An Empirical Study on Southeast Bank Limited.(Part-5)

2.Introduction On SME

In almost every part of the world, limited access to finance is considered a key constraint to private sector growth. This is especially true for SMEs of our country as they are facing different types of problems for availing institutional finance though SMEs play dominantly important role in the national economy of Bangladesh by making up over 90 per cent of industrial enterprises, providing employment to 4 out of 5 industrial workers and contributing to over one-third of industrial value-added to gross domestic product (GDP). The relative SME share in manufacturing value-added is much higher and estimated to vary between 45 to 50 per cent of totaling value-added generated by the manufacturing industries sector.

Further as important sources of new business creation and developing new entrepreneurial talents, these industries provide the much needed dynamism and vitality to the national economy. Implementation of poverty alleviation action programs and strategies is a systematic and continuous effort in Bangladesh. For that purpose, the Poverty Reduction Strategy of the government has clearly identified some core principles and parameters both at macro and micro levels for reducing the existing poverty level at least half within 2015 as targeted in the Millennium Development Goals (MDGs). Rapid and sustainable growth of SMEs is undoubtedly one vehicle for accelerating national economic growth to the point of having a measurable impact in the way of reduction of poverty and unemployment, generation of more employment. More than 90% of the industrial enterprises in Bangladesh are in the SME size-class. Generally, SMEs are labor intensive with relatively low capital intensity. The SME also posses a character of privilege as cost effective and comparative cost advantages in nature. The SME policy strategies have been formulated to assist in the achievement of the goals and targets the MDGs set by the Government.  Because of the definitional problems mentioned above, information on SME is not readily available in Bangladesh. BBS conducts annual surveys of the manufacturing sector, called the Census of Manufacturing Industry (CMI), but as mentioned earlier the BBS lumps under the “Large” category information on all units with 50 or more workers and hence the information cannot be separated in most cases for the 50-99 workers size category, which is

the more commonly used cut-off size limit for medium enterprises. Moreover, there is quite a bit of backlog in the processing of the CMI data. The latest available published CMI report is for the period 1999-2000. The prime agency for the promotion of small and cottage industries in Bangladesh is the Bangladesh Small & Cottage Industries Corporation (BSCIC). BSCIC is required to maintain information and data bank on small and cottage industries in Bangladesh and accordingly the agency carries out nation-wide surveys of the sector at some time intervals. However, the latest such survey by BSCIC was conducted in the late 1980s and it was based on the definition of small and cottage industries given in the earlier industrial policies that used capital rather than employment size as the cut-off limit. Fortunately, BBS carried out a nationwide census of all non-farm economic activities in 2001 and 2003 and a preliminary report based on the census has been made available recently. The report presents data by employment size category but there is no information on the size of fixed assets.

3.1. Definition of SME

Schools are divided when it comes to defining SME. Each school has there own way of defining SME.

EU, USA and other country wise definition

Small and medium enterprises (also SMEs, small and medium businesses, SMBs, and variations thereof) are companies whose headcount or turnover falls below certain limits. The abbreviation SME occurs commonly in the European Union and in international organizations, such as the World Bank, the United Nations and the WTO. The term small and medium businesses or SMBs is predominantly used in the USA.

EU Member States traditionally have their own definition of what constitutes an SME, for example the traditional definition in Germany had a limit of 250 employees, while, for example, in Belgium it could have been 100. But now the EU has started to standardize the concept. Its current definition categorizes companies with fewer than 10 employees as “micro”, those with fewer than 50 employees as “small”, and those with fewer than 250 as “medium”. By contrast, in the United States, when small business is defined by the number of employees, it often refers to those with fewer than 100 employees, while medium-sized business often refers to those with fewer than 500 employees.

Both the US and the EU generally use the same threshold of fewer than 10 employees for small offices (SOHO).In most economies, smaller enterprises are much greater in number. In the EU, SMEs comprise approximately 99% of all firms and employ between them about 65 million people. In many sectors, SMEs are also responsible for driving innovation and competition. Globally SMEs account for 99% of business numbers and 40% to 50% of GDP.

