Financial system for SMEs is skewed

Small and medium enterprises, better known as SMEs all over the world, have an important role to play in industrialisation and economic growth as well as in creating employment opportunities.  It promotes cross-sectoral linkages raising exports and developing entrepreneurial skills. It has an important advantage in reducing regional imbalances. The future of SMEs thus is of major policy concern for reshaping industrial sector performance.
SMEs account for over 95.0 per cent of enterprises and 60.0-70.0 per cent of employment. The International Monetary Fund (IMF) indicated that SMEs in Bangladesh account for more than 99.0 per cent of private sector industrial establishments and 70.0-80.0 per cent of job opportunities of the non-agricultural labour force.
The share of SMEs' production value ranges between 28.0 and 30.0 per cent of our gross domestic product (GDP). Its contribution to national exports is also significant.
As globalisation and technological changes reduce the importance of economies of scale in many activities, the potential contribution of smaller firms is enhanced. But SMEs need to know how to enter into the global value chain in order to sustain and be competitive.
Though the word 'SME' is one of the buzz words, there is as such no existence of SMEs in the Bangladesh Economic Review prepared and published by the Ministry of Finance during the announcement of national budget every year.
The contribution of large and medium industrial enterprises is shown together, while the contribution of small industries is mentioned separately. So there is no way to find out SMEs' contribution to the GDP.
As per Economic Review 2014, contribution of large and medium industries (LMI) to GDP is 13.73 per cent while that of small industries alone was 5.23 per cent in 2011-12. The figures were 11.29 per cent and 4.68 per cent respectively in 2002-2003.
The figures reflect that contribution of small industries increased only by 0.55 per cent during the last seven years which is negligible, while the contribution of large and medium industries has increased by  2.44 per cent.
Size of industrial establishments is measured on the basis of employment or capital. Definition of Industrial Policy is the basis for defining the SMEs. There are, of course, variations in defining SMEs because of different reasons.  The Bangladesh Bureau of Statistics (BBS) has defined SMEs for preparing census and the National Board of Revenue for extending tax benefits. Banks follow their own criterion in defining SMEs for the purpose of extending loans.
The Bangladesh Bank (BB) in a circular mentioned that the Industrial Policy definition would be their basis of defining the SMEs. In calculating industrial loan by Bangladesh Bank, large-scale industries (LSI), middle scale industries (MSI) and small-scale and cottage industries (SSCI) are shown separately which of course give a picture of financing in these sectors.  
We are expecting a new Industrial Policy in 2015 which may contain some changes in defining different industrial categories. At the same time, some new definitions for handicrafts and venture capital (VC) may be included as were done in the Industrial Policy 2010 where definitions of micro industries, women entrepreneurs and hi-tech industries were included for the first time.
SMEs in the country suffer from several problems, of which financing is the most important one. Sometimes, these enterprises are termed as 'missing middle' because they have limited access to formal sector financing. There is absence of new and innovative credit schemes and financial instruments required to accelerate the flow of funds to SMEs.
Along with the financial constraints, they have less access to technology. Because of absence of scale, they can not establish market linkage and are not equipped with adequate business support services.
For addressing the SME financing constraints, some countries have introduced credit guarantee funds, venture capital, leasing, group-based and mandatory lending, Credit Surety Fund Scheme, Supply Chain Lending Scheme and many others.
SCENARIO IN SOME ASIAN COUNTRIES: Just like in Bangladesh, the SMEs are the backbone of the Asian countries, accounting for about 98.0 per cent of all enterprises and 66.0 per cent of the national labour force on an average from 2007 to 2012.
According to a study by the ADB, SMEs' access to banks has gradually improved because of various government support measures, such as
credit guarantees and mandatory lending etc. The table below gives a clear picture:

