Behavior of SMEs toward credit facilities in Pakistan

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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-sized businesses or SMBs is predominantly used in the USA. 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.

SMEs contribute to economic growth in various ways like by creating employment for rural and urban growing labour force, providing desirable sustainability and innovation in the economy as a whole. Further, a large number of people rely on this sector, directly or indirectly, for sustenance. Most of the current larger enterprises have their origin in small and medium enterprises.

The SME sector itself can be classified into micro enterprises, small enterprises and medium enterprises. These are the starting point of development in the economies towards industrialization. However, SMEs have their important effect on the income distribution, tax revenue, and employment, efficient utilization of resources and stability of family income.

Globally, this sector is the major growing force behind the fastest growing economy of China, in terms of contribution to the national GDP, scale of assets, diversification of products, and the creation of employment. Similarly, the role of SMEs is well acknowledged in other countries such as Japan, Korea, and all other industrialized economies in terms of economic development.

The contribution of SMEs to Pakistan's economy, employment and poverty reduction can be seen from the fact that 90% of all private sector manufacturing units employ less than 99 workers and the SMEs employ some 78% of non-agricultural labour force. They contribute about 30% to GDP, Rs.140 billion to exports, and generate 25% of exported manufacture [GOP 2005]. This data is based on the assumption that manufacturing units employing less than 100 workers are part of the SMEs.

Problem identification


Pakistan's SMEs are unable to achieve their maximum potential and are in dire need of 'hand-holding' and business support services.

Research reveals that despite the lack of collateral, SMEs are a better credit risk, as the default rate of this sector is much below than that of large enterprises (LEs). Throughout the world, SMEs have provided tremendous opportunities to financial institutions to design various tools for the sector's development like Program Lending Schemes, etc. Then there are clusters, technology parks and industrial estates, all being fuelled by the dynamism and vibrancy of small and medium enterprises.

The Government of Pakistan has been making new financial policies for the growth and improvement of SME industries. Banks and different financial institutions have introduced credit schemes and financing facilities but still there are problem for SMEs to get benefits from credits schemes and financing facilities or why SMEs avoiding to get this facilities.

Problem statement

What are the Financial Problems and Behavior of SMEs towards Credit Facilities in Pakistan?

Objective of study

The purpose of the study is to identify the financial problems encountered by SMEs and thereby to suggest such measures that would resolve the problems. The objectives of the study are:

To discuss the credit facilities offered by the government

To analyze government's support in obtaining credit facilities

To outline the financial problems faced by sample units and the role played by financial agencies with reference to commercial banks.

Rationale study

The SME sector's importance has been realized. "This sector has emerged as a lifeline of Pakistan's economy constituting nearly 99 percent of all economic establishment, out of which , 53 percent of the establishment belong to Wholesale & Retail Trade and Restaurant & Hotel sectors, 22 percent are part of Manufacturing sector and 24 percent fall in the Community, Social and Personnel Services sector. These establishments jointly contribute 30 percent to GDP employing 80 percent of the non-agricultural labor force, 25 percent to total export and 35 percent to manufacturing value addition." (Pakistan Economic Survey, 2008-2009)

There have been a number of researches done on the importance of SMEs. But few have focused on issues of finances and credit facilities available to them. This study has given an insight of financial problems faced by SMEs. It also helped to find out the reasons why SMEs have kept away from credit facilities offered by the government, banks and financial institutions.

Scope of study

This study finds the problems that are responsible to intend the SMEs toward the avoiding credit facilities. This research is an effort to evaluate the affect of the different reasons on SMEs still not getting these facilities. And the findings can be applied in order to make further researches related to SMEs credit facilities. Also this research has helped to know which points are important to change or need to relaxation in this criteria. This research had been conducted in different markets of Islamabad and Rawalpindi to get the SMEs holders response.


Literature review

The Small and Medium Scale Enterprises (SMEs) are playing very significant role in almost all the economies around the world in irrespective of the countries development stage. However it is obvious that SMEs function as a lifeline in informal sector in Asia, Africa, Latin America and Eastern Europe due to their contribution to overall economy in many aspects such as employment generation, exports, tax income, innovation, competitiveness, equitable income distribution, social stability, domestic resources usage, regional development and ultimately it is the main source of economic growth. The Pakistan is no exception to this phenomenon as a developing country located in South Asian region. Most of these SMEs around the world are struggling to survive in today's globalized competitive economy. They are hampered by the lack of technology, access to credits and markets, lack of infrastructure and competition from foreign products, etc (Dasanayaka, 2008).

