SME FINANCING : DEMAND SIDEssadmin.bibm.org.bd/notice/02-07-19/Monograph 03.pdfBSCIC Bangladesh...

RESEARCH MONOGRAPH 003

SME FINANCING : DEMAND SIDE

PROBLEMS AND SUPPLY SIDE RESPONSES

Ashraf Al Mamun

Md. Mosharref Hossain

A. N. K. Mizan

Associate Professor, BIBM

Lecturer, BIBM

Lecturer, BIBM

BANGLADESH INSTITUTE OF BANK MANAGEMENTMirpur, Dhaka

SME Financing : Demand Side Problems and Supply Side Responses

Ashraf Al MamunMd. Mosharref HossainA. N. K. Mizan

Published: November, 2012

Bangladesh Institute of Bank Management (BIBM)Plot No. 4, Main Road No. 1 (South), Section No. 2Mirpur, Dhaka-1216, BangladeshPABX : 9003031-5, 9003051-2Fax : 88-02-9006756E-mail : [email protected] : www.bibm.org.bd

Printed by Olympic Products Printing & Packaging, Dhaka, Bangladesh

The views in this publication are those of authors only and do not necessarily reflect theviews of the institution involved in this publication.

Published by

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Forewords

As part of the ongoing dissemination of BIBM research outputs, the presentresearch monograph contains the findings of the research project: “

The SME sector remainsone of the key policy focus areas of the Bangladesh Government as well as theBangladesh Bank.

This publication examines the problems of the demand side as well as the responses ofthe supply side while financing SMEs. It also

It gives me great pleasure, on behalf of BIBM, to offer this important resource to thepractitioners of the financial institutions, as well as to the academics and commonreaders.

I hope this monograph will be a useful reference point for financial institutionsinvolved in providing financial services to small and medium enterprises inBangladesh.

We do encourage feedback from our esteemed readers on this issue which certainlywould help us to improve upon our research activities in the years to come.

Director General

SMEFinancing: Demand Side Problems and Supply Side Responses”.

highlights on the current status of SMEs inBangladesh, issues of the small enterprises' access to formal credit, the stakeholder's roles insmall enterprise financing and finally, analyzes the gap between demand and supply side.

Dr. Toufic Ahmad Choudhury

iii

Acknowledgments

This research project has been completed with great support from manypersons and organizations.

We would like to specially thank Dr. Toufic Ahmad Choudhury, honorableDirector General, BIBM for his valuable advice, comments and innovative ideas toimprove our work throughout the year.

We are really thankful to Dr. Shah Md. Ahsan Habib, Professor and Director(Training), BIBM; Dr. Prashanta Kumar Banerjee, Professor & Director (Research,Development & Consultancy), BIBM; Mr. Habibullah Bahar, Agrani Bank ChairProfessor, BIBM; Mr. Abed Ali, Faculty Member, BIBM and Mr. Leif Andersen,Consultant, INSPIRED Project, European Union for their thoughtful contributionand comment on drafting and finalizing the report.

We are also verygrateful to all of our facultycolleagues for theirvaluableobservationsand constructivesuggestions whichhelpedusin completingthe report.

Bangladesh Bank, different financial institutions, SME Foundation, NASCIB andmany other organizations extended their support for completing the report. We dohighly recognize their contribution in fulfilling our objectives.

Our sincere appreciation goes to our field assistants for helping us in obtaining awide range of information from the field level. We are also thankful to Ms. PaponTabassum, Research Officer, BIBM; Mr. Sarder Aktaruzzaman, Proof Reader, BIBMand Mr. Md. Awalad Hossain, Computer Operator, BIBM for their support.

Finally, we would like to extend our gratitude to those who, directly and indirectly,extended their cooperation in our endeavor.

Ashraf Al MamunMd. Mosharref HossainA. N. K. Mizan

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RESEARCH MONOGRAPH 003

SME FINANCING : DEMAND SIDEPROBLEMS AND SUPPLY SIDE RESPONSES

Contents

Sl.No. Title Page

No.List of Abbreviations

Executive Summary

ix

x

1 Introduction

1.1 Objective of the Study

1.2 Data and Methodology

1

5

5

2 Current Status of SME Financing in Bangladesh and Role of Financial

Institutions7

3 Small Enterprises’ Access to Formal Credit 124 Stakeholders’ Roles and their Initiatives for Financing Small Enterprises

in Bangladesh

4.1 Government

4.2 Central Bank

4.3 SME Foundation

4.4 NASCIB

4.5 NGO/MFI

4.6 Business Bodies

16

16

17

19

19

20

20

5 Major Problems Faced by Small Enterprises in Bangladesh 20

6 Responses of Supply Side against the Problems Raised by the Demand Side 30

7 Gap Analysis between Demand Side and Supply Side and Some

Observations37

8 Recommendations 43

References 47

Appendix Table 49

Appendix Questionnaire 50

vii

List of Tables

List of Figures

List of Boxes

List of Appendix Tables

TableNo. Title Page

No.Table-1 Current Status of SME Loan Compared to Total Loan 7Table-2 Targeted SME Loan and Achievement 8Table-3 Segregation of SME Loan in Small and Medium Enterprises 9Table-4 Sector-wise Disbursement of SME Loan 10Table-5 Disbursement of SME Loan to the Women Entrepreneur 11Table-6 Summary Information on SME Refinancing (up to April 2011) 18Table 7 Main Obstacles Cited by Entrepreneurs for Accessing Formal Financial Sector 21Table-8 Barriers to Access of Credit: Overall Perception of Demand Side 21Table-9 Gap Analysis between Demand Side Problems and Supply Side Responses 41

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FigureNo. Title Page

No.Figure-1 Survey Results on Access to Formal Credit from Banks & NBFIs 13Figure-2 Reasons for Dissatisfaction with Bank Loan 14Figure-3 Reasons for not Obtaining Loan from Formal Sector: Entrepreneurs’ Perception 15Figure-4 Current Practices of Recording the Financial Information by the Entrepreneurs 28Figure-5 Responses of FIs against High Interest Rate 30Figure-6 Reasons for Charging High Interest Rate 31Figure-7 Responses of FIs against Excessive Security and Guarantee Requirement 32Figure-8 Responses of FIs Whether Security and Guarantee is Mandatory or Not 32Figure-9 Problems Faced by FIs Regarding Unstructured Financial Information 35

BoxNo. Title Page

No.Box-1 High Interest Rate and High Sunk Cost 24Box-2 Long Loan Processing Time 26Box-3 Insufficient Working Capital Loan, Long Loan Processing Time and Malpractice 27

Appendix TableNo. Title Page

No.Appendix Table 1 Descriptive Statistics of Major Demand Side Problems 49Appendix Table-2 One way ANOVA of Ranking 49Appendix Table-3 Questionnaire for the Survey of Small Enterprises 50Appendix Table 4 Questionnaire for the Survey of Banks/NBFIs 53

List of Abbreviations

Abbreviation Elaboration

ADB Asian Development Bank

ANOVA Analysis of Variance

BB Bangladesh Bank

BBS Bangladesh Bureau of Statistics

BIBM Bangladesh Institute of Bank Management

BSCIC Bangladesh Small and Cottage Industries Corporation

CIB Credit Information Bureau

FCB Foreign Commercial Bank

FI Financial Institution

FY Financial Year

GDP Gross Domestic Product

IDA International Development Association

MFI Microfinance Institute

MIDAS Micro Industry Development Assistance and Services

MoF Ministry of Finance

NASCIB National Association of Small and Cottage Industries of Bangladesh

NBFI Non-bank Financial Institution

NGO Non-government Organization

OECD Organization for Economic Co-operation and Development

PCB Private Commercial Bank

SAPRI Structural Adjustment Participatory Review Initiative

SB Specialized Bank

SE Small Enterprise

SCB State-owned Commercial Bank

SMCI Small, Medium and Cottage Industries

SME Small and Medium Enterprise

SMESPD SME & Special Programmes Department

TIN Tax Identification Number

VAT Value Added Tax

WB World Bank

ix

The economic and social importance of the Small and Medium Enterprise (SME) sector iswell recognized in academic and policy literature. SMEs play a very significant role in theeconomy in terms of balanced and sustainable growth, employment generation,development of entrepreneurial skills and contribution to export earnings. Although the termSME is widely used in different literatures and studies, the present study focuses on smallenterprises (SEs) only. Therefore, throughout the report the term small enterprises (SEs)have been used. Basically the specific objectives of the paper are: i) to identify the problemsfaced by small enterprises in obtaining loans from financial institutions in Bangladesh, ii) topoint out the responses and initiatives of the supply side to address the problems faced by thedemand side and iii) to identify and analyze the gap between demand side expectations andthe supply side responses and finally to formulate suggestions for policy initiatives.

To achieve the objectives of the study, data has been collected both from primary andsecondary sources. Primary data have been collected through interview and questionnairesurvey from both the demand side and supply side stakeholders. For this purpose, two sets ofquestionnaires (Appendices 3 & 4) were developed; one set for demand side and the otherone for supply side. For collecting the information from the demand side, as many as twelvedistricts have been selected on the basis of the concentration of small enterprises mentionedin the 'SME Credit Policies and Programmes 2010' by Bangladesh Bank. However, thecurrent study does not extensively cover the small businesses in rural areas and moreemphasis is given to the urban and semi-urban areas of the twelve districts where smallenterprises are concentrated. From these districts, 509 small enterprises were interviewedthrough the questionnaire. Among 509 small enterprises, 96 (18.86%) from manufacturing,335 (65.81%) from trading and 78 (15.33%) from the service sector were randomly selected.

As one of the main objectives of the study was to identify the major problems of the demandside, the entrepreneurs were selected from both the group of existing and potential (who areyet to get any financing facilities) borrowers of the formal financial institutions. The existingborrowers identied the problems related to SME financing by the formal financialinstitutions. On the other hand, the other group provided good insights regarding access toformal finance. For better understanding the ranks of the demand side problems, descriptivestatistics (Appendix-1) have been used and to judge the significance of the data set, one wayANOVA(Appendix-2) has been performed.

x

Executive Summary

For collecting the supply side information, a sample survey was conducted on 26 financialinstitutions consisting of state-owned commercial banks, private commercial banks,development financial institutions, foreign banks operating in Bangladesh and some non-bank financial institutions. To highlight the problems of the demand side, both the acceptedand rejected loan proposals of some particular banks and financial institutions were alsoreviewed.

The current status of the SME financing has been analyzed in terms of SME loan comparedto total loan, targeted SME loan and achievement, segregation of SME loan in small andmedium enterprises, sector-wise disbursement of SME loans by the financial institutions anddisbursement of SME loan to the women entrepreneurs.

Small enterprises' access to formal credit has been highlighted in the study. Access tosufficient and adequate capital to grow and further develop their activities is one of the mostimportant problems faced by many small businesses in our country. This is because most ofthe financial institutions considered that this sector characterizes high risk, involve hightransaction costs and provide low returns on investment. Choudhury and Raihan (2000)conducted a survey on SME access to credit under SAPRI study where they found that, “theaccess to formal credit is not available at all to 50.53 percent of the stakeholders. Only 35.79percent of SME stakeholders enjoy unrestricted access to the formal credit. The rest (13.68percent) of them have restricted access to the formal credit”. However, our study found that60.31% of the small enterprises got the access into the formal credit while the other 10. 41%enterprises did not have their access at all. On the other hand, 29.27% of enterprises did notapply for formal credit as they managed their funds by themselves.

