Access to Finance and Technolgical Upgradation for Smes

Introductory Summary

1. The Small and Medium Enterprises popularly called SMEs are considered the engine of economic growth due to their contribution in employment creation, income generation, higher productivity, innovation, transformation, poverty reduction and overall economic growth. SMEs are typically labor intensive industries with relatively low capital base as such for a country like Bangladesh SMEs have a natural comparative advantage.

2. SMEs are considered "Missing Middle" as banks and other formal financial institutions are apparently reluctant to expand their credit portfolio to SMEs; because of their higher risk than other corporate or commerce. MFIs, as the suitable alternative, cannot play desired role in rationalizing financial services for SMEs because of their nature and method of funding. Firstly, their products are designed for the alleviation of poverty. Secondly, the organizational and financial structures make them difficult to expand the services for SMEs. However, SMEs need a variety of financial services whereas the MFIs generally offer one or a few limited financial services. For example, SMEs may need to finance fixed investment which needs longer term maturity, a gestation period, different forms of credit services, not only working capital but letters of credit, it may also need equity etc. These products are not offered by the MFIs.

3. Financing provided by the banks and financial institutions represent the primary source of institutional financing for SMEs in Bangladesh. Still SMEs are underserved by these lenders due to several reasons. First, financial institutions require borrowers to pledge fixed assets such as land as collateral, which most SMEs are unable to provide. Second, SMEs are perceived to be high risk undertaking. Third, SMEs may require long-term growth financing, but often have access only to short-term working capital. Fourth, the repayment terms of the financing often do not match the cash flow profile of SMEs. Fifth, accounting practices and maintenance of financial records are inadequate or unreflective of actual position, leading to banks reluctance to finance. Sixth, generally a vulnerable group, prone to failures due to any change in status requiring funds for family and social needs. Seventh, diversion of funds to land or other sector. However, majority SMEs are still doing business in traditional system what makes them tough to arrange necessary papers and documents asked by the banks.

4. ADB study (2005) on bank finance mentioned that banks and other NBFIs in Bangladesh do not perceive SME as attractive and profitable business. The formal sector thinks that SME lending would not be cost effective for them because they do not have sufficient and consistent financial records and adequate assets for collateral requirement that is essential for formal financial institutions. In this regard National Task Force on SME (2005) has given emphasis on the allocation of bank finance for the development of this sector.

5. There is an issue of interest rate charged by banks and FIs for SME finance. Very often it is argued that the interest rate on SME loan is too high and needs to be lowered. Following the interest rate liberalization, the responsibility to determine interest has been left to the lending banks and financial institutions. Under the liberalized interest rate regime central bank's intervention to reduce interest rate for a particular sector will not be in order and involve the risk of being construed as a retrograde policy. Then again, the cost of deposit fund and other socio economic issues particularly the inflation, operating cost and non recovery trend force the banks to charge high interest rate.

6. Conversely, though financing is very important for SMEs, the cost of fund that increases the cost of doing business is also the factor for their competency, sustainability and expansion. Banks and FIs should consider the fact that if the rate of interest is too high, the profitability of entrepreneurs, especially for those of the small projects will be adversely