LAHORE: Pakistan's small and medium enterprise (SME) sector desperately needs bank financing, but several factors are hindering its availability. The primary obstacle is the government's heavy borrowing, which is risk-free and highly lucrative at current interest rates.
SMEs in Pakistan lack collateral to provide to the banks, and providing them loans on the basis of their balance sheet is a risky business. This is especially true when banks get 2-3 percent above the policy rate of 22 percent from government securities. The profit that they earn is very high and the risk of default is zero. They might earn 3-4 percent higher on SME loans than the loans they provide to the state, but the risk of default is very high, particularly in the current economic scenario.
Moreover, if the banks have surplus cash, they would be glad to accommodate larger enterprises that provide collateral to cover their risks. The advantage of serving larger companies is that the size of the loan is larger, which could be handled by a small staff. In case of SMEs, the bank needs a larger manpower to handle Rs1-2 million loans against a loan of Rs100 million to a single entity.
At current high interest rates, larger enterprises are hesitant to obtain loans. Most have put on hold their investment plans. The SMEs on the other hand do not mind paying higher interest rates because they have traditionally been served by private and illegal loan sharks that charge much higher interest on a monthly basis.
The SMEs seldom default on loans taken from loan sharks, that are powerful enough to take over all their assets quickly in case of defaults. This means that the business model of SMEs is based on high interest rates. The commercial banks do not have a mechanism similar to that of loan sharks to take back their loans forcefully.
One consumer banking loan that banks willingly provide is car financing. The rules are such that the bank can snatch the vehicle on default in monthly installments. They charge enough upfront that eliminates their risk if they have to take back the vehicle even after a year of. They do not have to go to the courts for this purpose. There is no such law in house financing, which is the reason that banks are extremely reluctant to provide house loans. In Sri Lanka, banks can take over any house whose owner defaults in loan installments. They simply have to take the police for eviction and no court orders are needed.
The central bank should come up with a similar plan for the SMEs. This would ensure that competent SMEs would be able to scale up and incompetent ones would go into oblivion, which they even otherwise do as they do not upgrade their technologies. Strengthening SMEs is vital for Pakistan’s economy as over 70 percent of the jobs originate from this sector. Development of technically sound SMEs would mean production of quality and value added products in the country and elimination of non-documented low quality manufacturers.