The study explores main obstacles cited by the entrepreneurs for accessing formal financialsector and the major problems were ranked according to the responses of the entrepreneurs.The problems are listed here according to the ranking start from high interest rate,excessive security and guarantee requirement, insufficient working capital loan,ccomplexity of documentation, long loan processing time, unstructured financialinformation, financial institutions' negligence, high sunk cost for obtaining loan,malpractices in sanctioning loan, and lack of managerial capacity. ChoudhuryRaihan (2000) identified collateral as the prime barrier followed by bribe, delays, highinterest rate, banker's disinterest etc. On the other hand, our survey (2011) result showedhigh interest rate as the prime barrier. So it is evident that the factors acting as the primebarrier(s) have changed significantly.

ing

However, and

,

xi

The study pointed out several problems of the small businesses (demand side) for theiraccess to finance into formal sector. In order to address those problems that small enterprisesencountered, we have conducted another survey centering the financial institutions that aresupplying the funds to the small enterprises. Financial institutions responded to all theproblems differently. Financial institutions had strong disagreement over the issue ofcharging high interest rate. Survey result shows that 65 percent of the financial institutionsresponded that existing interest rate is not high, whereas 35 percent of the respondents thinkthat the rate of interest is high. The reasons for charging high interest are: high monitoringand recovery cost, smaller range of credit limit, higher rate of provision, required collateral isnot available, high cost of maintaining relationship, risk is high, high cost of fund.

Financial institutions showed mixed response about the excessive security and guaranteerequirements. The survey results show that 58% of the respondents think security andguarantee is the real problem for providing loan to this sector. On the other hand, 42% of thefinancial institutions do not consider it as a problem.

Regarding complexity of documentation the financial institutions' responses were mixed.46% of the respondents do not think that complexity of documentation is the barrier foraccessing finance from their institutions. However, 54% respondents complained thatdocumentation really create some problems while taking their credit decision. In response tothe claim of the entrepreneurs that the financial institutions' documentation requirement isvery rigid, most of the respondents answered that they do not have any other alternativeswithout maintaining such documentation. Some of the respondents mentioned that, as perthe regulatory guidelines, they must follow the documentary requirement. But, dependingon the nature of their relationship and future business prospect sometimes they mayminimize the documentation requirements

The common perception of the demand side indicates that financial institutions take muchtime for processing the loan. But our survey result shows that, supply side does not supportthe perception of demand side, rather all the financial institutions in our sample stronglystated that their loan processing time is not high. Their responses range from 12-25 dayswhich is on an average 15.13 days. Whereas the demand side expected to have the loanwithin 10.61 days (on an average), supply side required 15.13 days (on an average) todisburse the loan.

In response to the issue of the availability of insufficient working capital most of the financialinstitutions explained that they are providing working capital loan to the small enterprisesprovided that the borrower fulfill their requirements.

.

xii

The FIs (supply side) opined that small businesses do not maintain good record of theirtransactions as per their requirement and most of the small business have unstructuredfinancial information. The supply side respondents cited that they are facing severeproblems while assessing the financial risk of the borrower due to unstructured financialinformation.

Besides, FIs may offerlower interest rate to the borrowers who have willingness to accept a collateralized loancontract relative to unsecured loans.

In response to Bankers' Negligence about small enterprise financing, banks and otherfinancial institutions strongly opposed the demand side claim and mentioned that, as it is thegovernment's priority sector and central bank's regulatory requirement as well as their owninterest, they do not show their negligence in this respect.

From the survey result it is evident that, high sunk cost is regarded as a relativelyinsignificant problem in obtaining loan from the FIs. In response to this problem, financialinstitutions mentioned that to some extent it is true but it does not mean that FIs themselvesare responsible for such cost.

Financial institutions did not agree at all against the complaint of demand side regardingtheir malpractices in sanctioning loan. Although the respondents do not take this complainton their own shoulders, a few of them mentioned that it may be true for some other FIs.

The study analyzed the prevailing gap between demand side and supply side problems.The gap exists between the two sides mainly due to perceptional and procedural differences.Finally, based on the observations and findings, to minimize the gaps and to reduce theproblems of demand side in getting finance from the financial institutions, the studyrecommends the following actions:

In regard to high interest rate, FIs have the scope to reduce such rate by searching for low costfunds. Bangladesh Bank and SME Foundation should intensify their efforts (refinancing andpre-financing) to provide low cost funds to the commercial banks.

In relation to excessive security and guarantee requirement, the financial institutions maytake care for the collateral free loan where personal guarantee is strong and the project hasgood future prospects. Moreover, FIs can concentrate on finding collateral substitute such ascash flow based lending, extensive monitoring, social security, etc.

To minimize the problems related with the insufficient working capital loan, FIs should notconsider the prior relationship with the borrower only rather they should also put emphasis

xiii

on the business prospects of the borrowers. Besides, FIs should make them understand aboutthe process of working capital assessment and the minimum time required for the approval ofsuch capital.

To eliminate the problem of unstructured financial information of borrowers, the businessowners should be encouraged to use proper accounting records on their businesstransactions. Moreover, they should be educated about the benefit of accounting andfinancial information to avail incentives such as tax holidays and easier access to bank loans.

To overcome the issue of financial institutions' negligence in dealing with the SE clients,banker should have good customer relationship, positive and caring attitude towards thesmall entrepreneurs. To address the issue, lack of managerial capacity of the smallentrepreneurs, government as well as the other stakeholders can take capacity buildingprojects and impart quality training to the small entrepreneurs.

To reduce the sunk costs of the borrowers in terms of money, energy and time, therelationship official should provide the prospective borrower a so that the borrowermight visualize al the requirements of the loan clearly. Long loan processing time may bereduced by adopting standard loan approving procedures based on information technologyand maintaining better information management.

To address the issue of malpractices (taking bribe, nepotism etc.) in sanctioning loan tosmall enterprises, the FIs have to adopt better internal control and governance mechanism toidentify such activities, and if found, involved officials must get exemplary punishment.

There is an urgent need to adopt a new business model for financing SEs. Thus, FIs shouldre-engineer (business process re-engineering) their existing financing process of SEs to takespecial care for them.

The local government bodies can operate the rural information centers in a better way toprovide information to the small entrepreneurs about the different sources of refinancing orpre-financing schemes available in our country. To address the problems of gettingdocuments from different issuing authorities, government and other relevant authorities canease the documents-obtaining process by establishing separate counter for the SE clients invarious departments across the country.

To enhance their effective contribution in the sector NASCIB can organize more effectivetraining for the skill development of the entrepreneurs, can take initiatives to establish

,

check list

xiv

business links of the small businesses with large corporations for better marketing of Small,Medium and Cottage Industries (SMCI) products. Government and trade associations mayinitiate building a good relationship between businessmen and bankers by participating indiscussions, seminars, and symposiums to reduce lack of understanding of bankingprocedures by the businessmen.

In order toidentify thepotential suppliers of financial services

and evaluate the cost of the financial. In order to ensure access to finance for the SEs, the FIs canestablish branches in the rural areas. If it is not possible, they may establish extensive creditlinkage programswith the NGO/MFIsof the country for covering larger area.

NBFIs may also diversify their SE financing portfolio by offering more innovative financingproducts throughout the country such as small lease, micro lease, seed money, factoring,invoice financing, venture capital, investment funding etc. NGO/MFIs can extend financingfacilities for the small enterprises because it can reduce their administrative costs andenhance the quality of their portfolio. They can also enter in the small enterprise financingmarket by forming strategic partnerships with the FIs.

1

reduce the information asymmetry, a very good relationship between the FIs and itsSEs should be established by whichSEs can

xv

1Since administrative cost of microfinance is higher than the SE financing.

SME Financing : Demand Side Problems and Supply Side Responses

1. Introduction

The economic and social importance of the Small and Medium Enterprise (SME) sector iswell recognized in academic and policy literature. SMEs play a very significant role in theeconomy in terms of contribution toward balanced and sustainable growth, employmentgeneration, development of entrepreneurial skills and export earnings. Bangladesh economyis characterized by low per capita income, high level of unemployment, mass poverty andsocial deprivation. In these circumstances, higher growth of SMEs can reduce poverty to asatisfactory level by creating jobs for the skilled and unskilled manpower in this sector.Cross country study (Ayyagari et al. 2003) shows that SMEs account for over 51 percent ofGDP and 57 percent of employment in high income countries while the correspondingfigures for low income countries are only16 and 18 percent respectively. It is recognized thatSME sectors in developing economies are underserved, especially in terms of finance.

Prior to a discussion on the problems of SME financing in Bangladesh, the definition of thesesmall and medium enterprises should be cleared. Throughout the world, there are a lot ofdefinitions of SME and the researchers and policy makers are far away from a unanimousdefinition. In Bangladesh, two definitions exist regarding SMEs; one is given in 'SME CreditPolicies & Programmes 2010' published by Bangladesh Bank and other is in the 'IndustrialPolicy 2010' published by the Ministry of Industry. Recently Bangladesh Bank has issued acircular (SMESPD, Circular No-1, 19 June, 2011) to determine the size of the SMEs in order2

1

2According to Bangladesh Bank Circular, means an entity, ideally not a public limited

company, which complies with the following criteria:A with total assets at cost including installation of fixed asset and excluding

land and building from Tk. 50 lac to 10 crore and/or number of employee ranges from 25 to 99. A with totalassets at cost including installation of fixed asset and excluding land and building from Tk. 5 lac to Tk 1 crore and/or numberof employees ranges from 10 to 25. A with total assets at cost including installation of fixed asset andexcluding land and building from Tk. 5 lac toTk 1 crore and/or number of employees ranges from 10 to 25.

A with total assets at cost including installation of fixed asset and excludingland andbuilding from Tk. 10 crore to 30 crore and/or number of employee ranges from 100 to 250.A with totalassets at cost including installation of fixed asset and excluding land and building from Tk. 1 crore to 15 crore and/or number ofemployees ranges from 50 to 100. A with total assets at cost including installation of fixed asset and excludingland and building from Tk. 1 crore to15 crore and/or number of employees ranges from 50 to 100.

If on one criterion, a firm falls into the 'small' category, while it falls into 'medium' category based on the othercriterion, the firm will be deemed as in the 'medium' category. On the other hand, if on one criterion, a firm falls into the'medium' category, while it falls into 'large' category based on the other criterion, the firm will be deemed as in the 'large'category.

Small and Medium Enterprise

Small Enterprise-

Medium Enterprise-

Note:

manufacturing concernservice concern

trading concern

manufacturing concernservice concern

trading concern

2

to harmonize the definition with the industrial policy. It is important to note that industrialpolicy does not cover the definition for trading concerns.

Although the term SME is widely used in different literatures and studies, the present studyfocuses on small enterprises (SEs) only. Therefore, throughout the report the term smallenterprises (SEs) have been used.

The main characteristics of small business are: (i) they are operated by a family or closegroup; (ii) business owner is the day-to-day decision maker; (iii) formal business records arenot widely available and even if some formal records are available, information may not beaccurate and are rarely audited. Small enterprises are labor intensive businesses and in mostcases they are able to serve niche market segments that are not covered by the largerbusinesses. It makes innovative use of knowledge, experience, resources and simpletechnologies to turn local market conditions into business opportunities. In many developingcountries, 95% of all companies have less than 50 employees (NCDO 2005). If the aim is tostimulate private sector development, there is a clear demand to cater for specific needs ofsmall businesses. Every dollar invested in a small enterprise generated an average ten dollarsof economic activity in the local economy (SEAF 2005).

