Improving small business access to bank credit By Nasir Jamal

THE first of its kind credit guarantee scheme for small and rural enterprises launched last week is projected to enhance the risk-averse banks’ appetite for financing small entrepreneurs. But the banks will have to build their capacity for cash flow-based lending for that to happen.

The State Bank of Pakistan (SBP) has launched the scheme under its foreign-funded financial inclusion programme (FIP). In addition to the scheme, the SBP has announced a refinance scheme for the small and medium entreprises (SMEs) in the NWFP, FATA (Federally Administered Tribal Areas) and Gilgit-Baltistan.

The primary purpose of the two schemes, according to the SBP, is to increase the flow of formal banking credit to the SME and agriculture sectors with “greater emphasis on revitalisation of business activities in the troubled areas of the NWFP, FATA and Gilgit-Baltistan”.

“The establishment of the credit guarantee scheme fulfills a long-standing demand of the small entrepreneurs because the banks just don’t finance SMEs assuming them to be a high risk sector,” says Hashim Raza, a consultant and researcher who has worked with the Small & Medium Entreprises Development Authority (Smeda).

“I hope that now the banks will enhance financing for the SMEs because the SBP will share their losses under the scheme. But the results depend on the response of the market to the scheme,” Hashim said.

The scheme provides that the SBP will “share bona fide losses of the lending banks to the extent of 60 per cent of their financing to the eligible borrowers”. Though the SMEs are the largest employers, they have not been able to avail their due share in financing from the formal sources, particularly the banking sector. The recent SBP data shows that the share of SME and agriculture finance in the banks’ total financing is just 10 and 4.8 per cent.

Moreover, only seven per cent of the total SMEs use formal financial institutions for meeting their funding needs thus posing a big challenge to the banks, requiring them to enhance the level of credit to the neglected sectors of the economy, SBP Governor Salim Raza said at the launch of the schemes: ‘Within these areas lie the best projects for increase in economic growth, reduction in income disparities and poverty, and promotion of innovation and entrepreneurship.”

The SMEs’ share in export earnings and GDP (gross domestic product) is estimated to be 25 and 30 per cent. The agriculture sector employs 42 per cent of the labour force, contributes around 22 per cent to GDP and 60 per cent to exports, directly or indirectly.

“Importance of this sector in our rural economy may further be seen from the fact that it provides livelihood to 66 per cent of our population,” according to the governor.

The SBP acknowledges that credit disbursement situation has further aggravated for the SMEs and agriculture in the NWFP, FATA and Gilgit-Baltistan, where social and economic infrastructure have been seriously damaged due to ongoing war on militancy.

“Taking cognisance of the situation, the SBP has initiated many important steps to improve the flow of credit to the agriculture and SME sectors and boost revitalisation efforts in the affected areas,” Mr Raza said as he urged the banks to take the opportunity provided through these schemes to “reach out to the deprived segments of society”.

Governor Raza said the major objective of the scheme was to enhance the flow of credit to the small and rural entreprises, which were creditworthy but could not offer adequate collateral to satisfy the normal requirements of banks.

“Due to the banks’ perception about such customers being more risky, the central bank will share their losses on their lending under the scheme,” he said. “In addition to sharing credit risk of banks, the scheme will contribute in lowering the transaction costs,” he added.

The initial seed money of eight million euros has been provided by the United Kingdom’s Department for International Development (DFID), with the option of later being increased through allocation of funds from other sources like the federal government and international/bilateral agencies.

Half of the financial resources under the scheme have been allocated for the NWFP, FATA and Gilgit-Baltistan and the rest for the priority clusters/areas in other parts of the country.

Under the scheme, the banks will provide short- to medium-term loans up to a maximum of Rs5 million for up to three years for both working capital and medium-term capital needs. The lenders will be allowed to charge an interest rate of KIBOR (three months) plus 300bps.

An SBP announcement said it will allocate credit guarantee limits to the selected participating financial institutions (PFIs) on quarterly basis. For the component of scheme reserved for the NWFP, FATA and Gilgit-Baltistan, all banks would be considered as PFIs and for the other component few banks in good financial condition and having considerable share and expertise in small/rural/agricultural financing will qualify for receiving credit guarantee.

Under the refinance scheme, the banks will provide short-term facilities for working capital requirements and long-term facilities for BMR and upgradation of SMEs or installation and setting up of new units in the NWFP, FATA and Gilgit-Baltistan. The rate of service charges under the scheme will be linked to weighted average yields of relevant six-month Treasury Bills and Pakistan Investment Bonds. The scheme will remain valid for a period up to end 2012.

Hashim said the sustainability of the scheme depended on the volume of the lending to the SMEs. “If the volume goes up, it will become sustainable.” But for the SME financing to increase, he said, the banks would have to build capacity for cash flow based lending and enhance their business analysis skills.

The SBP’s prudential regulations for SMEs “encourage cash flow based lending by allowing the banks to take clean exposure (facilities secured solely against personal guarantees) on a SME up to Rs3 million provided the funded exposure should not exceed Rs2 million”. However, the banks’ aversion for risks and their lack of business analysis skills have prevented them from increasing financing to the SMEs.

Yet, he said, the credit guarantee scheme should have positive impact on the SME sector as well as on the banks because SME financing was going to open a new opportunity to increase their exposure to the private sector. He, however, warned that the scheme, which was right step taken at a right time, would not produce the intended results on its own unless the SMEs were also offered financial support for product diversification.

Source: http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/improving-small-business-access-to-bank-credit-230