Banks in Pakistan lend to small and medium enterprises (SMEs) selectively and, at times, reluctantly. They have a reason to do so: about 95 per cent of SMEs work in the informal sector i.e. they are not documented. Lending to them is far riskier than lending to a tax-paying individual.
That explains why banks offer personal loans generously, but keep SME lending under tight controls. This helps grey banking or informal lending-borrowing thrive. Since grey banking largely remains unchecked, tax-evading SMEs don’t mind being ignored by banks.
But as the government makes tax evasion more difficult — and as gradual digitisation of the economy makes it easier to trace movement of untaxed funds — things are bound to change. Banks will have to realise that instead of ignoring SMEs that don’t fulfil borrowing prerequisites, it’s better to sensitise them to the need for documentation. It is in the interest of banks to boost SME financing because that is where they can earn fatter profits and that is where interest-earning streams run longer.
Unlike corporate entities that believe in frequent credit shopping, SMEs do business with banks of their choice for a long time.
Fresh lending to the private sector was Rs923bn in 2018. In that credit pie, the share of fresh lending to SMEs was just Rs63bn, or 6.8pc
SMEs, too, should realise that getting registered and coming under the tax net is key to their survival and growth. The more they try to delay this, the higher the cost of regularisation. Besides, as the need for promoting SMEs becomes more pressing with a new phase of industrialisation taking place in the backdrop of the China-Pakistan Economic Corridor (CPEC) and associated foreign investment, undocumented SMEs would miss future tax and non-tax incentives.
Also Read: SMEs make record borrowing of Rs513 billion
Keeping this official line in mind is important before analysing the latest rise in SME financing. According to the State Bank of Pakistan (SBP), banks’ stock of lending to the SME sector swelled to Rs513 billion in 2018 from Rs450bn in 2017. This means banks made fresh lending of Rs63bn to SMEs last year. Banks and even the central bank tend to look at such numbers through the prism of percentage. If you, too, are fond of using that prism, say bravo to banks and the SBP for this 14pc increase in SME lending in 2018.
But now look at the issue a bit differently. In 2018, banks’ fresh lending to the private sector stood at Rs923bn. In that credit pie, the share of fresh lending to SMEs was Rs63bn, or just 6.8pc of the total.
According to the SBP, the SME sector is contributing 30pc towards Pakistan’s GDP, employs more than 80pc of non-agriculture workforce and generates 25pc of export earnings. Are banks doing justice to SMEs by offering them less than 7pc of their total fresh lending to the private sector? Official estimates put the total number of SMEs at around 3.2m, but only a fraction of them qualifies for bank loans.
The oft-quoted reason is that many of them operate in the informal sector. Why doesn’t the government tell us how many of them are documented? Do all of those registered and documented SMEs get formal bank finance? Even if we suppose that 10pc of the 3.2m SMEs are in the formal sector — and this is a guarded estimate given the pace of regularisation of SMEs in the past 10 years — the number comes to 320,000 to be exact. But banks cater to a little more than half of them. Why?
Till the end of 2017, the total number of SME borrowers stood around 164,000, according to SBP data. Bankers say they did not reach out to a large number of new SMEs in 2018 whose figures are yet to come out.
The disbursement of Rs63bn loans to 164,000 SMEs in 2018 means the average per-party lending was less than Rs385,000 even if we suppose the number of SME borrowers remained at the 2017 level. Bankers admit privately that over the years they have become addicted to parking funds in zero-risk government treasury bills and bonds. When it comes to private-sector lending, they seldom look beyond corporate and personal finance.
When we hear stories of agriculture loans growing, we forget that net fresh lending to the agriculture sector grows slowly. But most of us tend to look at gross agricultural lending. SME lending, like agricultural finance, requires specialised banking skills. That, combined with a larger number of loan applicants, increases both the cost of credit and the workload on bank branches. Though higher interest rates compensate the additional cost of credit, most banks lack both the expertise and the will to exploit the full potential of SME financing.
It is not clear if they actually reached out to new SME borrowers in 2018. But in 2017, we saw a decline in the number of SME borrowers to about 164,000 from more than 177,000 in 2016. Giving banks a pat on the back for achieving a 14pc growth in SME financing is good. But does the SBP also question them on why they cater to only a fraction of the total number of SMEs in Pakistan? By the way, the central bank actually issued a press release to celebrate this achievement.
The CPEC is gathering pace. New foreign investment is expected to come in a big way in a couple of years from some countries, most notably Saudi Arabia. That means more scope for the establishment of new, and expansion of existing, SMEs in up- and downstream industries in mining, petroleum production, infrastructure development, gas and electricity production, alternative energy, food and agriculture etc. So the demand for formal finance by the SMEs of the manufacturing sector will likely grow manifold.
Similarly, if Pakistan overcomes its present economic crisis and starts growing at 5pc-plus rate in coming years, SMEs in trading and services sectors will also be doing well. That will create additional demand for bank financing.
Banks will have to come out of their comfort zones, reach out to new SMEs and service the existing ones with more dedication. Islamic banks and Islamic banking divisions of conventional banks need more to do in this regard as their combined share in SME finance is very low — 10pc as of 2017. A lot depends on whether the government lives up to its promise of revitalising the SME sector through the introduction of a culture of research and innovation.
Published in Dawn, The Business and Finance Weekly, February 25th, 2019