For most of the developing and transition economies, the common challenges that SEstypically confront include barriers related with access to finance in the formal financialsector, institutional, legal and administrative barriers. Small enterprises, throughout theworld, for their heterogeneous characteristics face severe problems. In this regard Levy(1991) highlighted some of the common problems faced by most developing countries, viz.,the financing constraints; regulatory constraints; technical, marketing and other non-financial input constraints; and cost constraints.

Identifying problems related to small enterprise financing is a much-debated issue. Differentliteratures give deeper insight into the problems of the demand side and the activities of thefinancial institutions (supply side) in coping with the problems. Most of the small businessesare family-based and lack appropriate financing for their start- up and maintaining theoperations. Their access to formal credit is not easier compared to the medium and largeenterprises. Some studies (EBRD 2004; Hossain 1998; PECC 2003) concluded that theinability to access to credit is one of the major bottlenecks of SME, as almost all ofthese economies have poorly developed banking sectors. Thus, this financing problemhinders their normal business operations that result in the lack of potentiality for futuregrowth. Empirically, it has been tested and found (Beck et al. 2005) that lack of access to

3

external finance is a key obstacle to firm growth, especially for SMEs. A number of studies(Schiffer and Weder 2001; Beck et al. 2005; and Beck and Demirgüç-Kunt 2006) usingfirm-level survey data have shown that SMEs not only perceive access to finance and thecost of credit to be greater obstacles than large firms, but see these factors as constrainingSMEs (i.e., affect their performance) more than large firms.

Small entrepreneurs face several difficulties in obtaining finance from the formal sector.Interest rate and collateral requirement are among the major problems inhibiting their accessto finance from the formal financial institutions. Haque and Mahmud (2003) reveals that,high interest rate, collateral requirement and lack of skills and attitude of bankers are amongthe most significant problems for small and medium entrepreneurs in availing of financefrom the formal financial institutions. Quader and Abdullah (2008) ranked high lending rateand collateral requirement as the most significant financing problem for the demand side.On the other hand, financial institutions also encounter several problems while financingsmall enterprises. A report revealed that collateralrequirements, weak credit skills and practices, cumbersome loan processing anddocumentation were the major supply side problems in most of the Asian countriesspecifically in the ASEAN countries for financing SMEs. In addition, Beck (2008)revealed that banks in developing countries are less exposed to SMEs, tend to providea smaller share of investment loans, and charge higher fees and interest rates to SMEsrelative to banks in developed countries.

Availability of required working capital at appropriate time is another significant problemfor most of the small businesses. For the day to day business operation, timely availability ofworking capital and its utilization is required. This kind of problem arises mainly due todelay in payments made by the debtors. The funds of many small enterprises in industrialunits are blocked in receivables. As a result, recycling of funds is affected and productionsuffers. In his study, Hossain (1998) revealed that SMEs encounter great difficulties whileraising fixed and working capital because of the reluctance of banks to provide loans toSMEs. In many cases, it is found that financial institutions take long time for processing theworking capital loan even after taking the positive credit decision.

Low quality financial statements, lack of quality information, and lack of adequateguarantees often hinder small enterprises to have access into the formal financial sector.Most of the literatures (Demirgüç-Kunt and Maksimovic 1998; Beck 2005, andBeck Demirgüç-Kunt 2006) showed that around the world informality and low qualitybalance sheets, lack of quality information and lack of adequate guarantees stand out as

RAM Consultancy Services (2005)

et al.

et al.and

4

SME-specific factors that banks perceive as obstacles in serving these firms. Using a surveyof banks in Argentina and Chile, Torre (2008) showed that, informality and low qualitybalance sheets in Argentina, lack of quality information in Chile, and lack of adequateguarantees in both countries stand out as SME-specific factors that banks perceive asobstacles in serving these firms. Similarly, Stephanou and Rodriguez (2008) pointed outsome problems related with the demand side as informality, unavailability and unreliabilityof financial statements, low managerial capacity of owners, their family-owned nature andcredit worthiness. (2005) depicts that lack of information about the SMEs tothe lending institutions is also a great problem to ensure access to finance.

Most of the entrepreneurs in our country are illiterate and are unable to prepare properbusiness plan that may help them to achieve their goal easily. Proper documentation, on theother hand, creates major problems for obtaining funds from the formal sources. Many SMElinked products and services are available in different financial institutions but in many casessmall businesses are not aware about these products and services. These problems are alsosupported by empirical evidence. (2005) report identified some problemsfrom the demand side as lack of well-developed business plan, problems related todocumentation, lack of knowledge about the available SME financing products provided bydifferent financial institutions.

OECD (2006) study pointed out several problems on both the demand side and supply side asthe difficulties that SMEs encounter when trying to access to financing. These are:incomplete range of financial products and services, regulatory rigidities or gaps in the legalframework, lack of information on both the bank's and the SME's side. In the same paper, thestudy also focused on the problems relating to the attitude of the banks, in particular, start upsand very young firms that typically lack sufficient collateral, or firms whose activities offerthe possibilities of high returns but at a substantial risk of loss.Along with the finance relatedproblems, there are some non financial problems like managerial capacity, willingness topay, lack of motivation to grow, lack of using money efficiently etc. are associated with thesmall businesses. In this context, Brkanovic (2005) provides insights about the non-financialobstacles of SME financing in Serbia, like lack of modern mechanisms in deploying financefor the SMEs.

After reviewing different literatures and studies, it is evident that the small enterprises(the demand side) are encountering multidimensional problems while obtaining financefrom the formal financial sector. Moreover, there exist many barriers in this sector in theform of underdeveloped or inefficient legal and administrative framework.

et al.

RAM Consultant

RAM Consultant's

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Bakht (1998) and Ahmad et al. (1998) revealed in their study that the policy environmentwithin which SMEs in Bangladesh operate imposes legal, regulatory and administrativeconstraints. Sometimes the entrepreneurs need to procure various papers and documents tobe eligible for loan and therefore they need the support from the different regulators andadministrators. But in many cases they face difficulties in this regard.

This paper examines the present scenario of financing problems identified by the demandside and the responses of the supply side. Thus the specific objectives of the paper are:

(i) To identify the problems faced by small enterprises in obtaining loans fromfinancial institutions in Bangladesh.

(ii) To point out the responses and initiatives of the supply side to address the problemsfaced by the demand side and

(iii) To identify and analyze the gap between demand side expectations and the supplyside responses and finally to formulate suggestions for policy initiatives.

To achieve the objectives of the study, data has been collected both from primary andsecondary sources. Primary data have been collected through interview and questionnairesurvey from both the demand side and supply side stakeholders. For this purpose, two sets ofquestionnaires (Appendices 3 & 4) were developed; one set for demand side and the otherone for supply side. For collecting the information from the demand side, as many as twelvedistricts have been selected on the basis of the concentration of small enterprises mentionedin the 'SME Credit Policies and Programme 2010' by Bangladesh Bank. However, thecurrent study does not extensively cover the small businesses in rural areas and moreemphasis is given to the urban and semi-urban areas of the twelve districts where smallenterprises are concentrated. From these districts, 509 small enterprises were interviewedthrough the questionnaire. Among 509 small enterprises, 96 (18.86%) from manufacturing,335 (65.81%) from trading and 78 (15.33%) from the service sector were randomly selected.

As one of the main objectives of the study is to identify the major problems of the demandside, the entrepreneurs were selected from both the group of existing and potential (who areyet to get any financing facilities) borrowers of the formal financial institutions. The existing

1.1 Objective of the Study

1.2 Data and Methodology

3

3Dhaka, Narayang nj, Chittagong, Comilla, Noakhali, Barisal, Narsingdi, Gazipur, Rajshahi, Nilphamar , Dinajpur and

Rangpur.a i

6

borrowers identify the problems related to SME financing by the formal financialinstitutions. On the other hand, the other group provides good insights regarding access toformal finance. For better understanding the ranks of the demand side problems, descriptivestatistics (Appendix-1) have been used and to judge the significance of the data set, one wayANOVA(Appendix-2) has been performed.

For collecting the supply side information, a sample survey was conducted on 26 financialinstitutions consisting of State-owned Commercial Banks (SCBs) , Private CommercialBanks (PCBs) , development financial institutions , foreign banks operating in Bangladeshand some non-bank financial institutions . To justify the problems of the demand side, boththe accepted and rejected loan proposals of some particular banks and financial institutionswere also reviewed. While selecting the sample of small enterprises and banks/FIs,the following factors were considered:

i) Different sectors of small enterprises such as manufacturing, trading and servicewere considered.

ii) Financial institutions having extensive involvement in SME financing wereconsidered.

iii) The number of SME linked products offered by banks and NBFIs to respond to thecustomer needs.

Published literature, research papers, different books were reviewed to complete thetheoretical background and relevant websites were visited to collect secondary information.

This paper is divided into eight sections. After a brief background as part of introduction(Section-1), Section-2 highlights the current status of SMEs in Bangladesh. Section-3reveals small enterprises' access to formal credit. Section-4 represents the stakeholder's rolesin small enterprise financing in Bangladesh. Section-5 presents the major problems faced bysmall enterprises in Bangladesh. Section-6 focuses on the responses of supply side againstthe problems raised by the demand side. Section-7 analyzes the gap between demand andsupply side and, finally, Section-8 represents the recommendations.

4

5 6 7

8

4

5

6

7

8

Sonali Bank Ltd., Janata Bank Ltd., Agrani Bank Ltd., Rupali Bank Ltd.Uttara Bank Ltd., Pubali Bank Ltd., AB Bank Ltd., National Bank Ltd., Eastern Bank Ltd., Islami Bank Bangladesh

Ltd., IFIC Bank Ltd., NCC Bank Ltd., EXIM Bank Ltd., BRAC Bank Ltd., Bank Asia Ltd., Mutual Trust Bank Ltd.,The City Bank Ltd., Social Islami Bank Ltd.

Bangladesh Krishi Bank, BASIC Bank Ltd., Rajshahi Krishi Unnayan Bank.HSBC, Commercial Bank of Ceylon PLC.IDLC Ltd., ULC Ltd., IPDC Ltd.

7

2. Current Status of SME Financing in Bangladesh and Role of Financial Institutions

Table 1: Current Status of SME Loan Compared to Total Loan

The current status of the SME financing has been analyzed in terms of SME loan comparedto total loan, targeted SME loan and achievement, segregation of SME loan in small andmedium enterprises, sector-wise disbursement of SME loans by the financial institutionsand disbursement of SME loan to the women entrepreneurs.

Table 1 highlights the current status of the SME outstanding loan compared to the total loanprovided by the banks and non-bank financial institutions operating in Bangladesh. In 2010(Jan Dec), the share of SME loan in total outstanding loan on the part of State-ownedCommercial Banks (SCBs) was the highest 31.79% compared to Specialized Banks (SBs)20.64%, Foreign Commercial Banks (FCBs) 10.21%, and Private Commercial Banks(PCB) 19.12% in the banking sector. The average of all banks showed that the totaloutstanding loan in the SME sector was 21.48%. It was observed that the FCB's outstandingloan in this sector was the lowest, only 10.21%. In case of the Non Bank FinancialInstitutions (NBFI) the share of SME loan compared to total outstanding loan and advanceswas The average of all banks and NBFIs was only 21.07%.

In 2011 (January-June), the Table shows that SCBs' share of SME sector in total loan was27.81%, while the shares of SBs, FCBs, PCBs and NBFIs were 20.22%, 9.30%, 18.81% and15.22%, respectively. The average share of all banks and NBFIs in SME sector was only20.12%. While the survey conducted by Beck et al. (2009) found that the average share ofSME sector in total loan is 41%, 69%, 14% and 8%, respectively in India, Sri Lanka,Pakistan and Nepal. Therefore, SME Financing by the FIs in Bangladesh is lagging far fromIndia and Sri Lanka. But it is ahead of Pakistan and Nepal.