In India, the Micro and Small Enterprises (MSEs) sector plays a pivotal role in the overall industrial economy of the country. It is estimated that in terms of value, the sector accounts for about 39% of the manufacturing output and around 33% of the total export of the country. Further, in recent years the MSE sector has consistently registered higher growth rate compared to the overall industrial sector. The major advantage of the sector is its employment potential at low capital cost. As per available statistics, this sector employs an estimated 31 million persons spread over 12.8 million enterprises and the labour intensity in the MSE sector is estimated to be almost 4 times higher than the large enterprises.

In South Africa the term SMME, for Small, Medium and Micro Enterprises, is used. Elsewhere in Africa, MSME is used, for Micro, Small and Medium Enterprises.

Definition for SMEs is often considered to be an obstacle for business studies and market research. Definitions in use today define thresholds in terms of employment, turnover and assets. They also incorporate a reasonable amount of flexibility around year-to-year changes in these measures so that a business qualifying as an SME in one year can have a reasonable expectation of remaining an SME in the next. The thresholds themselves, however, vary substantially between countries. As the SME thresholds dictate to some extent the provision of government support, countries in which manufacturing and labour-intensive industries are prioritized politically tend to opt for more relaxed thresholds.

Breaking down the SME definition, Industry Canada defines a small business as one that has fewer than 100 employees (if the business is a goods-producing business) or fewer than 50 employees (if the business is a service-based business). A firm that has more employees than these cut-offs but fewer than 500 employees is classified as a medium-sized business.

Definition of the Government of Bangladesh

• Small Enterprise (SE) has less than 50 employees and / or less than 15 million Taka in Fixed Capital Investment.
• Medium Enterprise has 51-99 employees and / or Fixed Capital Investments between 1.5 and 100 million Taka

Bangladesh Bank Regulations for Small Enterprises

• Private entity with less than 60 employees for the Manufacturing Sector 30 employees for the Service Sector, 20 employees for the Trade Sector.

1) Service Sector: Total Assets (excluding lands and buildings) between 50,000 and 3 million Taka

2) Trade Sector: Total Assets (excluding lands and buildings) between 50,000 and 5 million Taka

3) Manufacturing Sector: Total Assets (excluding lands and buildings)
between 50,000 and 10 million Taka

Definitions of different commercial Banks of Bangladesh are as follows –

• HSBC Turnover                     < 2.5 million USD
• Citibank NA employees         <  60
• BRAC Bank Loan size           < 3 million Taka
• AB Bank Loan size                 < 100 million Taka

Southeast Bank definition regarding SME

Small Enterprise means an entity, ideally not a public limited company, which fulfils any of the following criteria:

Medium Enterprise means an entity, ideally not a public limited company, which fulfils any of the following criteria:

3.2. Some Issues in SME in Bangladesh

Financial services for the poor have proved to be a powerful instrument for poverty reduction enabling the poor to build assets, increase incomes and reduce the vulnerability to economic stress. Today, access to credit is recognized as a ‘right’ of people globally. Over the years, there has been phenomenal growth in activities of microcredit in many countries of the world and a transition in the paradigm and modalities of microcredit. Microcredit Summit Meeting first held in Washington DC, USA in February 1997 has launched a global movement to reach 100 million of the world’s poorest families, especially the women of those families, with credit for self-employment and other financial and business services by the year 2005. The UN has declared 2005 as the “International Year of Microcredit”, now is the time to reflect on the experiences of Bangladesh, the birthplace of micro finance and the country with the biggest and most vibrant micro finance sector.

As the microcredit movement matures, clearer idea of what its strengths are and what are its limitations. To move forward, countries like Bangladesh  need to be more effective, and increase outreach, design products to include the poorest, and also provide finance for growth and employment oriented small and medium enterprises (SMEs) which are needed to spread the poverty alleviation net wider, so that significant decline in poverty takes place.

A significant number of people around the world are excluded from full participation in the financial sector. Although the unbanked has been an issue for some time, the subject is now receiving greater attention, helped by the fact that 2005 is the United Nations’ Year of Micro-credit. Banking the unbanked is about bringing banking and financial services to those people who, up to now, have not had access. Although the unbanked is usually thought of in terms of individuals, it is an important issue for small firms as well.

Small and medium sized enterprises (SMEs) may not always have the same access to banks and financial institutions as big firms. Thus access of SMEs to the range of financial services is a key issue that needs to be considered in terms of banking the unbanked.