Without institutional credit means that many SMEs are forced to finance their operation using their own capital, while many shortfalls normally being met by relatives, friends and even non-institutional credit sources. This has indeed been documented in a number of studies on financing of SMEs in ASEAN and Asia-Pacific countries such as Malaysia, Thailand, Indonesia, Philippines, Singapore, Taiwan, South Korea, Pakistan and others. Experiences show that SMEs in many of these countries have restricted access to institutional credit. Many SMEs, especially small-sized enterprises, in these countries seldom approach banks or financial institutions when they are short of funds. This is due to fact that they are not confident of obtaining bank loans or credit. In addition, their limited experience with bank officials has done little to change their preconceptions of the difficulties in obtaining credit (Mohammad AsriHj Abdullah & Mohammad Isa Haji Bakar, 2000).

Like other developing countries across the world, SME sector, in Pakistan also does not have adequate access to financing from formal sector. SMEs have been relying primarily on the credit facilities from the informal sector. Cost of finance from informal sector is higher than the cost of finance from formal sector like banks. In Pakistan corporate sector is the major recipient of financial system credit with 54% share followed by SME sector 19% However, there has been a rapid growth in SME financing now. In fact, it has registered a growth of 72% and has risen from Rs. 145 billion to Rs. 251 billion by June 2004 (Kashif Hamid &Abaidullah, 2006).

The access to finance is a subject of significant research interest to academics and an issue of great importance to policy makers for both developed and developing economies for many years. There are a number of factors that have contributed to this. First, there is some empirical evidence that the expansion of access may reduce prevailing poverty in developing countries. Second, the interest in access also comes from the fact that arguments about the channels through which financial development may lead to growth often include access related stories. A third reason is the widespread lack of access to financial services in emerging economies, particularly when compared to the extent of access in developed countries. Fourth, recent Investment Climate Survey conducted by the World Bank shows that one of the major impediment of fostering firms is lack of access to financial services which would expand economic growth and employment generation as well as reducing poverty in many developing countries (Bataa Ganbold, 2008).

In Pakistan SME sector is confronted with a number of demand and supply side constraints hindering smooth growth of this underprivileged sector of the economy. Lack of access to formal sources of finance by SMEs is one of the major obstacles. SBP has been paying special attention to address this problem and its efforts are leading to improvements in the supply of credit to SMEs (State Bank of Pakistan Annual Report, 2007-2008).

Small and medium-sized enterprises (SMEs) are the backbone of all economies and are a key source of economic growth, dynamism and flexibility in advanced industrialized countries, as well as in emerging and developing economies. SMEs constitute the dominant form of business organization, accounting for over 95% and up to 99% of enterprises depending on the country. They are responsible for between 60-70% net job creations in OECD countries. Small businesses are particularly important for bringing innovative products or techniques to the market (Organization for Economic Co-operation and Development, 2006).

SMEs are vital for economic growth and development in both industrialized and developing countries, by playing a key role in creating new jobs. Financing is necessary to help them set up and expand their operations, develop new products, and invest in new staff or production facilities. Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business. But if they are successful, there comes a time for all developing SMEs when they need new investment to expand or innovate further. That is where they often run into problems, because they find it much harder than larger businesses to obtain financing from banks, capital markets or other suppliers of credit. The difficulties that SMEs encounter when trying to access finance can be due to an incomplete range of financial products and services, regulatory rigidities or gaps in the legal framework, lack of information on both the bank's and SME's side. Banks may avoid providing financing to certain types of SMEs, in particular, start-ups and very young firms that typically lack sufficient collateral or firms whose activities offer the possibilities of high returns but a substantial risk of loss (Organization of Economic Co-operation and Development, 2006).

Private Banks is the leading lenders in the SME finance market. Four of the five banks with the highest number of individual shares in SME finance portfolios are private commercial banks. Among the public sector banks, National Bank of Pakistan (NBP) has slightly more than 8 percent of the total SME financing extended by the banking sector. The public sector banks (Bank of Punjab, Bank of Khyber, and First Women's Bank Limited) have the third largest share of SME financing, after the big-five banks and private banks. Islamic banks are also making significant improvements in capturing the SME finance market. Among these, Meezan Bank has the highest outstanding portfolio, approximately Rs 3.7 billion, followed by Dubai Islamic and Dawood Islamic banks. Specialized banks' share in SME financing extended by the banking sector is low, 2.19 percent; SME bank has the largest portfolio, Rs 8 billion. Foreign banks play a negligible role in SME finance. Bank procedures and policies used for SME lending are too complex, making them time consuming and costly for both parties (Nenova, Niang&Anjum, 2009).

In order to meet the financial requirement of the SME sector, the policy envisages incorporation of SME financing in the Annual Credit Plan of the State Bank of Pakistan (SBP) and monitoring to cater for underserved segment of the SME. Review of prudential regulations, periodically, in line with the SME credit demand and supply data. The establishments of credit guarantee and credit insurance agencies, operating in line with sound international practices, to provide incentives and risk cover for banks, so as to provide them the relevant comfort in financing SME (D-8 Secretariat, 2007).