-

-

13.91%.

(Tk. in Crore)

Source: Bangladesh Bank, SME & Special Programmes Department

Name ofBanks/NBFIs

2010 2011 ( January-June)

Total Loans&

Advances

BalanceOutstandingof SME Loan

% of SMEOutstanding

to TotalLoans

Total Loans&

Advances

BalanceOutstandingof SME Loan

% of SMEOutstanding

to TotalLoans

SCB 68702.48 21839.54 31.79 78557.74 21845.81 27.81SB 20578.15 4247.31 20.64 22462.76 4541.94 20.22

FCB 18486.44 1887.54 10.21 20812.24 1936.08 9.30PCB 204442.22 39083.85 19.12 219788.24 41332.98 18.81

Total Banks 312209.29 67058.24 21.48 341620.98 69656.81 20.39NBFIs 17741.02 2468.34 13.91 18943.22 2883.44 15.22

Total Banks& NBFIs 329950.31 69526.58 21.07 360564.20 72540.25 20.12

8

Table-2 is concerned with the overall status of total target, total disbursement, achievementof target and percentage of SME disbursement by banks and NBFIs'. In 2010 (Jan-Dec), allthe banks and NBFIs surpassed their respective targets. The highest target achievers(222.70%) in that year were the SBs and the lowest target achiever (100.48%) were theNBFIs. It may be mentioned here that the targets were jointly set by the individual banks inconsultation with the SME & Special Programmes Department of Bangladesh Bank.

In terms of disbursement of SME financing by group of institutions, Table-2 shows that, in2010 the share of PCBs' disbursement in total SME loan was the highest at 75.63% andFCBs' disbursement was the lowest at 2.12%. The share of SCBs' and SBs' disbursement intotal SME loan was 14.05% and 5.03%, respectively. The disbursement status of SME loanof PCBs is very significant compared to the share of SCBs'. In Bangladesh, mainly thebanking system contributes towards SME financing. The share of SME loan disbursementby the banking system was 96.83% whereas the contribution of NBFIs was only 3.17%.

In 2011 (January-June) compared to 2010, the Table-2 shows that there was a significantdecline in the share of target achievement for SME loan in relation to total target indisbursing SME loan. The share of PCBs' SME loan disbursement was highest (81.42%)among all the group of financial sector (total banks and NBFIs). The total SME disbursementby the banking sector was 96.42% while for the NBFIs it was only 3.58%.

Table-3 shows the segregation of SME loan into small and medium enterprises on the basisof the total SME loans disbursed by the banks and NBFIs in Bangladesh. In 2010,

Table 2: Targeted SME Loan and Achievement

(Tk. in Crore)


Banks/NBFIs


TotalTarget

TotalDisburse-

ment

% ofAchieve-ment toTarget

% of SMEto Total

SME Dis-bursement

TotalTarget

TotalDisburse-

ment

% ofAchievement toTarget

% of SMEto Total

SME Dis-bursement

SCB 5083.10 7523.98 148.02 14.05 7668.00 2107.98 27.49 8.06SB 1210.00 2694.66 222.70 5.03 3365.00 1225.89 36.43 4.69

FCB 731.69 1133.93 154.97 2.12 1197.43 592.12 49.45 2.26PCB 30144.6 40494.57 134.33 75.63 42325.9 21302.00 50.33 81.42

Total Banks 37169.4 51847.14 139.49 96.83 54556.3 25227.99 46.24 96.42NBFIs 1688.66 1696.79 100.48 3.17 2393.80 935.35 39.07 3.58

Total Banks& NBFIs 38858.1 53543.93 137.79 100 56950.1 26163.34 45.94 100

9

the percentage of small enterprises loan compared to total SME disbursement ranges from34.25% to 47.39% among the SCBs, SBs, FCBs and PCBs. The aggregate disbursement insmall enterprises by all banks was 42.82% and by NBFIs was 49.17%. The totaldisbursement by the financial sector in small enterprises was 43.02%.

In 2010, the share of medium enterprises' loan to total SME disbursement ranges from52.61% to 65.75% among the SCBs, SBs, FCBs and PCBs. The aggregate disbursement inmedium enterprises by all banks was 57.18% and by NBFIs was 50.83%. The totaldisbursement by all banks and NBFIs was 56.98%. Therefore, the banks' and NBFIs' totalSME loan disbursement was concentrated more in medium enterprise sector (56.98%) andless in small enterprises sector (43.02%).

Although, in 2011 (January-June) the concentration of total SME disbursement in smallenterprises (44.66) and medium enterprises (55.34) remained almost similar to those in theprevious year, but there was a significant shift in disbursement by the SCBs, SBs and NBFIsfrom medium enterprises to small enterprises. The SCBs' share in small enterprisesfinancing was 58.95% and 41.05% in medium enterprises. The SBs' concentration in smallenterprises was 42.92% and in medium enterprises it was 57.08%.

The share of NBFIs' was 62.91% and 37.09%, respectively in small enterprises and mediumenterprises. If the focus for concentration in small enterprises continues by all the banks andNBFIs then the small enterprises will be able to be benefited and they will be able to graduatefrom small to medium enterprises category.

Table 3: Segregation of SME Loan in Small and Medium Enterprises

(Tk. in Crore)


Banks/NBFIs


Small% of TotalDisburse-

mentMedium

% of TotalDisburse-

mentSmall

% of TotalDisburse-

mentMedium

% of TotalDisburse-

ment

SCB 3458.23 45.96 4065.75 54.04 1242.64 58.95 865.34 41.05SB 923.01 34.25 1771.65 65.75 526.18 42.92 699.71 57.08

FCB 537.40 47.39 596.53 52.61 274.17 46.20 317.95 53.8PCB 17281.86 42.68 23212.71 57.32 9053.66 42.50 12248.34 57.5


Total Banks& NBFIs 23034.89 43.02 30509.04 56.98 11685.04 44.66 14478.3 55.34

10

Table- 4 highlights on the sector-wise disbursement of SME loan by the banks and NBFIs inBangladesh. The disbursement of SME loan was categorized as service sector, trading sectorand manufacturing sector. In 2010, disbursement of SME loans by all banks was 67.35% intrading, 27.72% in manufacturing and only 4.94% in service sector. On the other hand, theNBFIs concentration for trading, manufacturing and service sectors were 47.92%, 28.01%and 24.07%, respectively.

Here it is evident that banking sector disbursed SME loan largely in the trading sector andleast in the service sector, while NBFIs maintained more or less balanced approachcompared to the banking sector in disbursing their SME loan. The aggregate average of SMEloan disbursement by the banks and NBFIs was 66.69% in trading sector, 27.73%manufacturing sector and 5.59% in service sector.

The 2011 (January-June) figures revealed that 63.51%, 30.14% and 6.35% were disbursed intrading, manufacturing and services sectors respectively by the banks and NBFIs. 2011(January-June) experienced a little increase of SME loan disbursement in the trading,manufacturing and service sector compared to 2010. It is evident that, trading sector isgetting more finance from the banks and NBFIs. If the banks and NBFIs do not reallocatetheir funds for the manufacturing sector then the productive sector would not develop.Bangladesh is at present largely engaged in the manufacturing of common consumer goods,requiring rather simple technologies that are predominantly labor-intensive and that do notrequire a very high degree of skills to produce. Thus, increasing financial access to SMEmanufacturing can ensure the better growth for future.

Table 4: Sector-wise Disbursement of SME Loan

(Tk. In Crore)


Name ofBanks/NBFIs

2010 2011 ( January-June)Total

Disburse-ment

% toServiceSector

% toTradingSector

% toMfg.

Sector

TotalDisburse-

ment

% toServiceSector

% toTradingSector

% to Mfg.Sector

SCB 7523.98 3.05 61.50 35.45 2107.98 3.37 55.24 41.39SB 2694.66 1.65 49.86 48.49 1225.89 2.04 52.16 45.79

FCB 1133.93 12.81 47.93 39.27 592.12 12.05 49.22 38.73PCB 40494.57 5.11 69.59 25.30 21302.00 6.08 66.12 27.80


Total Banks &NBFIs 53543.93 5.59 66.69 27.73 26163.34 6.35 63.51 30.14

11

The women entrepreneurs are contributing to our national economy and they are creatingjobs as well. Therefore, women entrepreneurs are coming forward by establishing SMEs andthey are desperately seeking financial assistance from the formal financial institutions.But the contribution of formal financial institutions in financing women entrepreneurs arenot that much significant. Table-5 shows the status of SME loan disbursement to the womenentrepreneurs by the banks and NBFIs in Bangladesh. In 2010, the average disbursement ofSME loan for women entrepreneurs to total SME loan disbursement was 3.73% by all banksand 4.29% by NBFIs. The aggregate disbursement by all banks and NBFIs was only 3.75%in 2010.

In 2011 (January-June) the aggregate disbursement to women entrepreneurs by all banksand NBFIs was 3.66%. It would be a worthy contribution to the society and to womenentrepreneurs if the banks and NBFIs can disburse more SME loan to them.

Banks and NBFIs are very important stakeholders in the field of small enterprise financing.They are playing an important role in ensuring access to finance for the small enterprises.The FIs are trying to align their businesses by developing small enterprise based products.The NBFIs are offering factoring (Receivable Financing), a very good product for workingcapital financing for their clients. This is definitely a good initiative by the NBFIs in thecontext of Bangladesh.

Although financing of SEs in off-farm rural economic activities are largely dependent onequity financing from personal and family savings, currently banks and financial institutions

Table 5: Disbursement of SME Loan to the Women Entrepreneur

(Tk. in Crore)


Banks/NBFIs


TotalDisburse-

ment

Disbursementto Women

% to Dis-bursement

TotalDisburse-

ment

Disbursementto Women

% to Dis-bursement

SCB 7523.98 73.89 3.51 2107.98 31.73 3.38SB 2694.66 58.03 4.73 1225.89 43.98 6.72

FCB 1133.93 2.88 0.49 592.12 1.28 0.46PCB 40494.57 806.81 3.79 21302.00 348.32 3.51

Total Banks 51847.14 941.61 3.73 25227.99 425.31 3.61NBFIs 1696.79 40.12 4.29 935.35 21.89 5.27

Total Banks &NBFIs 53543.93 981.73 3.75 26163.34 447.20 3.66

12

are also coming forward to provide finance to this sector. Different initiatives have alreadybeen taken and practiced by the financial institutions in order to facilitate the smallenterprise financing mostly at the behest of Bangladesh Bank. Some of those initiatives areas follows:

- Separate SME division, SME units/centers and dedicated desk.- Separate SME dedicated desk for women entrepreneurs.- Separate monitoring team for SME.- Separate team for selling loan and collecting deposit through SME products.- Special credit risk management team for SME banking.- Different trainings for SME officials as well as for entrepreneurs.- Commission/incentives based on the performances of direct sales team.- Dedicated collection team for SME loan.- Customized products and services for SME.- Establishment of SME/Krishi Branch.- Delegate loan authority to the branch managers and head of SME up to a certain limit

for quicker decision.- 24 hours call center and doorstep banking.- Organizing SME service fortnight in every years.- Develop clusters under area approach etc.

Beck et al. (2002) clarify how financial constraints affect firms of different sizes. Their studyof 4,000 firms in 54 countries offers evidence that large firms internalize many of the capitalallocation functions carried out by financial markets and financial intermediaries. Theyconclude that financial constraints affect the smallest firms most adversely and that anincremental improvement of the financial system that helps relax these constraints will bemost beneficial for SMEs.