It is generally recognized that SMEs have a significant role in employment generation, poverty reduction and overall economic growth, especially for a developing economy like Bangladesh. SMEs are typically labor intensive industries with relatively low capital intensity. As such for a country like Bangladesh which is labor abundant and capital scarce, SMEs have a natural comparative advantage. In recognition of the strategic importance of the development of SMEs in promoting industrial growth, employment generation and poverty alleviation the SME sector has been declared as a priority sector in the Government’s Industrial Policy 2005 and various measures have been initiated to help maximize the SMEs growth potential.

Availability of finance is thought to be a major constraint to formation and growth of SMEs in Bangladesh. Banks are reluctant to expand their SME credit portfolio because they do not consider SME lending an attractive and profitable undertaking. This is so because SMEs are regarded as high risk borrowers because of their low capitalization, insufficient assets and their inability to comply with collateral requirements of the banks. Administrative costs are also higher because close monitoring and supervision the SME operation becomes necessary.

Despite all these facts banks and financial institutions have been providing finance to the SME sector and the volume of finance is showing an increasing trend. Most importantly the share of private sector banks in disbursement of credit to the SME sector has been increasing in recent years comparatively at a higher rate than the NCBs and state owned DFIs.
There is an issue of interest rate charged by banks and financial institutions for SME finance. Very often it is argued that the interest rate on SME loan is too high and needs to be lowered. In this regard it may me mentioned that following the interest rate liberalization policy as a part of financial sector reforms, the responsibility to determine interest on loans and advances 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. For entrepreneurs, though the supply of and access to finance is very important, the cost of fund is also a factor for their sustainability and expansion. The banks and financial institutions should consider the fact that if the rate of interest is too high, then the profitability of entrepreneurs, especially for those of the innovative projects will be adversely affected.

Bangladesh Bank (BB) has also undertaken programmes to provide relatively cheaper funds to the banks and financial institutions which might encourage them for SME financing.SME has been identified in the PRSP (Unlocking the Potential) as one of the seven critical sectors for pro-poor economic growth and special emphasis has been give on rapid growth and development of this sector. According to the PRSP the thrust of SME development should be on ‘modern’ SMEs that have higher growth potentials compared to the traditional SMEs. The policies towards SMEs should be based on a positive developmental attitude seeking to assist them by promoting efficiency, adaptation to new circumstances and technology, rather than protecting the sector through a distorted incentive structure. In the PRSP the actions suggested for the development of SMEs in Bangladesh include (i) Adoption of an unambiguous definition of SME; (ii) Strengthening of BSCIC’s capacity to provide market information; (iii) Simplification of regulatory procedures; (iv) Setting up an appropriate credit guarantee scheme for lending without real estate based collateral; (v) Enlarging the base of conduit lending institutions; (vi) Making BSCIC’s industrial estate programme demand driven; (vii) Priority development of the road network and supply of gas and electricity; (viii) Extension of BOIs One-Stop Service to cover SMEs; (ix) Greater public private cooperation for the design and implementation of effective business support service; (x) A differentiated and hassle-free indirect tax system for SME; (xi) Calibration of trade policy reform to support SME development.

3.3. Why all banks are set for Special SMEs?

Question arises why all the banks especially commercial banks are set for special SMEs? The answer is  Bangladesh Bank has set banks and non-banking financial institutions a target to disburse around Tk 24,000 crore loans to the SME sector during the current calendar year, a senior executive of the central bank said.

“This is the first time the central bank has set a target to disburse loans to the SME sector in the country. Bangladesh Bank earlier asked the banks to set their respective targets.
official of Bangladesh Bank said the country’s 48 foreign, state-owned and private banks and 24 non-bank financial organisations will disburse the loans.  According to official of Bangladesh Bank, outstanding loans to the SME sector stood at around Tk 52,000 crore and the number of loanees at about 4.4 lakh at the end of 2009.  He said if the 2010 target is achieved it would be the highest-ever loan disbursement to the sector in a single year. Acting managing director of SME Foundation Momtaj Uddin, however, termed the figure less-than-requirement. Referring to a research finding, he told that around Tk 18,28,000 crore is needed throughout the SME sector. He said the targeted loans should be properly disbursed to the entrepreneurs on easy terms. Most of the previous loans were restricted to the urban areas, he added.  Rural people, particularly women must be given SME loans, he said, adding that increased loans should go for the production sector. Asked which sub-sector would get priority, the official said: “Undoubtedly it’s the export-oriented manufacturing sector.”

