Banks play a crucial role for the financing of small and medium-sized enterprises (SMEs). SMEs represent a large fraction of companies and firms (associated of persons) in Pakistan’s economy and are contributing significantly to the employment and growth within their best capacity. As a matter of fact, SMEs in Pakistan are more informationally structured, more risky, more financially constrained, and more bank dependent than large companies and firms, thus create serious challenges in SME finance. Banks are facing various challenges in SME finance thus limiting their ability to fund SMEs. Most of the times, the borrowers get benefits from relationship lending and their personal connections are the main source of loan approvals. Most of the bank managers in Pakistan are well connected with their customers and take care of their financial needs, prepare loan applications, and try to get those approved. Even most of the times, when a bank manager resigns and moves to another bank, then he tries to take good customers along with him to his new place or tries to offer good lending terms to his good customers. Therefore, it wouldn’t be wrong to say that SMEs obtain more credit under the relationship lending. A bank’s core activities are deposit taking and lending and thus building relationships with the customers is one of the main job requirements of a bank employee dealing with the customers at branch level. There is no doubt that SMEs are of key importance for the economy and are fundamentally backbone of an economy. In Pakistan, most of the companies fall under SME, as most of the companies have small asset base, a smaller number of employees and revenues (turnover) is even less than a billion rupees. They cannot access capital markets or issue stocks thus they largely depend on bank loans and trade credit to raise the external finances. On average, default risk of SMEs is as high as that of a non-investment grade rated company with credit ratings of B.
Recently, Deputy Governor SBP stated that SMEs are the lifeline of the country’s economy, providing employment to 80 percent of the non-agricultural workforce, contributing 40 percent to GDP, and accounting for more than 25 percent of total export earnings. SBP has focused on creating an enabling environment where SME finance can grow, enabling SMEs to thrive and contribute to sustainable economic growth. As part of SBP’s Vision 2028, SBP aims to double SME financing to Rs 1,100 billion over the next five years, with Rs 100 billion to be added to the SMEs’ outstanding portfolio by the end of June 2025. SBP has asked all the banks to play their part in promoting SME finance and surpass the Rs 100 billion estimated increase for FY 2024-25. In order to promote SME finance, SBP has proposed the government to provide risk coverage to banks on their fresh financing to SMEs, whereby 20 percent and 10 percent first loss coverage would be provided to banks’ fresh exposures against SEs and MEs respectively. The necessary allocations for FY25 have already been made in the FY25 budget.
Strong bank-borrower relationships help reduce gap between the lenders and borrowers. Banks can better assess the risk of default for the existing borrowers, while the borrowers might get benefit from the credit limits availability and more favorable borrowing terms over time. Usually, when banks get comfort from the borrowers, borrowers make a good payment history then banks prefer to lend those tried and tested borrowers instead of lending to the new customers and parties.
In Pakistan, given its huge potential for generating employment, the Government of Pakistan has identified SME sector as one of the leading sectors along with agriculture and construction and housing, which will spearhead its efforts towards generating employment to alleviate poverty in the country.
It is observed that the long-term growth of SME sector in Pakistan remains limited due to various factors, including easy access to financing, shortage of skilled workers, lack of corporate governance and implementation of best practices; by far these are one of the biggest problems facing the sector. Limited access to credit for the SMEs is not something exclusive to Pakistan market only but most of the under-developed countries are facing this limited access to the capital thus making it hard for SMEs to make a sustainable and consistent growth.
It is relatively easy for banks to lend to large corporates where the economies of scale, published financial information, collaterals and creditworthiness parameters favor such types of lending. As the small businesses cannot offer adequate collateral and securities, banks are unable to determine whether the borrower possesses technical, managerial, and marketing skills that will allow him to generate adequate cash flows and repay the loan on time. The process of financial intermediation therefore breaks down for the SME borrowers. In Pakistan, economic condition is also volatile thus making it hard for banks to take a risky decision.
The SBP has made regulations for SMEs a number of times in past, so they can have better access to finances but failed to do so. The banks in Pakistan found it difficult to finance SMEs because their profitability was less as compared to large companies. The other issues were, Banks’ risk averse approach, alternate liquidity deployment options, high transactional cost of serving SMEs, lack of financial products’ innovation, lack of legal framework and banks inability to monitor the performance of SME to achieve high efficiency. The commercial banks of Pakistan are still not willing to finance the SMEs thus, it is due to ,this there is negative growth in financing SMEs.
As a first step towards financing of SMEs by banks in Pakistan, it is important to have a transparent and effective way of sharing of information and data. As most of the SMEs have no connection with the capital markets therefore, financial institutions should closely observe the trend of the borrowers. In collateral-based lending, the provision of collateral is the simplest way for SMEs and financial institutions to reduce the risk of lending. As a matter of fact, if banks can lend SMEs, then, SMEs can play a very important and vital role in Pakistan’s economy to address the twin problems of unemployment and poverty eradication.
Banks in Pakistan should make special lending programs for SMEs’. Banks should deploy separate funds for financing of the SMEs, it would be helpful if they allocate their x percentage of available funds for funding SMEs. In order to broaden the financial inclusion, banks in Pakistan should take following steps at least; Inclusion of all the banks and financial institutions in the SME lending program; make special emphasis on small enterprise; there should be a refinance window at concessional rates; emphasis on women entrepreneurship should be made; issue different refinance schemes with the assistance of different international donors agencies and with the support of the federal government.
There is no linear correlation between the banking structure and the SME financing, and it varies from bank to bank, however, overall situation of financing by the banks in Pakistan is not so positive. There is a theory that small banks can lend more to SEMs’ than large banks, which is not a valid theory. The reason is that small banks have limited funds, and they prefer to deploy funds in more secured projects than providing funds to high risk sector like SME sector. Therefore, large banks in Pakistan should come forward as there is a bright future for the large banks through small and micro businesses’, where the government of Pakistan should also encourage large banks to support SME financing. On this basis, the government should promote market-based reforms, and optimize operating environment of SMEs. This can only improve the ability of all the banks in Pakistan to provide financing services for SMEs, and fundamentally improve the financing environment for SMEs.