The figures above show that although SMEs account for about 99.0 per cent of the total enterprises, their access to bank finance in Bangladesh is much lower than other Asian countries except Kazakhstan. It clearly indicates that Bangladesh needs to improve the financing situation for SMEs to a large extent. In Korea, Thailand and Malaysia, contribution of SMEs to the GDP is much higher than that of Bangladesh.
SCENARIO IN BANGLADESH: Like many Asian countries, the government of Bangladesh has given enough thrust to increasing SME funding. But because of lack of clarity in some cases and unwillingness of the banks and non-banking financial institutions, the financial system for SMEs is skewed and they have to shuttle from here to there for access to finance. The Bangladesh Bank has given strong directives to banks for opening SME branches, making separate provision for loans, and other policies. But in reality, financing system for SMEs has not been raised to the required level. As is available in the website of the Bangladesh Bank, following three broad fragmented sectors are available for financing the SMEs:
1. Formal Sector
2. Semi-Formal Sector
3. Informal Sector
FORMAL SECTOR: The formal sector includes all regulated institutions like banks, non-bank financial institutions (FIs), insurance companies, and capital market intermediaries like brokerage houses, merchant banks, micro finance institutions (MFIs) etc.
SEMI-FORMAL SECTOR: The semi-formal sector includes those institutions which are otherwise regulated but do not fall under the jurisdiction of the central bank. Some of these institutions are: insurance authority, the Securities and Exchange Commission or any other enacted financial regulator. This sector is mainly represented by specialised financial institutions like the House Building Finance Corporation (HBFC), the Palli Karma Sahayak Foundation (PKSF), the Samabay Bank, Grameen Bank etc., non-governmental organisations (NGOs) and discrete government programmes.
INFORMAL SECTOR: The informal sector includes private intermediaries which are completely unregulated and unregistered in most cases.
Although percentage share of SME financing in the above three sectors is not very clear, it is a fact that because of stringent formalities, SMEs prefer to be in the informal sector and remain mostly in the extra-legal situation causing a serious risk for themselves.
Some statistics below can give us share of SME loans provided by
the banks:

Loan disbursement in the LSI was 62.13 per cent of the total. The MSI and the SSCI together received 37.87 per cent, about two thirds of the total banking finance went to the LSI. During 2012-13, the situation rather deteriorated in favour of SMEs, share of the LSI improved and reached about 66.0 per cent, and the remaining 34.65 per cent went to the MSI and the SSCI.

The LSI recorded the highest about 70.0 per cent while the SSCI was the lowest, about 6.06 per cent. There could be some detailed statistics to help us understand the actual situation. Banks are reluctant to provide loans to the SSCI sectors even though their requirements are much less than those of the LSI in order to avoid administrative costs and risks.
Funding for SMEs is still bank-centred. However, non-banking financing is also there to fill the void. In Bangladesh, non-banking financial institutions (NBFIs), such as leasing, factoring, invoice discounting and equity investment are in place. Besides, like other Asian countries, micro-finance institutions, venture capital funds, capital market financing, equity finance, corporate bond issuance and mezzanine financing and various other financing models are available.
TYPES OF FUNDING FOR SME: Financiers for SMEs in Bangladesh are mostly NGOs, government banks, capital market, friends and family, etc. Financing requirements vary from sector to sector while usual financing from banks is a problem for the SMEs. Banks are opening SME branches. Business firms go to banks to solve their financing problems and banks provide different kinds of loan products according to their needs. SME credit policy, sector-wise target-based lending for manufacturing sector by banks and financial institutions, priority to women entrepreneurs for disbursing more credit, refinance scheme for agro- processing industries have helped SME industries flourish.
There are collateral-free loans, but commercial banks mostly disburse loans against collaterals. Sometimes amounts of collaterals are higher than the loan amount. SME sector suffers largely as far as loans against collaterals are concerned. Extremely high interest rates prevent these enterprises from collecting finance from the banking sources. Problems of funding also vary from sector to sector and with different financial institutions. Non-traditional industries, including ICT firms, are the worst sufferers as they can not produce required collaterals.   
Thus SMEs are mostly engaged in high-risk trades like food processing, ICT and livestock. A poultry firm can be ruined overnight and an ICT firm can be closed due to its inability to develop saleable software. The SMEs cannot ensure regular payment of loan installments since they can not achieve expected level of profit. On the other hand, banks do not want to be at risk by financing such risky businesses. SMEs are unaware of their own value chain as they have to develop their own. So their scale of production is limited and often fails to meet the demand.
The writer is CEO of Business Initiative Leading
Development (BUILD), Dhaka, Bangladesh.
 [email protected]