Why have banks failed SMEs?
Even before the pandemic, CFOs of small businesses struggled to get the insights they needed to manage their finances effectively. Even though banks are willing to help, they are facing an increasing number of complex cases of SME clients. It can be stated that identifying the challenges that delay the growth of the SME sector is crucial, and SME relevant policies and regulations should be objectively evaluated. The sector plays a significant role in countries worldwide as SMEs account for the majority of businesses and are one of the main contributors to economic development and employment creation.
Starting an SME requires minimum funding, which makes starting them easy for people. Bangladesh has nearly 10 million SMEs which contribute to 23 percent of the country's GDP, represent 80 percent of the jobs in the industry sector, and employ 25 percent of the total labour force.
In an economy, commercial banks are generally the main source of finance for SMEs. For the sector to expand and flourish, it should have adequate access to bank credits, thus, industrial credit in Bangladesh is financed through government-sponsored industrial banks, such as commercial banks and specialised financial institutions. Despite such facilities, entrepreneurs in the sector cannot invest enough, which is what drives firms' growth strategies. In addition, the loans offered to them usually carry a high-interest rate because banks are not willing to provide small loan amounts with high monitoring costs.
There are some rules and regulations that cause difficulties for banks to lend to companies that are not registered, cannot show collateral, or cannot provide financial statements. However, SMEs are usually unable to provide sufficient and reliable information to financial institutions. At times, they cannot provide the audited financial information and statements that the banks require, thus creating informational asymmetry. This asymmetric information between the SMEs and financial institutions might prevent the lending transaction from taking place and create serious obstacles for SMEs to obtain credit from formal financial institutions. Moreover, SMEs tend to not maintain proper licensing which makes them difficult to trace, causing further problems for banks to maintain records.
To mitigate such challenges, Bangladesh Bank (BB) has been developing and designing initiatives to aid the SME industry's growth. The sector adopted the Small and Medium Enterprise Credit Policies and Programs in 2011. The policy includes SMEs' borrowing from commercial banks, a refinancing scheme, prioritising SME activities and special emphasis on lending to women entrepreneurs. It also eased the complex procedures and requirements for small enterprises such as relaxation of collateral requirements. BB offers attractive loan provisioning to support SME financing with only 0.25 percent of the general provisioning. Moreover, banks are willing to customise financial solutions by granting loans to SMEs in a cluster which enables the bank to trace SMEs better and lower their cost of capital.
It has been stated by the World Bank in its 2019 report titled, "Financing Solutions For Micro, Small And Medium Enterprises In Bangladesh", that a USD 2.8 billion financing gap exists in the SME sector. Over 60 percent of women entrepreneurs' needs remain unmet, with a lack of access to collateral being one major obstacle. The country lacked a single-systematic planned policy designed to aid SME financing. One probable recommendation can be building a business case for the financial institutions to provide tailored support for the SME market, especially for women entrepreneurs. Collaboration between the government, BB, and development partners can together encourage the specialisation of the financial institutions to serve the SME sector, where BB can remove some of the regulatory requirements that all financial institutions should comply with, while lending to this sector. Accordingly, lending regulations should be reformed to enable the SMEs to borrow against movable collateral such as equipment, inventories, account receivables, and intellectual property rights, rather than against fixed assets only. This is because the majority of SMEs don't possess fixed assets. Additionally, reforming insolvency laws will reduce legal uncertainties which may increase risks to lenders and constrain the supply of finance.
The SME sector in a developing country is usually subjected to discrimination and negligence in the context of access to government support, access to finance, management, and marketing expertise and technology. SMEs in Bangladesh are operating in a semi-formal manner, while banks are one of the most formal institutions. Notably, the SME financing gap for Bangladesh remains high compared to other South Asian economies. To minimise this gap between SMEs and the banking sector, the banks can relax their banking procedures in regards to SMEs. Furthermore, banks should develop an official credit rating system, which will give them an idea about the reliability of their SME clients, and lower the risks for lenders. In this regard, greater cooperation among banks would be of huge help.
Samantha Rahman is research associate, SANEM. Email: email@example.com