Restructuring SME Bank

Finance Minister Shaukat Aziz informed the Senate on Tuesday that as a result of its weak performance the SME Bank was being restructured with the ultimate objective of its privatisation over the next three years.
The bank's poor health was evident from the fact that as many as eight of its branch offices described as "unviable" by the Finance Minister, were closed down. Out of Rs 9.17 billion in advances, Rs 8.019 billion have become bad and doubtful and classified as non-performing loans.
It would appear that the bank was no more in a position to continue its financial assistance at a rising level to meet the demand for loans from the Small and Medium Enterprises despite improvement in the recovery of old loans.
It was also stated by the Finance Minister that the State Bank of Pakistan had made the necessary relaxation in its prudential regulations for the SME lending with a view to promoting growth of this sector.
But these steps did not seemingly prove to be enough to arrest the declining trend in the operations of the SME Bank nor do we see a major spurt in SME financing.
It may be recalled here that the SME Bank was established through the amalgamation of the then Small Business Finance Corporation (SBFC) and the Regional Development Finance Corporation (RDFC), which were created under an Act of the Parliament.
The two organisations was already in a bad shape at the time of amalgamation due mainly to loan financing on the basis of favouritism to clients having connections with politicians.
The situation was by and large reflective of the same picture of mounting levels of non-performing loans in the portfolios of state-owned banking system prior to 1997.
The process of privatisation of SME Bank as hinted by the Finance Minister is likely to take as long as three years with cost being met from an Asian Development Bank loan.
The bank will be first broken into a 'good bank' and a 'bad bank'. All the non-performing loans will be parked in the 'bad bank' which will be liquidated with cost being borne by the tax payers, while Rs 7.99 billion of provisions presently lying blocked as cash reserves plus a billion in performing loans would be given to the 'good bank'.
This would enable the 'good bank' to lend additional Rs 9 billion and become effectively functional, which will then be privatised.
The staff at the bank will also be pruned down with a Golden Handshake Scheme as SME financing requires a different set of skills which at present are not in available in the bank.
The specialised financing institutions created for catering for the needs of the SMEs appear to have failed to maintain a sustainable pace although the beginning was quite encouraging in the form of specialised small loans facilities from the Industrial Development Bank of Pakistan and other relatively smaller organisations.
The financing systems was designed well on a professional basis of feasibility studies for each small project.
The results turned out to be fairly positive as could be noted from the well established small-scale manufacturing industries throughout the country. But the demand for small loans from this sector has rapidly increased due to speedy growth of the sector in the country.
On the other hand, the facilities already available such as the one offered by the Industrial Development Bank of Pakistan have seemingly gone extinct due to unavailability of overseas credit lines as well as the large accumulation of non-performing loans.
In this context, the need to retrain and retool the specialised banking system requires greater attention than ever before.
It is indeed very disappointing to note that as against the urgency of channelling loan financing at increasing levels to SMEs and promoting their growth with the objective of enlarging job creation avenues in small towns and rural areas, the problems faced by SMEs in obtaining adequate loans financing appear to be turning more intractable.
News reports show that the SMEs are beset with mounting difficulties, including demand from banks for collateral against their loans request.
It appears that despite suitable modifications in the SBP's prudential regulations for loan financing to SMEs, the commercial banks continue to ask for collateral as they are not trained to appraise projects on cash flow basis.
The State Bank is making an effort to train bankers and also trying to create a relationship with SMEDA.
It may be more fruitful if large network banks have their desks at SMEDA offices where people approach for help.
SMEDA can provide the technical and management assistance while the banks must come forward with necessary financing.
The size of SME loans as a percentage of total loan portfolio of big banks is still very small.
Default rates are more or less in line with general bank loans. Since collateral cannot be the basis for lending to SMEs, the interest rate needs to cover the risk.
As a consequence, SME financing normally would be on higher lending rates than normal trade or industrial loans on collateral financing basis.
Same holds true for consumer loans from commercial banks.
One crucial issue that needs to be addressed for SME's to become the real back-bone of our economy is the reluctance on the part of small businesses to come into the formal sector.
Unfortunately small businesses shy away from any help and are prepared to remain small as they do not like to be a known face with the authorities.
Fear of registration with tax authorities is not the only issue. Greater is the fear of harassment they would face the moment they employ more than ten workers, at the hands of provincial functionaries ie labour department, social security institution, employees old age benefit scheme, education cess department.
And the plethora of monthly returns that need to be filed with all and sundry agency and separate audit by over half a dozen governmental organisations one after another.
This makes SMEs choose to do without any official guidance and help. For a number of years promises have been made to simplify the life of an investor in this country but real action and fruitful results are yet nowhere in sight.