Bank financing of SMEs
Both public and private financial institutions remain a minor source of funds for the SMEs in Bangladesh as well as in other developing countries. Of the total bank advances to the industrial sector only 5 to 10 per cent of both term and working capital loans are seen to go to the SMEs in Bangladesh. This proportion is reported to be in the range of 10 to 15 per cent in the APEC region. It is thus remarked by a ADB researcher that Âbank credit is just a flower added to the brocadeÂ, instead of being charcoal in snowy weather. SMEs also have to pay higher rate of interests, provide very high percentage of unmovable (real estates) collaterals and securities (often to the tune of more than 300 to 400 per cent of the loan amounts) and comply with highly restrictive requirements on institutional credits compared to those provided by their large counterparts. As a result, the SMEs share of financing resources is disproportionately much less than their relative contributions to employment and, to a lesser extent to industrial value added. But as the SMEs are linch pins of the employment-augmenting and poverty-focused development strategy, their unhindered growth and greater competitiveness need to be ensured through solving their financially related constraints. A few proposals are put forward as potential remedies towards breaking inertia of the banks in extending loans to the SMEs.
Most commercial banks and DFIs are reluctant to lend to SMEs because of lack of adequate information on the cash flows in business performance and hence the capacity for loan repayments by these enterprises. Further, inadequate financial record keeping and absence of proper financial accounting do not allow the institutional lenders to have required knowledge about their past credit histories and assess their creditworthiness. All these adversely affect the bank-client relationship which is indispensable for building Âreputation collateralÂ.
For all latest news, follow The Daily Star's Google News channel. Thus adequate disclosure of financial information, good business record keeping and clean track record of good corporate governance are the important prerequisites for risk-headging and reputation collateral building by the SMEs to encourage the banks for doing business with them. This may be further ensured by preparing and submitting good business plans covering both current operations and future developments which provide the banks a sound basis for informed assessment of the suitability of the potential SME borrowers as avenues for investments.
The next important contentious issue involved in SME financing by the commercial banks is the collateral requirement. While bank lending decisions are traditionally based on the availability of fixed assets on offer as collaterals, very few SMEs possess sophisticated buildings, machineries and equipments and clear and good titles to real estates, particularly in the developing countries like Bangladesh.
Thus the availability and accessibility to adequate credit information, based on credit scoring system may induce the banks to shift gradually from a purely collateral-based lending to a more information-based one, with greater emphasis on the borrowers project financial viability and performance track record. A credit scoring mechanism assigns different weights to different characteristics of the borrowers to predict the likelihood of repayments of loans.
On the supply-side, it is pertinent that the banks should be motivated to appreciate the intrinsic merits of the SMEs as profitable and dynamic business units, capable of growing and contributing to enterprise and economic growth. Both social perceptions and administrative attitudes must change and be judicious towards growth of the private enterprises, including the SMEs.
Finally, there must be institutional capacity building in the banking sector in terms of development of facilities and expertise required for loan applications screening, project appraisal and credit rating processes. All these are indispensable for improving credit risk management and minimizing the financial institutions failure.