Bangladesh Bank offer 100 percent refinancing facility if loans are given to production and service sectors but maximum 50-60 percent refinancing facility will be given in case of business loans. A recent BIDS study revealed that banks and non-banking financial institutions disburse loans mostly to the business sector.  Also revealed that the financial institutions gave loans to around 3.91 lakh small and medium entrepreneurs until September, 2009.

Of them, around 3.35 lakh are trading houses, 54,000 manufacturing and remaining service-sector firms. BIDS research recommended formulation of a guideline for giving collateral-free SME loans as the number of loan defaulters in the sector is negligible. The study conducted on branches of 14 banks revealed that SME loan recovery rate ranges between 80 percent and 100 percent. Bangladesh Bank has undertaken different plans to boost SME sector by increasing flow of money.

3.4. Identification and Assessment of Various Risks in SME financing

In the developing world Small and Medium Enterprise are playing a vital role for the development. They are the major and influential player in the economic growth of different countries like china and India. But still banks are very reluctant in case of lending to those entrepreneurs due to lack of security and high risk of default. Unavailability of finance thought to be a major constraint to formation and growth of SMEs in Bangladesh. Banks are reluctant to expand their SME credit portfolio because they do not consider SME lending an attractive and profitable undertaking.

Usually SMEs are labour intensive business firms. They play a major role in employment generation. So SME can be very effective in reducing poverty and ensuring long term economic growth. So the banks should come forward t finance those SMEs to contribute more in the development of the country. But there are lots of risks involved in SME financing, which the Bank should take very seriously. It is very important to identify and assess the risks properly to make the SME financing successful.

3.5. Importance

The economic and social importance of the small and medium enterprise sector is well recognized in academic and policy literature. It is also recognized that these factors in the economy may be underserved, especially in terms of finance. This has led to significant debates on the best methods to serve this sector.

There have been numerous schemes and programmes in markedly different economic environments. However, there are a number of distinctive recurring approaches to SME finance. Collateral based lending offered by traditional banks and finance companies is usually made up of a combination of asset based finance, contribution based finance, and factoring based finance, using reliable debtors or contracts. Information based lending usually incorporates financial statement lending, credit scoring and relationship lending. Viability based financing is especially associated with venture capital.

3.6. SME Finance Gap

A substantial portion of the SME sector may not have the security required for conventional collateral based bank lending, nor high enough returns to attract formal venture capitalists and other risk investors. In addition, markets may be characterized by deficient information (limiting the effectiveness of financial statement based lending and credit scoring). This has led to claims of an SME finance Gap particularly in emerging economies. There have been at least two distinctive approaches to try to overcome the so-called SME finance gap.

The first has been to broaden the collateral based approach by encouraging bank lenders to finance SMEs with insufficient collateral. This might be done through an external party providing the collateral or guarantees required. Unfortunately, to the extent that the schemes concerned run counter to basic free market principles they tend to be unsustainable. This sector is increasing called the Meso-finance sector.

However, there is no evidence of any significant structural barriers to the supply of bank or private equity finance to suitable SME applicants on mutually satisfactory terms and conditions in contemporary Britain. The main obstacles to funding here appear to be on the demand rather than the supply side of the business plans, accounting and other information; inadequate assets for use as security; and insufficient high levels of profitability, gearing, liquidity, stability and other business financial performance criteria on the part of funding applicants.

The risks of SME Financing

The risks of SME financing can be classified under top major heads they are as follows –

• Internal risks : credit risk and liquidity risk
• External risks: interest rate risk, growth risk, market demand, competition, commodity risk, government policy
• Project risks: legal risk, security risk, marketing risk, operating risk.
• Others: environmental risk, family risk, health risk.

