Drastic fall in banks' lending to SMEs

In his keynote address at a conference on "SME Banking in Pakistan: Global/local trends and role of value-added services," organised jointly by SBP and IFC, Governor, State Bank, Shahid Kardar showed a lot of concern over the fall in banks' lending to the Small and Medium Enterprises (SMEs) during the last three years.
Bank credit to SMEs, the Governor complained, had declined from Rs 437 billion in 2007 (16 percent of bank advances) to Rs 334 billion in December, 2010 (10 percent of advances) despite various efforts made by the State Bank to increase financial flows to this sector. Since input prices during this period had risen sharply pushing up demand for working capital, the fall in real terms was even higher than indicated by the nominal decline during this period.
Lauding the role of SME sector for fostering growth and creating employment opportunities, the Governor remarked that "most particularly and especially when you consider that almost 99 percent of all business establishments are services, providing employment to 77 percent of the non-farm workforce - contributing 30 percent to the GDP, no one can deny a key role of this sector in overall economy." The importance of this sector was also widely acknowledged all over the world in view of its success in sustaining high growth in countries like Korea, Taiwan, China, Vietnam and Thailand.
On its part, the State Bank had been trying to encourage the financial institutions to support the growth of SME sector. Specific prudential regulations in 2003 were issued to facilitate banks in financing SMEs in an effective manner and more recently a credit guarantee scheme was also launched. Scope of State Bank's refinance facility to facilitate the flow of credit to SMEs was enhanced in May, 2010 and the SBP was also presently conducting cluster surveys on SMEs in collaboration with IFC and LUMS. Financial industry, however, lacked the skills to develop innovative products for SMEs and seems to have failed to take full advantage of these initiatives.
The concern of the Governor State Bank about a drastic decline in advances to the SME sector, in our view, is largely justified because adequate provision of credit on affordable terms to this particular sector could have played a key role in achieving vitally important socio-economic objectives. Another worry, according to certain reports, was that a major share of aggregate SME advances was being disbursed for meeting working capital requirements and concentrated mainly in Punjab and Sindh. A falling trend in advances to the SME sector coupled with the banks' reluctance to finance the capital requirements of this sector and concentration of credit in relatively developed areas of the country simply means that a development model, which could have been very suitable in the prevailing conditions in Pakistan, has not been properly deployed to produce the desired impact on the economy.
Of course, if the SME sector should have been properly incentivised and shown the necessary dynamism, it could have enhanced the prospects of economic growth, employment generation, poverty alleviation and reduction in income inequalities which are the need of the hour. Besides, the development of SME sector usually leads to business innovation and nurturing of entrepreneurial skills which are highly valued and rewarding in a developing country.
The relevance and importance of this model of development in the context of Pakistan underscores the need not to be unduly deterred from the recent setbacks but to focus on the reasons for the failure of the authorities to take full advantage of this particular initiative and make necessary amends without losing more time. As is widely known, most of the businesses in the SME sector are family owned, are not well acquainted with the intricacies of modern corporate sector and try to avoid linkages to the formal sector due to the possibility of harassment by petty government functionaries in various organisations. They generally dislike disclosure requirements, which a loan from the bank or some other special favour from the government would entail, and would rather prefer invisibility.
Also, the State Bank must be aware that SME sector has probably suffered the most in the recent years due to acute energy shortage and increasing lawlessness in the country. Whereas large business houses and big enterprises could afford to produce their own electricity and safeguard themselves from extortionary tactics of criminal groups due to their links with the top authorities, owners of SMEs don't have such luxuries at their disposal. Therefore, it is only natural that activity in this particular sector would decrease in such a turbulent period which would result in reducing the demand for credit. In fact, at this particular juncture, it seems much more important to improve the overall enabling environment for a smooth growth of this sector than focusing only on easy availability of credit. Hopefully, the government would adopt a multidimensional strategy to remove the impediments in the free functioning of the SMEs with a view to maximise the gains from this potential source of development.