Perennial financial insolvency of small enterprises

Micro, Small, and Medium Enterprises (MSMEs) perform essential economic functions as major drivers of economic growth and social progress in Bangladesh as in other countries.

The contributions of MSMEs to employment creation, poverty alleviation, creation of new enterprises, start-ups, entrepreneurship development and innovation, and decentralised industrial growth are widely recognised and documented empirically in both developing and developed countries.

However, their full potentials for growth and expansion are compromised to a great extent because of their financial insolvency resulting from restricted access to the sources of institutional finance from banks and non-bank financial institutions.

Financing of SMEs has been a topic of high interest to the policy-makers and researchers because of indisputable significance of SMEs for helping inclusive-growth in the developing countries.

In Bangladesh, for example, though the SME sector holds enormous potentials to contribute to employment augmenting industrial development, poverty alleviation and national economic growth, their restricted access to sources of institutional finance acts as one of the deterrents to the sector's growth, expansion and dynamism.

The chronic problem of adequate and affordable access to equity capital, term loans as well as working capital loans including bridge financing continues to impede growth, smooth operations, and expansion of the SMEs.

In fact, limited access to institutional credit is a perennial obstacle to the SME sector growth, constantly haunting the SME businesses around the world.

Evidence from Asia-Pacific countries shows that financing barriers result in an average decline of 10 percent in the growth of small enterprises compared to 6 percent for their large counterparts.

Indeed, an avalanche of studies on SME financing issues conducted at national and cross-national levels are pouring in continuously in search of finding solutions to financial insolvency of the SMEs.

But empirical evidence suggests that a simple solution to an intractable problem needs adoption of a holistic approach hitting the core issues causing it from both supply and demand sides.

Why SMEs are financially constrained

Broadly six compelling reasons cutting across both supply and demand sides are commonly cited to hamper adequate flow of institutional credit to the SME sector:

--Information asymmetry,

--Exceedingly high collateral requirements,

--High loan processing and transaction costs,

--High risks associated with SME lending, arising from scale barriers. However, at least part of such risks are perceived rather than real, reflecting the problems of mind set and inertia of the bankers and institutional rigidities including bureaucratic hassles and extensive documentation requirements affecting SME lending practices,

--High interest charges on SME loan.

Other demand side bottlenecks impending SME access to institutional finance include lack of information on the cashflow situation and low capital base of the MSMEs, absence of well-conceived business proposals, and standard accounting procedures of the SME businesses,

Difficulties facing the SMEs in raising funds also vary in degree and intensity at different stages of their life cycles, such as "start-up", "Growth and Break Even", and "Maturity", "Transition", and "Exit".

Unfortunately, the SME entrepreneurs typically experience extreme barriers to procure funds at the most critical stages of start-up, and survival to pass the "break-even point" by making money. Though short-term loans, working capital, and long-term loans from the banks and non-banking financial institutions constitute the critically important source of funds these are most difficult to come by.

Sources of Capital and Financial Products Available to the SME sector in Bangladesh

Different country experiences show that SMEs can obtain necessary funds from a variety of sources such as banks, development financial institutions, specialized financial institutions, innovative credit schemes and financial instruments introduced and enhanced to increase flow of institutional funds to the sectors. The major innovations termed as "best practices" for addressing the SME finance gaps include the following:

-Dedicated SME Banks

-Equity financing

-Venture capital financing

-Angel investment network

-Start-up enterprise development scheme

-Guarantee Funds

-Credit Surely Funds

-Credit Rating and Scoring Agencies

-Leasing

-Factoring and

-Commercial banks partnering with the MFIs etc.

These lending schemes are being successfully used in many East Asian countries such as Thailand, Malaysia, Tai Pie China, Singapore, Philippine, India, Pakistan, Turkey, and some other countries resulting in two significant positive outcomes:

Greater and improved access of SMEs to the financial markets 

Gradually closing the "missing middle" problem affecting the disproportionately small number of SMEs as compared with the micro and large enterprises in many developing countries. These include "MFI graduates" who need to be serviced by the commercial banks, but their loan sizes are often higher than the upper threshold of micro-credit agencies.

Government of India has established "Mudra Bank" in 2015 to address the financial needs of micro, small and medium enterprises, by focusing mainly to develop a market for small industries and on providing venture capital for new "start-ups". Such moves to provide financial services to all income groups, leaving to gaps in the provision, financial inclusion" seems to be the policy agenda.

Current SME Financing Situation in Bangladesh.

In the recent years, banks and other financial institutions are responding favourbly to the Government initiatives towards channeling more funds to the SME sector.

The process got a big push with Bangladesh Bank creating a new department named "SME and Special Programme Department in 2009 and formulating the SME targeted credit policy to strengthen Governments efforts towards stimulating SME sector growth in the country and at the same time achieve the objectives of "financial inclusion" programme.

The joint initiatives of BB and Government brought favourable changes in SME financing by the banks and NDFIs, resulting in appreciable increase in credit flows to the SME sector. The total amount of SME loans disbursed increased from Tk. 535.44 billion to 1617.68 billion between 2010 and 2017 as evident.

Actually from recent information from BB Annual Reports. Another positive change occurred in credit flows to the women enterprises from Tk 18.05 billion to 47.73 billion during the same period.

Increasing flow of institutional finance to the SME sector is continuing through country of the Bangladesh Bank in the form of various category of SME loans injected in the sector.

These are aggregate figures which do not reveal the intra-size differences within the SMEs as recipients of the total flow.

Notwithstanding the positive steps towards enhanced flows of institutional credit to the SME sector, the overall picture is not yet very shiny, rather remains grossly inadequate compared to the needs of the SME sector.

Information available from various sources -- researchers, private practitioners and donor agencies though truncated, it is confirmed that only about 30-40 percent of SMEs are recipients of institutional loans.

While the trend is increasing, it is still grossly inadequate which acts as a serious obstacle to the sectors growth and expansion.

Remedial Options

There are plenty of "best practices" for SME financing around the world to learn and adopt selectively in Bangladesh.

However corrective policy measures and removal of institutional rigidities need to be introduced to prevent market failures and consequential size barriers constantly impeding the SMEs from accessing financial markets.

The state-owned commercial banks and the specialized financial institutions living on subsidies from the Govt. cannot be the right vehicles to extend credits to the SME sector as they are reluctant and too costly and unaffordable to the SMEs.

The private commercial banks given their underlying business philosophy of earning profits can never be SME-friendly to a desirable extent.

What is the option than?

However, since they have branches all around may be convinced by Government policy measure to work in partnership with the MFIs and extend credit facilities deep down into rural areas and reach the SMEs.

To start such partnerships there are lot of examples to borrow from the neighbouring countries in South Asian and East Asia.

A critically important precondition for making effective SME-friendly measures and regulatory regime is that our political culture should be strongly supportive of the financial needs of the poor, SMEs, the rural population and the farmers.

Consequently, extensive array of foremost government schemes may be designed to provide financial services to all low-income groups.

Needless to reiterate, Govt. has to initiate a number of rules and regulations to create an enabling environment for the new players to come forward with different types of financial products in the market.

This is important to diversify and increase the depth of our capital and financial markets so that fund seekers may have better bargains and improve their financial health.

The author is former professor of the Department of Economics at the University of Dhaka