3.7. The Management of Lending SMEs

The effective management of lending to SMEs can contribute significantly to the overall growth and profitability of banks. There has been considerable research and analysis into the methods by which banks assess and monitor business loans, manage business financing risks, and price their products and how these methods might be further developed and improved. There has been particularly intensive scrutiny of the kinds of business financial information that banks use in making lending decisions and how reliable that information actually is. Bank have traditionally relied on a combination of documentary sources of  information, interviews and visits, and the personal  knowledge and expertise of managers in assessing and monitoring business loans. However, when assessing comparatively small and straightforward business credit applications bank may largely rely on standardized credit scoring techniques (quantifying such things as the characteristics, assets, and cash flows of businesses/ owners). Using such techniques and also centralizing or regionalizing business banking operations generally can significantly reduce processing costs. Standardized computer based assessment may also be more accurate and fairer than reliance on the personal judgments of local bank managers. As a result, banks may now be able to offer more loans, faster and in larger amounts, and reduce previously high security requirements. However, business lending as whole is substantially more diverse and complex than personal and residential mortgage lending. This coupled with the large size and inherently risky nature of many business loans tends to limit the scope and desirability of computerized credit scoring in assessment and monitoring.

Higher growth of the Small and Medium Enterprises (SMEs) can help cut poverty to a satisfactory level by eliminating various prejudices against labour intensive and creating jobs for the skilled manpower in the SME sector. This was revealed in the just released Bangladesh Bank annual report for fiscal 2006-07.

The report said, the key reasons behind the SMEs are not entering into manufacturing are financial constrains, dismal state of utilities, technology and policy discriminations. On the others hand, Bank and others financial institutions generally prefer large enterprise clients because of lower transition costs, and greater availability of collateral.

The SMEs also fall outside the reach of micro finance schemes, and thus compelled to depend on formal sources of funds at much higher interest rates, the Bangladesh Bank report said.

The BB report, however, said that other interrelated problems like shortage of short and long term finance, lack of modern technology and lack of promotional support services are major obstacles in the way of development of the SMEs sector. Higher growth of the Small and Medium Enterprises (SMEs) can help cut poverty to a satisfactory level by eliminating various prejudices against labour intensive and creating jobs for the skilled manpower in the SME sector.
This was revealed in the just released Bangladesh Bank annual report for fiscal 2006-07.

The report said, the key reasons behind the SMEs are not entering into manufacturing are financial constrains, dismal state of utilities, technology and policy discriminations. On the others hand, Bank and others financial institutions generally prefer large enterprise clients because of lower transition costs, and greater availability of collateral.

The SMEs also fall outside the reach of micro finance schemes, and thus compelled to depend on formal sources of funds at much higher interest rates, the Bangladesh Bank report said. The BB report, however, said that other interrelated problems like shortage of short and long term finance, lack of modern technology and lack of promotional support services are major obstacles in the way of development of the SMEs sector.

Considering these obstacles, the report said, Bangladesh Bank has adopted a preferential lending policy to promote the SME sector in line with the government development policies. An amount of Taka 2.27 billion was refinanced through different banks and financial institutions under some schemes during the fiscal 2006-07.

In the country, the annual report said, financing small and medium enterprises (SMEs) from banking sector is a long-standing demand that has been high on the agenda of the economists and the policymakers.

In Bangladesh the SMEs account for about 45% of manufacturing value addition. They account for about 80%of industrial employment, about 90% of total industrial units and about 25% of total labour force. Their total contribution to export earnings varies from 75- 80% based on the

Economic Census 2001-2003.

The total number of SMEs is estimated at 79754 establishments, of which 93.6% are small and 6.4% are medium. The 2003 Private Sector Survey estimated about 6 million micro, small, and medium enterprises defined as enterprises, with fewer than 100 employees who contributed around 20-25% of GDP.

The report observed that the SMEs demand for bank loan, especially, medium and long term financing is relatively high.

The Banks are reluctant to extend loans, especially, term loans to SMEs and the reasons for banks’ reluctance to extend loans to SMEs are perception that the current legal system is unable to protect their interests, funding costs are relatively high, shortage of access to long-term capital, inability to conduct proper due diligence and the current unavailability of information.

For more parts of this post-

An Empirical Study On Southeast Bank Limited.(Part-1)

An Empirical Study On Southeast Bank Limited.(Part-2)

An Empirical Study On Southeast Bank Limited.(Part-3)

An Empirical Study On Southeast Bank Limited.(Part-4)

An Empirical Study On Southeast Bank Limited.(Part-5)

An Empirical Study On Southeast Bank Limited.(Part-6)

An Empirical Study On Southeast Bank Limited.(Part-7)