Term Paper on Impact of SME Financing by Commercial Banks

Main purpose of this term paper is to analysis Impact of SME Financing by Commercial Banks. SME financing has the capacity to play vital role inside the Millennium Development Goals (MDGs) in particular to eradicate extreme poverty and hunger and girl or boy equity and women allow man. Finally identify the strengths and weaknesses of the SME loan approval and monitoring process in Bangladesh Bank and make recommendations regarding the Commercial Banks SME Financing related activities.

Introduction

Bank is committed to provide high quality financial services/products to contribute to the growth of the country through stimulating trade and commerce, accelerating the pace of industrialization, boosting up export, creating employment opportunity for the youth, poverty alleviation, raising standard of living of limited income group and overall sustainable socio-economic development of the country. In achieving the aforesaid objectives of the Bank, Credit Operation of the Bank is of paramount importance as the greatest share of total revenue of the Bank is generated from it, maximum risk is centered in it and even the very existence of Bank depends on prudent management of its credit portfolio. The failure of a commercial Bank is usually associated with the problem in credit portfolio and it’s less often the result of shrinkage in the value of other assets. As such, credit portfolio not only features dominant in the assets structure of the Bank, it is crucially importance to the success of the Bank also.

Concept of Commercial Bank

Commercial banks primarily raise funds by issuing checkable deposits, savings deposits and time deposits. They then use these funds to make commercial, consumer and mortgage loans, and to buy government and private securities and bonds. Yet there are important differences from one commercial bank to another. All commercial banks perform two general functions: (i) acceptance of deposits from different sources and (ii) lending (direct lending to borrowers and indirect lending through investment in open-market securities.) They are always involved in trade finance activities, including providing short-term credit, which is often their most profitable business.

Local banks often have a wide local network and handle both small and large transactions. Local commercial banks (nationalized and private) in Bangladesh are no less competent than international banks and are more suitable for SMEs.

Small local commercial banks, with few or no branches, often specialize in short-term credit for trading activities and refinance these from the deposits they take from their customers. Being smaller and more flexible, their level of service is sometimes more attractive.

Foreign commercial banks, are part of (or are managed by) an international group, which may be beneficial to you as a tracer and borrower. There are now 12 foreign commercial banks in Bangladesh.

Definition of SME

SME finance is the funding of small and medium sized enterprises, and represents a major function of the general business finance market – in which capital for different types of firms are supplied, acquired, and coasted or priced. Capital is supplied through the business finance market in the form of bank loans and overdrafts; leasing and hire-purchase arrangements; equity/corporate bond issues; venture capital or private equity; and asset-based finance such as factoring and invoice discounting.

However, not all business finance is external/commercially supplied through the market. Much finance is internally generated by businesses out of their own earnings and/or supplied informally as trade credit, that is, delays in paying for purchases of goods and services.

Small Enterprise

Trading Concern: Total asset at cost excluding land & building from tk 50000 to tk 50lac & no. of employees less than 25 persons.

Manufacturing Concern

Total assets at cost excluding land and building from tk50000 to tk 1.5 crore & no. of employees less than 25 persons.

Service Concern: Total assets at cost excluding land and building from tk 50000 to tk 50lac & no. of employees less than 25 persons.

Medium Enterprise

• Trading Concern: Total asset at cost excluding land & building from tk 50 lac to tk .01 crore & no. of employees less than 50 persons.
• Manufacturing Concern: Total assets at cost excluding land and building from tk 1.5 crore to tk 2.0 crore & no. of employees less than 50 persons.

Service Concern

Table-1 Total assets at cost excluding land and building from tk 50 lac to tk .01 crore & no. of employees less than 50 persons.

Profile of SMEs in Bangladesh

Most of the industrial enterprises in Bangladesh are typically SME in nature. A total of 3869 new SME units were set up and 94 thousand new employment opportunities have been generated during the period of 2002 – 2006. Most of the employment has been created in the medium scale manufacturing sector. On the other hand, small scale manufacturing units could not live up to the expectation as regard to their growth. Small stale industries like insurance and education has been expanded and manufacturing, construction, trade, transports, real estate, health, and personal service has been believe to be shortened during this period.

