Consider the following: an entry-level tech worker in Silicon Valley can get a higher spending limit on credit cards than what banks in Pakistan are willing to loan to SMEs. At just Rs. 2.75 million, the average SME loan size is smaller than the ex-factory price of a new Suzuki Wagon R, a 1000cc locally assembled vehicle. Even the auto loan limit assigned to assistant manager-level bank employees is usually higher!
At this point, you may be mistaken for believing that while the average loan size may be smaller, the number of SME borrowers runs in the millions. After all, the number of SME establishments in the country is estimated at more than five million and accounts for 40 percent of the national output. Yet, as of December 2023, the aggregate number of SME borrowers across all banks stands at fewer than 175,000 businesses, virtually the same level as 10 years ago, at 168,000. In fact, the number of SME borrowers in the banking sector has not risen in over 23 years, peaking in 2006 under the economic stewardship of Ishrat Husain and Shaukat Aziz. In contrast, the total number of active credit cards exceeds two million.
Pakistan’s banking industry isn’t just averse to lending to SMEs—they actively run away from them. Of course, the casual explanation offered is that sovereign borrowing from commercial banks drains them of funds available for deployment (and then some). But truthfully, appeals to the “crowding out effect” are the refuge of scoundrels. Bankers won’t do business with SMEs because their reward matrix and compensation policy offer them no incentive to do so.
The fact is, that Pakistan’s bankers stopped lending to true SMEs a long time ago and have been quietly trying to wind down their outstanding exposure. Over the past 10 years, the definition of SMEs under SBP’s Prudential Regulations has been revised twice. The definition was last revised in 2016 and has since been retained at a maximum annual turnover of Rs. 800 million, despite several rounds of revisions to the Prudential Regulations for SMEs, making no allowance for inflation or currency depreciation.
As a result, commercial banks periodically conduct reclassification exercises of their respective portfolios parked with the commercial/SME and corporate banking departments, downgrading ex-corporate borrowers showing weak growth as SMEs and upgrading better-performing borrowers to the corporate relationship. Today, banking customers across both commercial and corporate banking departments are effectively name-lending relationships, with cash flow-based borrowers declared “non-bankable”.
Why does this matter, especially when it is in line with SBP’s guidelines? Truth be told, bankers don’t want to leave the comfy bubble of name lending, where the appetite for growing exposure is bound only by the sponsor’s history, especially the sponsor’s relationship history with the bank’s management. Never mind whether the business has creditworthy financials or strong growth prospects.
In recent years, banks have further ring-fenced themselves against lending to SMEs by developing credit manuals and risk acceptance criteria that define either minimum collateral requirements or require existing borrowing relationships with other banks. It’s a not-so-clever “you first” gimmick, ensuring no bank will ever get serious about lending to SMEs because no one else does either.
Don’t buy it, or still suspect there might be some truth to the “crowding out” explanation? Consider this: between June 2019 and June 2024, lending to SMEs increased by just Rs. 25 billion. During the same period, advances to corporate customers rose by Rs. 2.65 trillion—higher by a multiple of 106 times! Of this Rs. 2.65 trillion in incremental lending to corporate borrowers, Rs. 700 billion—or 26 percent—went to the 10 largest exposures of the banking sector.
Many might be misled into believing this stagnation in SME credit is an outcome of historically high markup rates. To verify this, look no further than the COVID-19 period. Banking credit declined between June 2019 and June 2021, even when SBP extended refinance to commercial banks to accommodate the freezing of principal and markup repayments on outstanding loans due to lockdowns and industry closures. In fact, when SBP rolled out the SME Asaan Finance Scheme in 2021–22 to incentivize lending to new and existing borrowers by extending loss guarantees and credit risk sharing, SME credit rose by just 3 percent per annum, compared to a 17 percent year-on-year rise in corporate lending.
Over the past 10 years, the regulator has attempted to lower or dismantle every possible barrier—real and imagined—to SME lending that bankers have used as excuses. These include but are not limited to:
“SMEs carry higher risk, which demands a higher return—but borrowers are not inclined to borrow at higher markup rates.” For much of the past decade, SBP kept the gates of refinance schemes open, where banks could avail refinance at a fixed rate from SBP while charging a credit spread of up to 8 percent to the end user. It didn’t work.
“SMEs cannot provide adequate collateral.” SBP allowed unsecured/clean lending of up to Rs. 10 million to SMEs solely against the provision of a personal guarantee, with no mortgage or collateral requirement. Didn’t work.
“Markup spreads don’t account for the credit default risk, which is too high in the SME sector.” SBP came up with risk participation/risk coverage of up to 50 percent on loans of up to Rs. 4 million. Didn’t work either.
Each time, the needle didn’t move on SME financing. Must be the “crowding out” effect.
Surely, if the government of Pakistan didn’t crowd out trillions of rupees in advances to corporate borrowers over the last five years, banks collectively could have found at least Rs. 100 billion in incremental lending to SMEs?
The truth is, the “crowding out effect” is the snake oil bankers sell to hide the fact that they don’t want to risk their career progression by making loans to SMEs—some of which might go under, as businesses are sometimes supposed to do!
Comments