Choudhury Raihan (2000) conducted a survey on SME access to credit under(SAPRI) study where they found that, “the access to

formal credit is not available at all to 50.53 percent of the stakeholders. Only 35.79 percent ofSME stakeholders enjoy unrestricted access to the formal credit. The rest (13.68 percent) ofthem have restricted access to the formal credit”.

9

3. Small Enterprises'Access to Formal Credit

and StructuralAdjustment Participatory Review Initiative

9Every initiative may not applicable for all FIs

13

10As the survey emphasizes more on the urban and semi-urban areas, the results shows better access to formal credit.

However, it might show different result if the enterprises of the rural areas could be covered.

Willing to take furtherloan 167 (88.83%)

Total Sample 509

Manufacturing 96

Trading 335

Service 78Not received

202 (39.69%)

Loan received

307 (60.31%)Not satisfied

119 (38.76%)

Satisfied

188 (61.24%)

Not Applied

149 (73.76%)

Applied but notreceived 53 (26.24%)

Not willing to take furtherloan 21 (11.17%)

Willing to take further loan 85(71.43%)

Not willing to take furtherloan 34 (28.57%)

Reason:

Doing business with their ownmoney or borrowing from family/relatives/

friendsReasons:

- Lack of collateral

In this study, a sample survey was conducted on 509 small enterprises of which 18.86% werefrom manufacturing concerns, 65.81% were from trading concerns and 15.33% from theservice concerns. The survey result (Figure-1) showed that 60.31% enterprises receivedloans from banks and other financial institutions, while 39.69% enterprises did not receiveany loan from the formal financial institutions. Out of those enterprises who received loan,46.11% enterprises received the full amount they had applied for and the other 53.89%enterprises received a part of their total requirement.

10

Figure 1: Survey Results on Access to Formal Credit from Banks and NBFIs

Source: Authors' analysis based on survey questionnaire

Total Sample 509Manufacturing 96

Trading 335Service 78

Loan received307(60.31%)

Not Received202 (39.69%)

Applied but notreceived 53(26.24%)

Not Applied149 (73.76%)

Not satisfied119 (38.76%)

Satisfied188 (61.24%)

Willing to take further loan167 (88.83%)

Not willing to take further loan21 (11.17%)



Reason:

Doing business with their ownmoney or borrowing fromfamily/relitives/friends

Reasons:

- Lack of collateral- Un-registered business- New business- Lack of managerial and

technical expertise- Poor business condition- Non-fulfillment of loan

conditions- High documentation- Non-availability of guarantor

14

In comparison to the previous study (Choudhury and Raihan 2000), our study found that60.31% of the small enterprises got the access into the formal credit while the other 10. 41%enterprises did not have their access at all. On the other hand, 29.27% of enterprises did notapply for formal credit as they managed their funds by themselves.

Among the enterprises who received loans (Fig -1) from the formal financial institutions,61.24% enterprises were satisfied in terms of loan covenants and, of them, 88.83%enterprises were willing to take further loan. But 11.17% enterprises were not willing to takefurther loan from the financial institutions mainly due to the fact that the requirement ofborrowing was over.

Again, among the enterprises who received loan (Fig -1) banks and financialinstitutions, 38.76% enterprises were not satisfied with the loan covenants and requirements.From the questionnaire survey and interview of different entrepreneurs we found thatinterest rate is the major reason for their dissatisfaction. About 76.51 per cent of thedissatisfied respondents claimed and gave the priority on interest rate. Complex and longprocessing, deposit of blank cheque against loan, too much paper work were also highlyemphasized by them. Total survey results are shown in igure-2.

11

12

ure

ure from

F

Figure 2: Reasons for Dissatisfaction with Bank Loan

Source: Authors' calculation based on survey questionnaire (Multiple responses)

11

12

Out of 509 enterprises 53 enterprises applied for loan but did not get the loan. Therefore, 10.41% of total sample didnot have their access at all from formal financial institutions

Out of 509 enterprises 149 enterprises did not apply for loan

Deposit blank cheque against loan

Bankers' negligence

Interest rate is high

Too much paper work

Sanctioned less than required amount

Profit goes to the bank for high interest

Repayment schedule is not in favour

Process is complex and long

No response

15

It is important to note that from the dissatisfied enterprises, 71.43% enterprises were willingto take further loans from banks and financial institutions and 28.57% enterprises were notwilling to take further loan. Again, from the satisfied respondents 11.17% enterprises werenot willing to take further loan. Thus, 10.81% enterprises showed their unwillingness to takefurther loan from the formal sector and the reasons they identified are:

.

From the survey it is found that 39.69% enterprises did not receive any loan from banks andfinancial institutions. Out of the total enterprises who did not receive loan, 73.76%enterprises did not apply for any loan as they were carrying on their business with their ownfinance and borrowing from other informal sources like family, relatives and friends. In ourquestionnaire survey we tried to identify the general perceptions of the entrepreneurs abouttheir reluctance in applying for loan form formal sector by asking the question “why are younot willing to borrow from banks/FIs?” with a detailed list. The responses of the question areexhibited in Figure-3.

On the other hand, 26.24% enterprises applied for the loan but they were rejected.The reasons behind the rejection were lack of collateral, un-registered business, newbusiness, lack of managerial and technical expertise, poor business condition,non-fulfillment of loan conditions, high documentation, and non-availability of guarantor.

business is notprofitable, negative attitude of bankers, harassment by the financial institutions, interestrate and service charge is high, obtaining loan from informal sector is easy, security andguarantee requirement is high

Figure 3: Reasons for not Obtaining Loan from Formal Sector: Entrepreneurs' Perception


44%

67%

31%

77%

49%

21%

13%

86%

41%

Could not fulfill the loan conditions

Complicated loan procedures

Bank’s negligence or lack of interest

Lack of collateral security

Easy availability of funds from other sources

Borrowing is disgraceful

High interest rate

High sunk cost for obtaining loan

Being afraid to involve with fin institution

16

4. Stakeholders' Roles and their Initiatives for Financing Small Enterprises inBangladesh

A large number of stakeholders are involved in developing SEs in Bangladesh. They havealready taken several initiatives from their end to facilitate the small enterprises for theirsuccess. Some of the stakeholders' roles and initiatives are discussed below:

Among the different ministries of the Government of Bangladesh, the Ministry of Industrytakes different initiatives to create better environment for the financial institutions to takepart in the SME financing activities. Bangladesh Government has already felt theimportance of SMEs in the economic development of the country. This is why thegovernment has developed a SME policy in the year 2005. In continuation to that, in 2007,the ministry of industry undertook SME sector development program with the objective tosupport government efforts to expedite the development of the SME sector throughstrengthening the policy environment for SMEs and improving SMEs access to credit andrelated services. As a part of the continuing efforts of the government to develop the SMEsector, the Industrial Policy 2010 has greatly emphasized for the growth and balancedexpansion of this sector. The industrial policy 2010 states the role of the government asfollows:

(a) Government will accentuate and sustain SME activities through motivation, loanallocation and training of the entrepreneurs.

(b) Refinancing the SME sector through the 3 (three) funds created by Bangladesh Bankwill continue.

(c) Women Entrepreneurs will be given priority in the SME sector. At least 15% of totalsanction will be held in reserve in favour of the women entrepreneurs and the interestrate will be 10% only.

(d) Special preferences will be provided to the development of the industries dealing withInformation and CommunicationTechnology.

Besides, the Ministry of Industry through BSCIC (Bangladesh Small and Cottage IndustriesCorporation) is identifying small entrepreneurs all over the country and providing themfinance, training and other related services. One of the important services that are providedby the BSCIC is that it arranges fairs to ensure selling of the products produced by theirregistered organizations. So the government through its different organs is trying to creategood business environment for the small entrepreneurs of the country.

4.1 Government

17

4.2 Central Bank

Bangladesh Bank, the central bank of Bangladesh, is very much proactive in takingfavorable policy decision and providing guidelines related to small enterprise financing forthe banks and non-bank financial institutions. For example, the Bangladesh Bank hasdeveloped and

: two important documents for enabling the banks to takeactive part in the small enterprise financing activities. Besides, Bangladesh Bank arrangesroad show, SME center/branch monitoring etc.

The Prudential Regulations for Small Enterprise Financing (2004) include 13 prudentialregulations. These regulations cover sources and capacity of repayment and cashflow-backed lending, personal guarantees, per party exposure limit, aggregate exposure of abank/ NBFI on SE sector, limit on clean facilities, securities, loan documentation, marginrequirement, Credit Information Bureau (CIB) clearance, minimum condition for takingexposure, proper utilization of loan, restriction on facilities to related parties, classificationand provisioning for assets. Besides these regulations it also stipulated developmentguidelines which consists of policy guidelines (product program guidelines, segregation ofduties, credit approval, credit approval authority), procedural guidelines (approval process,maintenance of negative files), credit administration (credit documentation, disbursement,custodial duties, compliance requirements), risk management (credit risk, third party risk,fraud risk, liquidity & funding risk, political & economic risk, operational risk, maintenanceof documents & securities, internal audit), collection and remedial measures (monitoring,recovery, collection objective, identification & allocation of accounts, collection steps,productivity tracking, agency arrangement) and preferred organogram and responsibilities.The central bank has developed this comprehensive guideline for enabling the formalfinancial institutions to carry on financing the small enterprises of the country. Afteranalyzing the policy guidelines of Bangladesh Bank, we have found that there is nopolicy- induced barrier in small enterprise financing.

In addition to Prudential Regulations 2004, Bangladesh Bank has developed the '' which is a further policy initiative for the financial

institutions to participate in small enterprise financing. This document focuses ons

Prudential Regulations for Small Enterprise Financing 2004 SME CreditPolicies & Programmes 2010

,

SME CreditPolicies and Programmes 2010

teps/measures taken by Bangladesh Bank for SME development, target for SME credit,area approach method, cluster development policy, priority to the small entrepreneurs,

18

priority to refinance in industry (manufacturing) and service sector, special arrangement forwomen entrepreneurs, identification of the real women entrepreneurs, eligibility of theborrower, training programmes, monitoring of SME credit, methods of monitoring of SMEcredit, SME service centre, clusters of SME.

The major success of this policy publication is the identification of potential SME clusters ofBangladesh across industries. This is very much helpful for the financial institution toundertake the cluster approach and area approach for financing the small enterprises.

The Bangladesh Bank has initiated refinancing facilities for providing low cost fund forfinancing small enterprises by the financial institutions. Bangladesh Bank has beencontinuing its refinancing scheme in 2010-2011 against the disbursed loan in SME sector bythe banks and financial institutions. The amount of the disbursed loan in SME sector wasTk. 29092.61 crore in December 2010 of 2010-2011( ). Table-6reveals that, during 2010-2011(uptoApril 2011), twenty one banks and twenty two financialinstitutions received Tk. 1806.00 crore from the refinance scheme as against 19,339enterprises. The refinance scheme included Tk. 1185.88 from Bangladesh Bank fund(number of enterprises 13,146 of which 2,554 are women entrepreneurs with Tk. 182.77crore), Tk. 284.92 from IDA fund (number of enterprises 2929) and Tk. 334.94 from ADBfund (number of enterprises 3264).