The SMEs are undoubtedly quite predominant in the industrial structure of Bangladesh comprising over 90% of all industrial units. 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 which contributed around 30-35% to GDP.

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.

SME Financing

There is wide recognition that small and medium enterprises (SMEs) play a critical role in the economic growth and industrial development of developing countries worldwide. The importance and role of micro and small enterprises for overall economic development of Bangladesh is inevitable too. SMEs contribute substantially to the economy both in terms of number of enterprises and workers. SMEs could provide non-farm opportunities particularly through manufacturing activities making   use of locally available inputs; thus strengthening the country’s industrial structure.

SMEs are accounting for 20.0 to-25.0 percent of GDP, 40 percent of employment, 80 percent of industrial jobs and 25 percent of the total labor force in Bangladesh. As such SME is considered a priority sector as announced by present Government of Bangladesh. Through Bangladesh Bank and the government of Bangladesh has taken a number of policy initiatives so that banks and other financial institutions might come up with mind setup for financing in that thrust sector. Bangladesh Bank launched a new department in 2011 to administer and develop a congenial environment for SME.

Objectives of SME Financing

Bangladesh Bank has given much emphasis on the issue of financial inclusion of large number of prospective entrepreneurs and borrowers. Financial inclusion may be possible through the development of SMEs; particularly extending the domain of SME policies.

Rapid and sustainable growth of Small and Medium Enterprises (SMEs) is undoubtedly an essential tool for accelerating national economic growth. SMEs are generating employment and thereby alleviating poverty. In Bangladesh, SMEs have emerged a cornerstone of economic development in terms of job creation, income generation, development of forward and backward industrial linkage and meeting local needs. Commercial banks have roles to play in facing challenges of globalization through a balanced and sustainable industrial development of the country by supporting SMEs. The main purpose of SME loans is to boost the economic development of the country by extending credit facilities to the market segment and that traditionally are a step behind in banking practices.

Strategies for the Development of SME Financing

For the first time, Bangladesh Bank has made a comprehensive policy and programs on SMEs which has got much appreciation of all the stakeholders in Bangladesh. After commencement of the present Government, Bangladesh Bank has taken a lot of action plans and programs on SMEs under the leadership of present Governor Dr. Atiur Rahman. Bangladesh Bank feels proud of its excellent policy, right leadership and available dedicated workforce. Some of the strategies for SME financing are outlined below-

• Setting up an   indicative target for SME loan disbursement,
• Following the “Area Approach Method³“
• Cluster development Policy
• Priority  to  the   small   entrepreneurs,   women entrepreneurs,
• Special emphasis for manufacturing and service sectors,
• Monitoring SME activities in the Head Office of Bangladesh Bank
• Following    separate    business    strategies    in financing SME
• Speedy loan sanction and disbursement.

Status of SME Financing in Bangladesh

47 Banks and 29 Non-bank financial institutions play a major role for SME financing in Bangladesh under supervision and regulation of Bangladesh Bank. However, previously banks generally did not finance any SME without collateral even women entrepreneurs. The wave has been changed at least partially in recent times since the government of Bangladesh emphasize that the SME sector would be the major roie player for fostering economic growth of Bangladesh like many developed countries in the past and like many developing countries at present.

Table-2 Total SME Loan Out Standing (in crore Tk.)

Source: Total SME loan outstanding (incrore Tk.)

The most popular approach for SME financing is collateral based lending. Besides internal financing by own finance, financing by banking institutions form the most important supply side source of external finance. As of June, 2011 the total outstanding of SME loan was Taka 3,60, 564 crores was 20.12% of the total loans and advances. The average share of bank financing bank financing to SME is about 95 %, out of which private commercial banks are the dominant supply sources.

By the end of June, 2011 their outstanding SME loans was Taka 18,943 crores which was only 5.3% of the total SME loan outstanding. In terms of sectoral segregation, trading sector on average contributes about 58% while the manufacturing sector contributes by 35% of SME loan outstanding. Figure-1 depicts the total SME loan outstanding for the period of March 2010 to June, 2011.

