting 9.5 percent of total SME Finance at the end of December 2007; by the end of June 2010, the SME sector's NPLs stood at nearly 25 percent of total SME advances.
The jump in the quantum of SME bad loans can be attributed to higher cost of borrowing that tracked the hike in discount rate. At the same time, however, bad lending quality is also to be blamed, with the burden mostly falling on the borrower.
"Between 1998 and 2003, there was substantial growth in terms of new names and large exposure being taken in what is called second tier borrowers. And I tell you that a majority of those were wrong calls by banks, because second tier was not adequately capitalised to sustain an economic downturn," Atif Bokhari, President United Bank Limited told BR Research.
Bokhari argues that in Pakistan, people lack the will to repay, even if they have the ability to pay back the loans, owing to which the SME sector has become a dangerous segment to dole out loans to. "SME portfolios of nearly all the banks have a default rate of more than 25 percent. You can't survive as a bank with 25 percent default rate," says Bokhari.
Ordinarily, the deterrent comes in the form of strong laws that protect the lender. However, bankers argue that that recourse to the law is not available.
Sharing Bokhari's view, Sultan Allana, Chairman Habib Bank Limited said, "If processes and systems are strengthened to enable quick and timely enforcements, banks may be comfortable in lending". Citing different cases, bankers assert that delay in banking courts, which often take 15 years to give a decree, is essentially beneficial for defaulters as they can get 15 years of free use of banks' money.
LAZY BANKING
Bankers may be passing the bucket to the judiciary, but at the end of the day the failure to include the SME sector is also to be blamed in part to bankers themselves.
Industry sources say that over the course of years bankers lost the focus on relationship-based banking that weakened their KYC; while some banks had resorted to credit-score based lending to SME, others had too few relationship managers for the size of portfolio they were handing.
Some bankers highlight high transaction cost involved in SME sector lending. But this, in other words of State Bank governor Shahid Kardar, is called "lazy banking". Today banks are not even looking at corporate clients; all they are doing is filling the appetite of government. And once the economy revives, banks will have to revert again to the corporate sector again," Kardar pointed out in his interview with BR Research.
A quick glance at who lends to the SME sector confirms Kardar's view. Although the share of big 5 banks in SME lending has fallen between December 2006 to date, it still accounts for 39 percent, according to SBP last banking quarterly review released in June 2010. This implies that small and mid size banks have failed to find their niche in the SME segment, and instead have been involved in the catch up game with the big five ones.
When asked about SBP's plans regarding the SME sector, Kardar says, the SBP will create an "incentive structure for the banks that would entice them to target the SMEs". These include getting support from the International Finance Corporation and the Asian Development Bank as well as introducing SME specific Export Refinance Schemes and providing first loss guarantee to the banks.
WILL SBP'S EFFORTS REAP FRUITS?
The answer to that might be, possibly yes, probably not. That's because at the end of day, a central bank can only use the monetary tools to breathe life into an economy or any of its particular sector. If the lungs are charred or damaged, even oxygen masks fail to help for long periods.
The bucket therefore falls on the government, where documentation of the economy holds foremost importance. Lack of adequate documentation of the SME sector, precludes bankers to provide loans to the sector.
Agreed, that in less developed countries like Pakistan, SME enterprises wish to remain in the informal sector, and so may remain un-bankable, because of the complex regulatory obstacles to formalisation.
But these exactly are the areas, where the government must step up its efforts, set up institutions to document, evaluate, and also direct the SME businessmen in their ventures.
In this context, while SMEDA's role has to be enhanced at one end, at the other, awareness must be created so that more and more businesses can brought into the formal sector - especially the agricultural sector where lack of infrastructure is also an impediment.
At the same time, in order to promote the culture of entrepreneurship in the country, the government must ensure a safe business environment and security of property rights.
Anecdotal evidence suggests that young businessmen from Karachi, who have ventured into dairy or poultry farming in suburban areas like Gadap, or have set up small factories in areas like Korangi, have been paying extortion money to unruly gangs in the area; failure to pay up the 'bhatha' often leads to kidnapping for ransom.
In such a scenario, monetary stimulus can do little; the real impetus needs to come from the government especially by focussing on increased documentation, faster judiciary, better governance, and higher level of awareness. Will the government be able to do it; your guess is as good as mine.
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HOW IMPORTANT ARE THE SMEs
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93% of firms
90% employment of private enterprises in industrial sector
80% of non-agricultural labor force
40% of GOP
25% of export earnings
35% of manufacturing value
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Source: SMEDA & BNU presentions
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