It is important to note that most of refinanced funds go to the trading purpose whileBangladesh Bank has given the priority to the industry and service sector as mentioned in the'SME Credit Policies and Programmes 2010'. This policy also indicates that 100% claims inindustry and service sector is being refinanced in order to create a friendly environment for

SMESPD, Bangladesh Bank

Table 6: Summary Information on SME Refinancing (up to April 2011)


Name ofBanks/FIs

Refinanced

Amount Refinanced (In crore Taka) No. of Beneficiary Enterprises (sector wise)

WorkingCapital

Mid TermLoan

Long TermLoan

TotalLoan

IndustrialLoan

CommercialLoan

Service Total

BangladeshBank

266.99 638.40 280.49 1185.88 3600 7616 1930 13146

IDA 69.09 119.15 96.67 284.92 1137 1306 486 2929

ADB 144.48 132.27 58.19 334.94 800 2096 368 3264

Total 480.56 889.83 435.36 1805.74 5537 11018 2784 19339

19

employment generation and higher production. The amount disbursed among the 19,339enterprises included Tk. 480.56 as working capital loan, Tk. 889.83 as medium term loan andTk. 435.36 as long term loan.

Small and Medium Enterprise Foundation got registration from the Ministry of Commerceon 12 November 2006 and from the Registrar of Joint Stock Companies and Firms on 26November 2006 under the Companies Act (Act XXVIII), 1994 . It is an independent andunique non-profit organization. It has been established with the objective of developing theentrepreneurship by reducing information asymmetry, proper training and education,targeted credit wholesaling and easing the distribution mechanism of SME products.The SME Foundation provides low cost funds to the financial institutions, which are used tofinance the small enterprises. By this credit wholesaling operation, the SME Foundationprovides low cost fund to the financial institutions which enable them to finance the smallenterprises at a lower interest rate. This is a pre-finance facility at the rate of 4% interest rate.Till date, SME Foundation has disbursed Tk. 7.75 crore to different financial institutions forlending to specific clusters especially in the manufacturing sectors. The financial institutionsusing this facility are EBL, MIDAS, NCCBL, and MTBL.Among the other initiatives, it hasundertaken projects for developing SME database, SME cluster mapping etc. So SMEFoundation can play a very important role for the development of SME sector of the country.SME Foundation should take proper initiative to collect low cost fund and let the financialinstitution use it for financing small enterprises. In addition to that it can undertake extensiveresearch initiatives to provide better policy advocacy for formulating dynamic SMEpolicies.

National Association of Small and Cottage Industries of Bangladesh (NASCIB) is a tradeassociation established in 1984 to highlight SMCI issues and work for the development ofsmall and cottage industries of Bangladesh. It organizes SMCI fairs for the marketing oftheir products produced by the indigenous raw materials, conducts research for thedevelopment of the sector, provide consultancy to the entrepreneurs country-wide andconducts training for the skill development of the entrepreneurs. NASCIB often, incollaboration with the banks and non-bank financial institutions, organizes events(e.g. Bank-SME beach festival at Cox's Bazar) to disseminate information about the bankingproducts available for the small enterprises. But the efforts are not sufficient enough againstthe desired need of the sector.

4.3 SME Foundation

4.4 NASCIB

20

4.5 NGO/MFI

4.6 Business Bodies

These institutions in the financial system of Bangladesh are called the semi-formal financialinstitutions. These are meeting the demand of financial services of the greater rural area ofthe country where the banks and other formal financial institutions have limited or no access.So they are playing a pivotal role in financing the rural small enterprises and contribute in abetter fashion to the economic development of the country.

Local business associations, such as, chambers of commerce and women entrepreneurs'associations play very important role in creating better environment for the smallenterprises. These organizations are working as bargaining institutions to ensure betterpolicy initiatives by the government, Bangladesh Bank and other regulators.

From the literature review, it has been observed that both demand side and supply sideencountered several problems such as, high interest rate and fees, collateral and guaranteerequirements, negative attitude of bankers, cumbersome loan processing anddocumentation, lack of quality information, lack of well developed business plan,ascertainment of capacity or willingness to pay, working capital requirements, informalityand low quality financial data, low managerial capacity of owners, high transaction cost,capital shortage, high administrative costs etc. Keeping these constraints in mind, the studyhas examined the current scenario regarding the problems faced by small enterprises inBangladesh.

In our questionnaire survey we provided a list of tentative problems faced by our smallbusinesses to rank them according to their merit as per the entrepreneurs' real experiences.In our list we also provided one option for 'other problems- if any' and in this regard theypointed out three other problems which are high sunk cost for obtaining loan, malpractices insanctioning loan and lack of managerial capacity. The detailed descriptive statistics of theproblems stated by the entrepreneurs are shown in appendix-1 and the list is exhibited inTable-7 according to their importance.

5. Major Problems Faced by Small Enterprises in Bangladesh

13

13The merit was justified by the rating scale starting from 'not significant' to 'most significant' ranked from 0 to 4 with

0 bearing not significant and 4 bearing most significant.

21

From Table-7, it is clear that high interest rate is the most significant problem according tothe perception of the entrepreneurs followed by security and guarantee, working capitalrequirement, complexity of documentation etc. However, Choudhury and Raihan (2000)conducted a similar survey on SME access to credit and found some different results asbarriers for access to credit which are shown in Table-8.

In their survey they identified collateral as the prime barrier followed by bribe, delays, highinterest rate, banker's disinterest etc. On the other hand, our survey (2011) result showedhigh interest rate as the prime barrier. So it is evident that the factors acting are the primebarrier(s) has been changed significantly. The reasons for their perception may be due to thelower interest rate charged for corporate loan compared to SE loan, lower return from thebusiness compared to the borrowing rate, lower bargaining capacity, etc. Moreover,nowadays the borrower is more conscious about the rate of interest than before. Inconnection with the collateral, both the studies found approximately similar result. But incase of bribe, previous study found it as the second most significant barrier while the currentstudy found it as a very insignificant barrier of access to credit. Our study found workingcapital as the third important problem although the previous study did not recognize it as aproblem at all. Both the studies have identified some other common barriers (such as longloan processing time, sunk cost, malpractice, and negligence of FIs, etc.) that are illustratedinTable 7 & 8.

Table 7: Main Obstacles Cited by Entrepreneurs forAccessing Formal Financial Sector

Authors' calculation based on survey questionnaire

* Importance is ranked from 0 to 4, with 4 being the most significant

Source:

Sl No. Obstacle Importance*1 High Interest Rate 3.692 Excessive Security and Guarantee Requirement 2.913 Insufficient Working Capital Loan 2.814 Complexity of Documentation 2.465 Long Loan Processing Time 2.15

6 Unstructured Financial Information 1.857 Financial Institutions’ Negligence 1.738 High Sunk Cost for Obtaining Loan 1.589 Malpractices in Sanctioning Loan 1.4010 Lack of Managerial Capacity 1.23

22

Among the problems high interest rate has the highest mean 3.69 (Table-7) signifying themajor obstacle in the opinion of the respondents. The values against high interest rate havethe lowest standard deviation which indicates consistency in ranking the problem.The second highest mean is 2.91 (Table-7) with the excessive security and guaranteerequirement.

Although it has been repeatedly emphasized by the central bank to lend money to the smallenterprises with little or no collateral, financial institutions are reluctant to lend withoutcollateral securities which is observed from the table where the respondents put higher values inregard to the security and guarantee. The third highest mean (2.81) is associated with theproblem of working capital which is consistent with the prior researches in the field. The smallentrepreneurs suffer a lotdue to lack of available working capital.The fourth important problemis documentation (2.46). As evident in earlier literatures, small entrepreneurs cannot approachtheformal financial institutionsdue to rigiddocumentation requirement.

t[In Descending Order]

The next important problem we identified is the long processing time (2.15) required todisburse the credit. The respondents opined that the average loan processing time should bearound 10 days. Although during the survey we have found that a few of the financialinstitutions are taking as little as 5 working days to disburse the credit but most of theinstitutions, due to lack of their internal capacity, cannot deliver the services so promptly. In afew instances, we have found some of the institutions are taking even more than a month todisburse their credit. In case of PCBs, loan processing time is much shorter than the SOBsand SBs. The reality is that if the institutions take longer time for loan processing, it would

Table-8: Barriers o Access of Credit: Overall Perception of Demand Side

Source: Choudhury and Raihan (2000), SAPRI SME Survey

Sl No. Barrier Percentage of Respondents1 Collateral 79.42 Bribe 66.03 Delays 54.64 High Interest Rate 39.25 Banker's Disinterest 27.86 Guarantees Required 27.87 Inadequate Volume of Credit 22.78 Harassment 11.39 High Sunk Cost 8.2

10 Lack of Information 6.2

23

not serve their purpose especially for the clients who need immediate finance. According tothe opinion of the respondents, the other two problems are less significant as they have givenlower score against them.

The mean score for unstructured financial information is 1.85 and the management capacity is1.23(Appendix 1). Regarding theunstructured financial information, the responses have lowerstandard deviation indicating less variation of their opinion. But regarding managementcapacity there is significant variation among the rankings provided by the respondents. Oursurvey indicates that higher standard deviation among the problems goes for long loanprocessing time which is 1.10 (Appendix 1) that reflects thehigher variationof the responses.

We have performed one way ANOVA (Appendix-2) to see whether values assigned by theentrepreneurs against the problems show uniformity or not. Our calculated F value (408.79)is far higher than the critical F value (1.88) rejecting the null hypothesis and the values arenot uniform in the sample units.

From our survey and interview we have identified several problems relevant with thedemand side. Some major problems of the demand side are elaborated below:

Interest rate has an implication on small enterprises' access to finance. Most of thesmall businesses are willing to take loan from the formal financial institutionsbecause of their lower lending interest rate which is expected to reduce their (SEs)cost of borrowing. On the other hand, high interest rate has greater negative impact ontheir borrowings as our current survey indicated. Banks and other financialinstitutions often perceive that SEs represent a greater risk than larger enterprise, andtherefore, they are charging higher interest rates. This makes it difficult for SEs toborrow from formal financial institutions.

14

Demand Side Problems : Survey Results

i) High Interest Rate

-

-

14A One-Way Analysis of Variance is a way to test the equality of three or more means at one time by using variances.

The null hypothesis of one way Anova is all population means are equal; the alternative hypothesis is that at least onemean is different. The decision will be to reject the null hypothesis if the test statistic from the table is greater than theF critical value.

24

Box 1: High Interest Rate and High Sunk Cost

Mr. X (requested not to disclose his name) started his Agro processing business in 2004 at KanchonNagar, Narsingdi in order to produce Lichi flavored gel and different items of pickles. He started thebusiness with 28 khathas of land and machineries (both from local and foreign). After starting thebusiness, he tried to obtain loan from different banks and NBFIs for supporting his initial operations butfailed to obtain the required amount of money. With the passage of time at last he arranged Tk. 75 lacsfrom a NBFI by offering the securities of land, factory building and machineries. The nominal interestrate was 19%, along with the fees and charges the effective interest rate stood at 21%. If the searchingcost of borrowing is considered then the actual cost of borrowing is more than the 21%. Initially he facedsevere problems to repay the installment for this high interest rate. To overcome the problem, he haddriven efficiently to create the market of his product for ensuring the better turnover and growth of hisbusiness. While he was trying to market the products he was able to create a strong forward relationshipwith the PRAN Foods and Fu-Wang Foods Ltd. Both PRAN and Fu-Wang are the reputed businessenterprises in Bangladesh having the larger network both at home and abroad with good creditworthiness. Both the companies require 6 lacs pieces of Lichi per day but his capacity is to supply only3.5 lacs pieces per day.After having success from this product he started to produce different pickles andwas able to attract the banking financial institutions. Later on a specialized bank provided him TK. 1.5crore to meet up his working capital with 17% interest rate. Currently he is doing well and earningsufficient profit.According to the opinion of the entrepreneur, the current interest rate is not a concern tohim as his margin is good enough to cover the cost of funds but the previous rate (21%) was reallychallenging to grow especially for the start-up business.