Bangladesh Bank and other international agencies like ADB, IDA have launched refinance schemes to support Banks and NBFls for SME development. The following table shows various refinance schemes under Bangladesh Bank’s administration and supervision.

Table-3 Cumulative Fund Disbursement as on October 2011

Source: Total SME loan outstanding (in crore Tk.)

AB Bank

Manufacturing enterprise

Small enterprise

An enterprise should be treated as small if, in current market prices, the replacement cost of plant, machinery and other parts / components, fixtures, support utility, and associated technical services by way of capitalized costs (of turn key consultancy services, for example), etc, excluding land and building, were to be up to tk. 15 million;

Medium enterprise

An enterprise would be treated as medium if, in current market prices, the replacement cost of plant, machinery and other parts / components, fixtures, support utility, and associated technical services by way of capitalized costs (such as turn key consultancy  services), etc, excluding land and building, were to be up to tk. 100 million;

Non-manufacturing enterprise

Small enterprise

An enterprise should be treated as small if it has less than 25 workers, in full time equivalents.

Medium enterprise

An enterprise would be treated as medium if it has between 25 and 1 00 employees.

ABBL SME Financing

The AB bank ltd. is now focusing on to capture this ‘missing middle’ by developing SME loan products and selling them through countrywide branches. In addition to the branches there are separate SME sales center running by SME business Development managers and a group of sales people, who exclusively concentrate on capturing SME business from market.

The bank concentrates on Medium Enterprise financing with a special focus to also finance the small enterprises.

Eligible clients

Eligible clients for SME financing are those, who can be termed as either small Enterprises or Medium Enterprises as per following definition of Bangladesh Bank.

Table-4 Small Enterprise

Product of SME Loan of ABBL

Small and Enterprise has emerged as the cornerstone of economic development of Bangladesh in terms of job certain, income generation, development of forward and backward industrial linkage and meeting local needs. However the full potential of the same has not yet been realized due to lack of necessary support. The constraints to the development of SMEs include lack of access to finance, poor power supply and infrastructure, marketing, product standard, lack of sufficient export incentive etc. In the change scenario of increasing competition in the large loan sector and curtailment of  single obligor limit by the Bangladesh Bank, it has become necessary of shift dependence  from large corporate to the medium and small enterprise.

The following loan scheme under the category of small and medium enterprise (SME) has been introduce:

1. Gati
2. Proshar
3. Digun
4. Sathi
5. Chhoto Puji
6. Uddog
7. Awparajita

AB Bank limited provides seven types of SME loans which depend on product size and product concern. The researcher analyze AB bank SME product by depending on both product Size and Product Concern. At first the researcher show the characteristics of product Size and Product Concern. Then analysis the SME Product of AB bank with Product definition, Maximum Loan Amount, Interest Rate, Service Charge, Tenor, Repayment, Security and/or Collateral of the product.

SME Profile

AB Bank limited provides seven types of SME loans which depend on product size and product concern. The researcher analyze AB bank SME product by depending on both product Size and Product Concern. At first the researcher show the characteristics of product Size and Product Concern. Then analysis the SME Product of AB bank with Product definition, Maximum Loan Amount, Interest Rate, Service Charge, Tenor, Repayment, Security and/or Collateral of the product.

Table-5 SME Product

Table-6 Loan Application& Disbursement scenario of SME in ABBL

Table-7 Growth Rate

Table-8 SME Contribution in Total Loan & Advance

BRACK Bank

Business Units

There are five different business units generating business BRAC BANK Limited-

• Small & Medium Enterprise (SME)
• Corporate Banking
• Retail Banking
• Treasury
• Remittance Services

All the units are being operated in a centralized manner to minimize costs and risks.

