The question hounding banks: how to solve a conundrum like SME loan?

In 2001, with a vision to provide banking solutions to the 'unbanked' small and medium entrepreneurs, Brac Bank began its journey.

The lender introduced small-ticket loans to the cottage, micro, small and medium enterprises (CMSME) to specifically bring the grassroots entrepreneurs under the umbrella of formal banking services.

Over the years, riding on the disbursement of CMSME loans, the bank also bagged a hefty profit as the small borrowers are seemingly more disciplined than their large and corporate counterparts when it comes to paying back the fund in time.

The model has subsequently motivated others to provide loans to CMSME entrepreneurs on a greater scale, helping them register good returns from the initiative in the process.

However, lenders are now in peril due to the economic meltdown brought on by the ongoing coronavirus pandemic while the central bank has imposed an interest cap of 9 per cent on all loans, including those for the CMSME sector.

For instance, Brac Bank's net profit crashed 40 per cent year-on-year to Tk 152 crore in the first half of this year.

The total value for outstanding loans with the bank stands at about Tk 26,000 crore, of which 47 per cent was distributed to the CMSME sector.

The instance of declining profits in Brac Bank is not a solitary case as the Association of Bankers, Bangladesh (ABB), an organisation of managing directors of all banks, claimed that average revenue of most of the banks had already plummeted between 20 and 35 per cent due to the interest rate cap and the pandemic.

Even with the tremendous support received from the government to tackle the ongoing recession, banks are now facing a new challenge in running their credit programmes for the SME and retail sectors, according to ABB.

Subsequently, on 12 July, the organisation sent a letter to the central bank governor expressing grave concern over the future of the country's CMSME sector.

"This trend in access to finance will face a major blow with a lending rate cap of 9 per cent as banks cannot afford to lend to the SME sector at that rate due to the high cost of lending and loan monitoring," ABB said.

CMSMEs are sprawled around the country and hence, a huge distribution network with adequate manpower is required to reach, onboard, assess and monitor borrowers. This makes it costlier to finance them compared with corporate entities.

As per the ABB's calculations, lenders have to count at least 10.62 per cent interest rate on CMSME loans considering the weighted average cost on deposits, operating costs, minimum credit loss costs and general provisioning.

Banks must add 4 to 5 per cent to the calculation if they want to enjoy profits from SME loans.

With this backdrop, the ABB urged the Bangladesh Bank to rethink the interest rate cap on lending products, with the exception of credit cards, in the interest of the SME sector.

Banks have requested BB to allow them to set at least a 14 per cent interest on SME loans.

"In such a scenario, if the 9 per cent is not lifted for SME lending, banks will be forced to cease lending to these entities, which ultimately will slow the growth of private sector credit, and hence, will affect the desired GDP growth," ABB said.

With reduced credit flow from banks, SMEs will eventually look for alternate financing arrangements from costly sources like microfinance institutions that charge rates upwards of 20 per cent or turn to loan sharks, the informal 'Mohajon' type usurers.

More than 10,000 employees who are engaging with the SME programme operated by banks may face unemployment if lenders do not pursue these loans, ABB said.

Banks will have to count their losses if they give out loans to the SME sector with a 9 per cent interest rate, said Syed Abdul Momen, head of SMEs at Brac Bank.

"We will be forced to scale down our SME credit programme in the days ahead if the existing interest rate cap persists," he said.

For instance, banks usually appoint one or two relationship managers (RM) to disburse a corporate loan of Tk 100 crore, but they have to deploy more than 30 RMs to distribute the same amount of loans to the CMSME sector, he said.

Therefore, it will be highly difficult to run the SME operation following the implementation of the 9 per cent interest cap.

The central bank has also introduced a Tk 20,000 crore stimulus package for the CMSME sector so that the small borrowers can tackle the ongoing economic fallout.

The package has to be implemented by banks but they will get 50 per cent of the fund disbursed to the borrowers from BB.

As per the guidelines of the stimulus package, CMSMEs can take working capital at 9 per cent interest. Of the interest, 4 per cent will be borne by the borrowers and 5 per cent by the government.

However, banks are showing reluctance to make effective disbursements from the stimulus package as BB asked the lenders to disburse a maximum of 30 per cent of their existing working capital.

Besides, lenders are allowed to give out at a maximum of 20 per cent of their credit ceiling set by the central bank under the stimulus package to the trading sector.

Another official of a private bank said that nearly 65 per cent of SME loans have gone to the trading sector.

"This has created a roadblock for banks to use the stimulus package despite the central bank instruction to implement all credit packages, which have been formed to mitigate the recession, by August."

The central bank should address the issues immediately as SMEs account for 20 per cent of the GDP, he added.

The sector also provides 80 per cent of the total industrial employment and 25 per cent of the country's labour forces.