Source: Authors' compilation

From our survey it is evident that about 91.94 percent entrepreneurs claimed existing interestrate is high. Box-1 represents the case of a borrower, focusing on the high interest rate. Theyalso informed that many banks and financial institutions impose different service chargesand processing fees in addition to existing interest rate which ultimately enhances theireffective rate of interest. Table-7 indicates that this variable is most significant with the rankscore 3.69. Besides, 5.11 percent entrepreneurs do not think that the rate of interest is high.However, 2.95 percent enterprises did not mention anything about the interest rate.

From the interview with higher officials of different banks and financial institutions it wasfound that the average rate of nominal interest offered by the banks and financial institutionsranges between 15% and 18%. Some banks and financial institutions also impose servicecharge and different fees which increases the effective rate of interest for the borrower.Our survey result shows that the entrepreneurs preferred to have the loan within the range of7% 13% rate of interest and the average of their expected rate of interest is 10.38%.

25

ii) Excessive Security and Guarantee Requirement

iii) Complexity of Documentation

Collateral is typically an obligatory condition for granting a loan.

They typically agree to accept collateral in the form of realproperty, products or valuable assets. They are less inclined to accept the balance of achecking account, finished commodity, guarantees of another company or a bank andsecurities as collateral. Thus small businesses often have difficulty in providingsufficient and good-quality collateral to banks. Our survey results show that 56.38 % ofthe respondents think that is the real problem for obtaining loanfrom the formal sector. On the other hand, 40.08% of the entrepreneurs do not take it aspart of their problems. It is to be noted that 3.54% of the respondents did not offer anyopinion in this regard.

As a result, it is oneof the major obstacles for obtaining loan from the formal financial sector. Most ofthe financial institutions are reluctant to sanction credit to those firms who mightfail to offer collateral.

In our questionnaire survey we asked the entrepreneurs, “What alternatives canbanks/NBFIs accept instead of security and guarantee?” They suggested several itemsas alternative to security and guarantee requirement, such as:

.

Documentation is another barrier for small business. Most of the businesses arefamily oriented and they do not maintain proper documents necessary for theirbusiness. From our survey it is observed that 53.24% of the entrepreneurs claimeddocumentation as the obstacle for accessing finance from the formal sector.However, 42.24% respondents do not face any problems in this regard for theirfinancing and 4.52% have no comment.

During the interviews some of the entrepreneurs mentioned that (specially the newbusiness) for the lack of some documents they are not getting finance from thebanks and NBFIs. However, some old business also face severe problem for thesame reasons. In response to the question, “What kinds of documents create majorproblems for you?” the entrepreneurs identified:

.

Security and Guarantee

hypothecation of goods,groupor socialguarantee, minimumsecurityandguaranteerequirements

RS problems created by surveyor,property related documents, bank statements, deed of business, rental agreementwith the house owner, TIN and VAT registration certificate, environment clearancecertificate, etc

26

iv) Long Loan Processing Time

v) Insufficient Working Capital Loan

Loan should be disbursed when needed. Some time it is found that, due to the timelag of loan requirement and disbursement many businesses can not continue theiroperation in line with the market demand. In many cases especially for thebusinesses that are seasonal in nature face this problem seriously.

In terms of our survey results, 67.58% of the total sample businesses claimed thatcommercial banks and their closest financial institutions take longer time in theirdecision making regarding loan approval and disbursement (Box 2 & 3), while26.22% respondents did not consider it as long. 6.20% respondent did not answerthe question.

The entrepreneurs/ respondents were also asked to opine about their expected loanprocessing time by asking the question, “In your opinion how many days isoptimum?” Their responses range from 5-15 days which is on an average 10.19 days.

In Bangladesh obtaining working capital loan is one of the major problems for smallenterprises. Most of the entrepreneurs explained that financial institutions arereluctant to provide working capital loan if the clients do not have prior relationshipwith them. On the other hand, small businesses fail to arrange this loan if they need it

Box 2: Long Loan Processing Time

The Alternative Energy Management Ltd. is a CNG conversion centre for all types of vehicles.The business is situated at Fulbaria, Savar, Dhaka. The proprietor Mr. Sadi Mohammad is an Engineer.He has started his business in the year of 2003. His present capital is around 30 lacs. Now the businesshas accounts receivable of around 3 lacs. The business is providing CNG conversion and other(Washing, Cylinder testing) services to Hanif Enterprise one of the biggest transport businesses ofBangladesh. The business has one important specialization that is conversion of Diesel engines intoCNG compatible engines. As a result it has a large customer base in those areas who are truck-owners.The business is running on a leased land. Last year he has applied for a working capital loan to a privatecommercial bank at Savar bazar for the amount of Tk 7 lacs. 20 days after the application he couldn't getthe loan. That time he was in real need of money to meet the working capital needs. Although therequested amount was within the limit of drawing power of the client, the bank was taking too muchtime to decide. As Mr Sadi is a very good client of the bank the branch manager arranged the fund fromhis personal account. The proposal was approved after 35 days. Later on Mr. Sadi has paid off the branchmanager.


27

on an emergency basis. Even some of them mentioned that they do not get therequired amount from the supplier of funds. Entrepreneurs rank this variable as thesignificant one which bears the score of 2.81 (Appendix-1). For the lengthydocumentation process and in some cases, because of the harassment by the officialsof the FIs, they failed to manage actual amount of working capital. We interviewedseveral business owners regarding the issue and found that inspite of having all theorganizational set up with modern equipment and ready market demand they couldnot run their businesses due to the working capital problem (Box-3).

Financial information is the key to access into the better financial services.However, small enterprises do not maintain the structured financial informationthat is required by the supply side to appraise their proposals. In our survey, weasked the entrepreneurs about their current practices for recording financialinformation. In response to this question, we found that only a few of therespondents maintain their records through formal financial statements. On theother hand, most of the accounts are not adequately maintained as per the financialinstitutions' requirement. The responses of the entrepreneurs are depicted inFigure-4.

Box 3: Insufficient Working Capital Loan, Long Loan ProcessingTime & Malpractice

Mr. S. H. S. Millat an MBA graduate has established Taseen Food Industries Ltd in 2003 atAnandanagar, Hemayetpur, Savar, Dhaka, Bangladesh with the intention to sort pulses, rice as well as toproduce high quality Pop corn and sugar packaging. Except sugar, he exported all other products toseven different countries. He has started his journey with the total asset of Tk. 8 crore including land(1 Bigha), factory building (20,000 Sq. feet) and some machineries arranged both from local andabroad. For that purpose initially he applied to a specialized bank for term loan to develop factory siteand installation of the machineries. He applied for Tk. 2.5 crore as term loan and received Tk. 2 crore.For availing the loan he provided his factory site including bulding and machineries as security. Inaddition to that, he also provided collateral of 7 bighas of land situated at Maona, Gazipur. Later on heapplied for Tk. 6 crore as working capital loan because of increased volume of operations. But he wasgiven only Tk. 2.5 crore which was not sufficient to maintain his large production capacity. Thesecurities he offered for such loan was undervalued by the bank officials (Tk. 8 crore of total asset wasvalued at only Tk. 3 crore). The consequence of this financing gap led him to shut down the pop cornproduction. For sanctioning the loan the bank took nine months which is very unusual in practice.Moreover, for obtaining this loan he had to spend Tk. 5 lacs as bribe. Currently his total asset is Tk. 16crore and monthly turnover is about Tk. 10 crore and net profit that goes to him is about Tk. 30 lacs.


vi) Unstructured Financial Information

28

Figure 4: Current Practices of Recording the Financial Informationby the Entrepreneurs


In our interview, most of the entrepreneurs acknowledge that due to the lack of theiraccounting knowledge and expert accounting people in their businesses they are unable tokeep the record properly. Moreover, they rank this variable as moderately significant withthe average score of 1.85 (Table-7).

Banks and other financial institutions should provide their support in the form offinancing, consultancy and advisory support for enhancing the growth potential ofsmall businesses. But most of the entrepreneurs opined that many officials of the FIsdo not cooperate with them properly or timely, when they need financial services.Our survey result showed that, the weighted average rank score is 1.73 (Table-7)which reflects that the variable is marginally significant. Moreover, a few businessowners claimed that bankers had rejected their proposals without any appraisal orinvestigation of their business conditions where they strongly advocated that theirbusinesses have the merits to receive the loan fromtheformal sector.

In order to enter into the formal credit sector small enterprises have to incur moresunk cost (Box-1) than the large firm. Because, financial institutions do not easilyprovide their services to the small firms to fulfill their financial needs, smallbusinesses try to get the loan from different financial institutions one after another

vii) Financial Institutions' Negligence

viii) High Sunk Cost for Obtaining Loan

32.22%

3.92%

17.28%

24.32%

73.51%

2.13%

13.57%

1.39%

Daily sales record

Transaction recorded in computer

Cash memo

Monthly statement

Daily register

Formal financial statements

Maintain monthly and yearly record

Computer software based recording

29

which increases their sunk cost in various forms. From our survey we found that theaverage rank score of the variable is 1.58 (Table-7) indicating the variable asmarginally significant. Choudhury and Raihan (2000), based on 190 enterprisessurvey mentioned that about 8.2 percent of the respondents (both borrowers andnon-borrowers) opined high sunk costs as barrier of access to credit.

Sometimes malpractices in sanctioning loan hinder small enterprises to haveaccess in the formal credit. Malpractices in sanctioning loan bearing the rank score1.40 (Table-7) signifies the importance of the variable. A few of the entrepreneursclaimed that some officials of financial institutions demand extra money other thanthe stipulated fees or charges in order to get the required loan amount which theycalled bribe (Box-3). On the other hand, some entrepreneurs mentioned thatsometimes ineligible borrowers also get the loan with the collaboration of FIs andin a few cases nepotism is also prevalent.

Managerial capacity to operate the business is another obstacle in our country.In most of the cases managements do not have any degree/training either from theformal institutes or vocational learning centers. In many cases we found that theyare not well experienced regarding the business or production process. Manyproprietors have no successor to operate the business in case of their absence.However, our survey result (rank score 1.23, Table-7) indicates that entrepreneursdo not consider this variable as one of the significant problems.

Besides the problems discussed above, there are a lot of problems our smallenterprises face. The technological requirements, the methods and skills ofproduction, marketing of products and services, quality of manpower needed forproduction, absence of SME information data base, management capacity,willingness to pay, availability of information regarding the financial products andservices are also noteworthy.

ix) Malpractices in Sanctioning Loan

x) Lack of Managerial Capacity

30

6. Responses of Supply Side against the Problems Raised by the Demand Side

Figure 5: Responses of FIs against High Interest Rate

At present, all the commercial banks and some non-bank financial institutions are playingsignificant role in financing small enterprises. The increased involvement of the financialinstitutions in financing small enterprises is mainly due to the central bank's policy initiativesand creation of business opportunities. Financial institutions are not generally interested indealing with small enterprises, mainly due to their perception of high risk in small enterprisesfinancing. The reasons behind their perception are the difficulty to ascertain if firms have thecapacity to repay and/or the willingness to pay. There is a strong belief in many banks that it iseasier to extend one large credit instead of a lot of small ones.