Table-9 Operating Profit

Products of SME Financing

• Anonno: A collateral free business loan to one year going concern i.e. small and medium sized trading, manufacturing, service, agriculture, non-farm activities, agro-based industries etc. all over Bangladesh.
• Apurbo: A mortgage backed business loan to small and medium sized trading, manufacturing, and service, agriculture, non-farm activities, agro-based industries etc. all over Bangladesh.
• Aroggo: The main objective of this loan is to finance private clinics and diagnostic centers. Through this loan, health centers will get the opportunity to upgrade their medical facilities or expand business. This will contribute to the overall enhancement of health facilities available in Bangladesh.
• Pathshala: This credit facility is for small & medium sized private educational institutions, like kindergartens and schools which are spread all over Bangladesh.
• Digoon Rin: This product’s main objective is to help various Small and Medium sized Entrepreneurs to meet their short-term cash flow shortage or bridge the fund-flow gap. To avail this facility the enterprise has to give 50% cash security (Fixed deposit of BRAC Bank) of the loan amount i.e. double of the Fixed Deposit amount can be availed as Digoon RIN.
• Supplier Finance: A loan facility for the enlisted Suppliers of various large retailers, marketing companies, distributors, exporters etc. This product’s main objective is to help various Suppliers to meet their short-term cash flow shortages or bridge the fund-flow gaps.
• Prothoma Rin: An asset product offered to women entrepreneurs to expand their businesses. This product’s main objective is to help women entrepreneurs to meet their short-term cash flow shortages or bridge the fund-flow gaps.
• Cash Secured Loan: Cash secured loan is a loan facility for small and medium sized trading, manufacturing, service, agriculture, non-farm activities, agro-based industries etc. spread  all over Bangladesh through the branches or unit offices across the country.
• Proshar: Proshar is a loan facility for Small and medium sized manufacturing industries located in the surrounding areas of unit offices across the country. It is primarily meant for working capital finance/ fixed asset purchase for the business.
• Bizness Loan: This loan facility caters cash flow requirement of medium sized enterprises located around the unit offices which are at proximity of the BRAC Bank Branches. To avail this loan facility healthy banking track record is required and medium sized entrepreneurs can avail this loan facility against 30% to 50% cash security.
• Trade Plus: This product offers both funded & non funded loan facility to import oriented Small & Medium Entrepreneurs and constantly supports them to smoothly operate their import activities.
• Super Supply Loan: Super Supply Loan is a loan facility for small & medium sized suppliers located throughout the country. This loan facility offers 25% overdraft & 75% revolving loan of the sanctioned loan mount.
• Bizness Account: It is special interest bearing current account. The account holder will have numerous facilities including a smart BiZness card.

SME Loan Disbursement Procedure

For SME loan operation,

BRAC BANK LIMITED Ltd has in total 429 unit offices, 167 zonal office, 14 territory and 1800 Customer Relationship Officers. These CROs work for the Bank to converge clients for getting the SME loan. SME Loan process flow is shown below-

Disbursement Amount & Client Base of SME Financing

BRAC Bank’s SME financing is continuing its journey of serving the SMEs, as can be observed from the tremendous growth in client base and from the disbursement amount.

Table-10 Disbursement Amount of SME Financing in million BDT (Cumulative)

Table-11 Number of SME loan disbursement (Cumulative) & Recovery

Mercantile Bank

In the present day banking, focus has greatly shifted to the SMEs for maintaining a sustainable growth of the banks and the economy of a particular country as well. Properly managed and healthy SMEs are the source of employment opportunities and income generation among the lower segment of the economy. They can contribute to social stability and generate tax revenues if it can be handled properly in the fiscal policy. SMEs can be an important source of local supply and service providers to the large enterprises. They usually have extensive local knowledge of resources, supply patterns and purchasing trends. Developing countries contain a huge, largely untapped market for large enterprises. By working closely with SMEs, large enterprise can develop a new customer base that may not be accessible to the traditional distribution networks of these corporations.

SMEs also represent an important source of innovation. They tend to occupy specialized market “niches” and follow competitive strategies that set them apart from other companies. This might include re-engineering products or services to meet market demands, exploring innovative distribution or sales technique or developing new and untapped markets. This often makes them good partners for large companies.

