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Challenges to SME sector


SMEs often face problems that are uncommon to the larger companies and multi-national corporations. Common issues/challenges are categorized as under

Reluctance on part of SMEs

SMEs especially Small Enterprises show high reluctance while accessing the formal credit due to many factors such as Inadequate and delayed credit, Cumbersome lending procedures and Insistence on collaterals and guarantees

Lack of Infrastructure for SME Business

Some banks have not developed the necessary infrastructure in terms of IT and human resource to handle large number of small loans, such as Credit Scoring, Cash flow based Lending, Program Based Lending etc. Credit scoring techniques provides sophisticated statistical tools for identification of variables that are powerful predictors of risks of default and enable banks to devise product programs for different segments of SMEs.

Absence of SME R&D Centers in Banks

Most financial institutions don’t have research and development centers, as a result, they lack new and innovative business ideas. Lack of assessment of the sectoral credit market size, viability of SMEs operating in different sectors of the economy, credit requirements etc results in lack of new business ideas and development of customized and structured asset and liabilities products for SMEs

Corporate Finance Mindset

Most Credit Officers are inclined to balance sheet based and collateral based lending owing to their extensive experience in corporate lending. Due to this mindset, they are unable to assess cash flows from informal records, financial health from family lifestyles of SME sponsors and other non-financial aspects etc. Due to this mindset, commercial banks have not developed appropriate baking products and procedures for SMEs. Resultantly, they lack in appropriate structures and skills for SME credit evaluation, product design and marketing of SME credit tools etc.

High Lending Costs

The costs of lending to SMEs are high and cut deep into the profitability of SMEs. Due to the feasibility issue arising from maintaining a large number of small ticket borrowers, banks remain contented and focused normally on corporate clients.

Lack of Business Planning and Strategic Vision

SMEs do not have formal procedures or disciplines for carrying out the business tasks. They are mostly run conventionally by family members, who may not be professionally literate to support the position. This informal management obstructs access to finance.

SMEs perceived as high risk borrowers

Lending to SMEs is perceived by banks to be a risky business venture. The uncertainties facing small industries, vulnerability to market and economic changes, and lack of collaterals make banks reluctant to deal with them. SMEs are also perceived to be least equipped in term of both human and capital resources to withstand economic adversities.

Informal Organizational Structures

SMEs generally lack segregation of responsibilities and proper organizational structures/divisions based on area specific expertise. Lack of organizational hierarchy and proper internal control policies and procedures render most SMEs as one-man-show and highly dependent on skills, knowledge base and experiences of their owners/sponsors. These characteristics increase the risk perception of banks resulting in less availability of credit to the SMEs.

Low level Financial Literacy

Low level of financial literacy is in fact a multi faceted problem for SMEs. First, SMEs do not have proper awareness of different financing options offered by financial institutions, and secondly, they lack the capability to present their project proposals and borrowing requirements. This has restricted SMEs’ ability to access formal sources of finance, thus forcing them to meet their financing needs from the informal market at exorbitant mark-up rates.

Shortage of Marketing Skills/efforts on part of banks:

Though some financial institutions market their products, most do not aggressively target their low-end borrowers. The marketing aspect also entails providing facilitation to their borrowers in preparing basic financial record which is considered a hall mark of financial institutions in developed world. Banks generally deal with borrowers who have previous track records and this result in financial exclusion of many potentially good borrowers.

External Shocks

Owning to their peculiar nature, SMEs generally operate in low margin and labor intensive sectors with small markets and high elasticity of their products. These conditions along-with limited availability of capital make SMEs more vulnerable to external shocks. In the recent past, the impact of rising energy prices, law and order situation and other factors have adversely impacted the financing to SMEs. Recent Floods wiped out fixed investment/earning assets of many SMEs particularly SEs and have negatively affected their prospects of sustainability without external support.

Informal Accounts and Management Systems

Financial institutions are generally attuned to evaluating repayment capacity of their borrowers through proper financial statements. Due to low levels of literacy and high costs associated with preparation and maintenance of accounting records, SMEs generally keep track of their performance through cash based single entry journal/ register, hand-written vouchers/receipts and utility bills etc. Recent experiences where some SMEs in their desperate efforts to get financing facilities actually colluded with un-ethical / morally deranged chartered accountants to spin wrong/baseless financial statements also cautioned banks. In this scenario, proper evaluation of an SME turns into a difficult task and so banks generally shy away.

Lack of credit and collateral history

Though the Credit Information Bureau has been expanded in recent years to include all loans (irrespective of their size), banks additionally require records of collaterals prior to extension of lending facilities. Currently, the Collateral Registry is available for maintaining record of limited companies only under SECP. Limited applicability of available collateral registry and absence of collateral registries of immovable assets created informational asymmetries between enterprises and lenders and victims of this situation are edge customers particularly SMEs.

Lack of Collaterals to Meet Banks’ Requirements

Lack of collateral is a widely cited obstacle encountered by SMEs in accessing finance. Lenders typically request collaterals in order to alleviate the associated credit risks. Lack of collaterals is not limited to start-ups as well-established SMEs are also collateral deficient due to low capital base and labor intensive nature. In developing countries the issue of collateral is much more severe.