Product Program of Mercantile Bank Limited

Product Program Guidelines (PPG) for SME financing of Mercantile Bank Limited are designed and developed to meet up all types of justified business requirements of SME customers. However, the features of the products so far developed may be changed, revised, while new products can also be developed to cope with the market demand as per guidelines of Bangladesh Bank and the Bank’s own policy.

Business Support Services on SME Financing

Business Advisory Service Centre

SME Foundation has taken initiatives of enterprise development by providing business support services to the SMEs. In this regard, the Foundation has set up an SME Advisory Service Centre at the SMEF office premises in Dhaka. The nature of business support services provided for enterprise development are as follows:

1. Provide basic information and data on SME sectors
2. Provide reference materials on how to start SME business
3. Policy advocacy on SME development

Table-Service Center provided advice to 181 entrepreneurs as over the reporting year the follows.

SME Business Manual

The Foundation is going to publish a SME Business Manual. The business manual contains important issues like business start-up. Tax and VAT, banking and insurance, utility services, registration & license, quality certification, import and export procedures etc.

SME Product Display & Sales Center

SME Foundation has taken an initiative to establish SME Product Display & Sales Center at SMEF office premises. Till reporting date, 60 SMEs have shown their interest to display their products at the product display & sales center.

Local SME Product Fair

SME Foundation assisted different trade bodies/ Associations (NASCIB, CWCCI, Tat Shilpo Samity and Fashion & Design Association) in organizing seven SME fairs with a view to market expansion, promotion, and linkage establishment between the buyers and sellers.

International SME Trade Fair

SME Foundation facilitated a number of SME entrepreneurs in attending international SME fairs held in Malaysia, Nepal, Sri Lanka and India. The entrepreneurs displayed their products and attended seminars/ workshops at the fairs.

Establishment of Cluster-based Industrial Park

SME cluster development is considered as one of the best approaches for the private sector development. SME Foundation moved to set up a Co-located Cluster Industrial Park with the support of International Finance Corporation (IFC).

Export Potential of SMEs

Small and medium enterprises (SMEs) are considered to be the backbone of economic growth of an economy in industrial development. Due to their numbers, size and nature of operations SMEs have a significant role in promoting growth and strengthening the infrastructure for accelerated economic expansion and development in the country. Promotions of SMEs in fact lead the economic development and help broaden the base export as well. SMEs typically account for more than 90% of all firms outside the agricultural sector, constitute a major source of employment and generate significant domestic and export earnings.

Table- Statistics world’s trade in selective SME products

Value in mln US$

The above statistics represent the poor performance of Bangladesh in the export in the SME sector. The total volume of world trade in most of the SME products is really big in terms of Bangladesh export. Our SMEs can reach in a height in the world trade if proper policy support and infrastructure are provided.

Access to SME trade finance at competitive interest rates can be strengthened through export credit guarantee schemes for SMEs, and subcontracting and specialist soft loans for SME export activities.

SME Financing in Bangladesh:

An Economic Outlook and the Role of the Commercial Sector

The Vision   2021 envisages a democratic system where the citizens of our country will be assured of social justice, environmental protection, human rights and equal opportunities; and where the rule of law and good governance flourish.

In the milieu of major economic challenges, where the world economy is still struggling to recover from the global crisis and the developed nations are battling with macroeconomic problems including sovereign debt and financial setbacks, [he current economic scenario of Bangladesh is indeed buoyant where our GDP growth for the Fiscal Year (FY) 2010-11 has been 6.66% and the target for the FY 2011-2012 is 7. Firms enjoy positive economies of scale due to greater scope for flexibility, development of entrepreneurship and closeness to markets, it makes them less vulnerable to risks and long term threats.

Bangladesh has approximately 27,000 medium sized enterprises and about 150,000 small sized enterprises contributing to_25%. of GDP. Out of the total, number, 14 % SMEs are involved with manufacturing sector, 15% SMEs are involved with service sector, 22% SMEs are involved with production and sales of agricultural .products and 40% of SMEs are involved with wholesale, retail and repair business. These SMEs directly employs 1.5 million people and indirectly supports employment of up to 15 million persons. Of the total manufacturing output 40% is contributed by SMEs and this sector alone employs about 80% of the industrial workforce. SMEs constitute the dominant source of industrial employment in Bangladesh and about 90% of the industrial units fall into this category. The total contribution of SMEs to export earnings ranges from 75 percent to 80 percent, according to a recent economic census and make up 75 percent of the domestic economy.

Contribution of SMEs in the Economy of Bangladesh

SMEs is a integral part of the total economy of Bangladesh. SME can contribute to archive national income and rapid employment creation in the goal of reduction extreme property and women empowerment.

1. To fulfill internal demand

SMEs plays a vital role to fulfill the demand of internal goods and services. New production, expansion of traditional goods and for the diversification. SME have a special opportunity to contribution.

2. Increase Export and Decrease Import

Using of internal resource and increasing local product a structural and multi SME sector can reduce import. SME sector work for the backward and forward linkage.

3. Employment Creation

Rapid employment creation and national income. SME plays significant role. SMEs can contribute for the reduction of urban tendency creating local level employment.

4. Innovation

SMEs contain innovation of new product and services. Where expansion of technology can contribute for the expansion of consumer.

5. Poverty Reduction

SMEs can contribute millennium development including poverty reduction increasing national income, employment generation and verity of production.

6. Women Empowerment

Women participation in micro credit and garment plays important role in building up industrialization. So, ensure women participation in every sector of economy.

Other Contribution

• Economic growth
• Social balance and social welfare
• Regional development

Findings

The broad spectrum of small is medium enterprises (SMEs) services a subset of SME financing is disbursting not only in Bangladesh but also all over the world with various degree of penetration. Bangladesh Bank, the centre of directing, leading, supervising and the provider of all rules and regulation, about SMEs among the Commercial Banks. The target of Bangladesh Bank is reaching the SME services on the grassroot level. Because, Bangladesh is a country where many small and medium industries not only industries but also other institutions are scattered everywhere. But, only for the suitable financing those industries are deprived of bring to light. SME Financing is a good support for the expansion of small and medium industries. In this financial service there is too little chance to default. The expansion of industries will be a good result for us. Because, that can contribute to the GDP growth, employment creation income generation and eradicate extreme poverty. In this reason all the Commercial Banks expanding their SME branch in all regions for National Development.

Recommendations

1. Credit facility, no doubt, is a necessary.
2. Provide more information, technological support and training about SME financing.
3. To boost up any industry in any region the region should be selected first.
4. Opening of SME / Agriculture Branch.
5. Allocation of 15% refinance fund for women entrepreneurs
6. Training programme for entrepreneurs and Bankers.
7. The priority should be given to SME financing in the rural area.
8. Interest rate should be reasonable.
9. Build up interrelationship among the Commercial Banks.
10. Sanctioning loan of Taka 25,00,000.00 to women entrepreneurs without collateral but against personal guarantee
11. Giving reasonable grace period, reasonable interest rate and easy installment size
12. Identification and selection of real entrepreneurs
13. Cordial Banker-Customer relationship
14. Declaration of area base SME cluster, SME sector for information of Bankers and entrepreneurs
15. Restructuring and justifying import duties on raw materials and finished goods of SMES.
16. Providing collateral free loan.
17. The government should also come up with pragmatic policies and take appropriate measures to support and patronize SME financing as a thrust sector with more incentive package.

Conclusion

In the study the researcher have seen that if installment is longer than recovery interest rate is high. So, every commercial bank should decrease the interest rate, size and increase periods as well as carefully access the business, requirements of loan and willingness of clients to repay loans. As a result it helps the Commercial Banks to reduce their credit risk and it also helps them to dominate in SME financing sector more strongly SME financing.

Bangladesh Bank feels that only Banks and Financial Institutions under leadership of BB cannot develop SME financing. For this, joint efforts of all the related Government and Private organizations are very urgently required. Besides, it would be very useful and beneficial if all the professional bodies on SME all over South Asian countries unite together to form a forum, proceed forward to form linkage with each other.