In the previous section, we have discussed several problems of the small businesses for theiraccess to finance into formal sector. In order to address those problems that small enterprisesencountered, we have conducted another survey centering the financial institutions that aresupplying the funds to the small enterprises. Financial institutions responded to all theproblems differently that are summarized below:

Banks and other financial institutions often perceive that SEs represent a greater riskthan larger enterprise, and therefore, they are charging higher interest rates compared tothe corporate lending. Our survey result showed that financial institutions are chargingon an average 15-18 percent interest against the small enterprises loan while thecorporate lending goes with 13 -16 percent. From our survey it is found that 65 percent(Figure-5) of the financial institutions responded that existing interest rate is not high,whereas 35 percent of the respondents think that the rate of interest is high. They alsoalleged thatmany lenders of the informal sectors chargemuch higher rate thanFIs.

i) High Interest Rate : Financial Institutions' Disagreement Over the Issue

Source: Authors' calculation based on survey questionnaire

3 5 %

6 5 %

0 %

1 0 %

2 0 %

3 0 %

4 0 %

5 0 %

6 0 %

7 0 %

Y e s N o

31

Accordingly they had identified several factors responsible for charging such highinterest rate which are exhibited in Figure-6. The reasons for charging high interest are:high monitoring and recovery cost, smaller range of credit limit, higher rate of provision,required collateral is notavailable, highcost of maintaining relationship, risk is high, highcostof fund.

Most of the financial institutions suggested that small enterprises can enjoy lowerinterest rate compared to prevailing market interest rate if the borrower repays theinstallment regularly, maintain significant savings with them, channelize their salestransaction through FIs, maintain sound credit ratings, etc. However, FIs also tooksome initiatives in this regard to reduce the interest rate like searching for low costfunds (refinancing facilities), building better customer relationship that may reducethe default risk and ensuring proper utilization of investment etc.

Security and guarantee is one of the major obstacles for obtaining finance from theformal financial sector. Because, financial institutions perceive that small enterpriselending entails greater risk and in this case collateral

mall businesses often have difficulty in providing sufficient andgood-quality collateral to banks. As a result, the supply side considered this sector lessattractive to them. Our survey results show that 58 % of the respondents think securityand guarantee is the real problem for providing loan to this sector. On the other hand,42% of the financial institutions do not consider it as a problem (Fig - 7).

Figure 6: Reasons for Charging High Interest Rate

Source:Authors' calculation based on survey questionnaire

ii)Excessive Security and Guarantee Requirement : Mixed Response

could be one effective way ofmitigating such risk. S

ure

73%

96%

77%

35%

15%

19%

88%

Hig h co s t o f fu n d

Ris k is h ig h

Hig h co s t o f main ta in in g re la tio n s h ip

Req u ired co llate ral is n o t av ailab le

Ra te o f p ro v is io n is h ig h

Smaller ran g e o f cred it limit

Hig h mo n ito rin g an d reco v ery co s tHigh monitoring and recovery cost

Smaller range of credit limit

Rate of provision is high

Required collateral is not available

High cost of maintaining relationship

Risk is high

High cost of fund

32

According to the SME Credit Policies & Programmes (2010) of Bangladesh Bank,banks/financial institutions may provide collateral free credit facilities up to Tk. 25,00,000against personal guarantee in SME sector especially for small and women entrepreneurs.Although 42% of the respondents mentioned that it is not the problem and SME policysuggested collateral free loan to some specific sector, total disbursement of collateral freeloan is not remarkable. In 2010 the aggregate average disbursement by all banks and NBFIsto the woman entrepreneurs was only 3.75%. We have also asked the financial institutionswhether it is mandatory or not according to their own lending policy. In response to thisquestion, 23% respondents told that it is mandatory and other 77% answered that it is notmandatory in their lending policy (Figure- 8). Currently some of the banks/NBFIs areoffering up to Tk. 5 lac and a few of them are providing up to Tk. 10 lac to the smallenterprises without collateral. In addition to that, they have also taken several initiatives toprovide collateral free loan such as: group based lending, frequent visit as part of strongmonitoring, introduction of cash flow based lending, strong banker-customer relationship,development of credit products which automatically generates savings and works as acollateral substitute.

Throughout the world, cash flow-based lending is getting popularity for large as well assmall businesses. If the enterprises can generate better cash flows, it is easy for the lender toprovide loan with minimum collateral. Survey among the FIs regarding the cash flow basedlending as a substitute of security and guarantee requirement shows both positive and

Figure 7: Responses of FIs against Figure 8: Responses of FIs whetherExcessive Security and Guarantee Requirement Security and Guarantee is mandatory or not

Source:Authors' calculation based on survey questionnaire

58%

42%

0%

10%

20%

30%

40%

50%

60%

70%

Yes No

23%

77%

0%10%20%30%40%50%60%70%80%90%

Yes No

33

negative responses form the FIs. 57% respondents answer positively and they identified thefollowing reasons:

- It reduces the default risk.- Regular cash flow enhances the repayment capacity.- Suitable for those customers having prior relationship and good business record.- Suitable for the borrowers receiving consistent and frequent order from the large

reputed and credit worthy firms.

However, 43% of the respondents answered negatively and they showed their opiniondifferently which are as follows:

- It may increase credit risk.- Market is not yet matured for cash flow based lending.- Integrity and willingness to pay of the borrower is also important even though cash

flow is sufficient.- Our market is so volatile that the prediction of future cash flow is very difficult.- Small businesses are not maintaining good record of their transaction that is needed

for the determination of future cash flow.- Cash flow of small businesses is more inconsistent.

Proper documentation sometimes hinders small enterprises to get access to theformal financial sector. From our survey it is observed that 46% of the respondentsdo not think that complexity of documentation is the barrier for accessing financefrom their institutions. However, 54% respondents complained that documentationreally create some problems while taking their credit decision. They argued that,there are many businesses, mostly in the rural area, operating without registration,and thus they do not have the trade licenses. Beside, the trade license, some timesmall businesses can not fulfill the criteria of other documents like business deed,bank statements, TIN, VAT registration certificate etc. and as a consequencefinancial institutions do not find them eligible for sanctioning the loan. In addition tothat, the respondents claimed that due to lack of their knowledge regarding therequired documents sometimes entrepreneurs submit their proposals withoutattaching the every required document. In this circumstance, it takes longer time forarranging the needed documents that leads to the deviation from serving theiroriginal purpose.

In response to the claim of the entrepreneurs that the financial institutions'documentation requirement is very rigid, most of the respondents answered that they

iii) Complexity of Documentation: Mixed Responses

34

do not have any other alternatives without maintaining such documentation. Some ofthe respondents mentioned that, as per the regulatory guidelines, they must followthe documentary requirement. But, depending on the nature of their relationship andfuture business prospect sometimes they may minimize the documentationrequirements. In this regard, financial institutions cited that a strong data base aboutthe borrower can help them to make the documentation requirement flexible.

The common perception of the demand side indicates that financial institutions takemuch time for processing the loan. But our survey result shows that, supply side doesnot support the perception of demand side, rather all the financial institutions in oursample strongly stated that their loan processing time is not high. Their responsesrange from 12-25 days which is on an average 15.13 days. Whereas the demand sideexpected to have the loan within 10.61 days (on an average), supply side required15.13 days (on an average) to disburse the loan. Financial institutions also cited thereasons for this required time which are:

.

Working capital is the major requirement for the day to day operation of the smallbusinesses. But most of the entrepreneurs claimed that financial institutions arereluctant to provide working capital loan and even if they obtain the loan, they do notget the required amount from the financial institutions. Most of the financialinstitutions explained that they are providing working capital loan to the smallenterprises provided that the borrower fulfill their requirements.

iv) Long Loan ProcessingTime : FIs' Disagreement

v) InsufficientWorking Capital Loan : Mixed Responses

vi) Unstructured Financial Information StrongAgreement of the FIs

absence of required information fromborrower, insufficient documentation, time required to obtain CIB report (brancheswhere there is no internet facilities), time required for proper appraisal of loanproposal and time required for loan approval

:

Small enterprises are required to provide accurate and qualitative information to theFIs for them to undertake a reliable risk assessment. Accurate risk assessmentsobviously depend on the availability of good information regarding the business andits prospects. However, all the FIs (supply side) opined that small businesses do notmaintain good record of their transactions as per their requirement. In most of thecases, financial institutions have to produce the entrepreneurs' financial statementswhich increase their operating cost also. Besides, all the respondents cited that theyare facing severe problems while assessing the financial risk of the borrower whichare illustrated in Figure-9.

35

Figure 9: Problems Faced by FIs Regarding Unstructured Financial Information

Source:Authors' calculation based on survey questionnaire (Multiple responses)

In our survey we have also asked the FIs, “How can the record keeping practices of the smallbusinesses be improved?' In response to the question, they provided the followingsuggestions to the entrepreneurs which may ensure the quality of financial information-

- do transaction through their bank account.- record keeping habit should be developed.- appointment of experienced employee or outsourcing good accountants.- may use inventory management software.- computer based record keeping system may be started.- should participate in different trainings on record keeping practices.

In response to Bankers' Negligence about small enterprise financing, banks andother financial institutions strongly opposed the demand side claim and mentionedthat, as it is the government's priority sector and central bank's regulatoryrequirement as well as their own interest, they do not show their negligence in thisrespect. In order to provide better support regarding financing and some otherancillary services most of the respondents referred to their newly established SMEdedicated desk and other consultancy and advisory support for enhancing the growthpotential of small businesses. Some respondents also agreed that sometimes

vii) Financial Institutions' Negligence : Strong Disagreement of the FIs

56%

29%

93%

77%

22%

34% 37%41%

36

entrepreneurs fail to provide all necessary documents and can not fulfill the loanrequirement that makes the FIs reluctant to finance them. Some respondents (FIs)informed that sometimes they reject loan application ab-initio, as the enterprises arenot eligible to obtain the loan. In such cases, FIs do not require further investigationbecause loan proposal itself is sufficient to justify its merits. It createsmisunderstanding among the loan applicants and they sometimes interpret it asbanker's negligence.

From the survey result it is evident that, high sunk cost is regarded as a relativelyinsignificant problem in obtaining loan from the FIs. In response to this problem,financial institutions mentioned that to some extent it is true but it does not mean thatFIs themselves are responsible for such cost. In some cases, if small enterprises donot fulfill the loan requirement then they have to move around different FIs includinginformal sector which ultimately increases their sunk cost. FIs also mentioned thatexcept service charge and loan processing fees, which ranges from 0.5 percent to 1percent on the basis of disbursed loan amount, they do not charge any additionalamount in this regard.

Financial institutions did not agree at all against the complaint of demand sideregarding their malpractices in sanctioning loan. Although the respondents do nottake this complaint on their own shoulders, a few of them mentioned that it may betrue for some other FIs. They also suggested that if there are some instances in thisregard then centralized credit system with best internal control techniques may beestablished, which ultimately may reduce such malpractices.

During our interview most of the FIs told that they are always ready to acceptqualified small enterprises to sanction credit provided that they fulfill the loanrequirements. They also highlighted that borrowers' managerial capacity to run thebusiness willingness to pay, honesty and integrity, commitment to grow, motivation,readiness to accept change, technological innovation, capacity to face competitionetc. are much more important to have access to the formal financial sector.

viii) High Sunk Cost for Obtaining Loan : Mixed Response

ix) Malpractices in Sanctioning Loan : Strong Disagreement of the FIs

,

37

7. GapAnalysis between Demand Side and Supply Side and Some Observations

Many academician and policy makers have asserted that there exists a “financing gap” forSEs. There is no commonly-agreed definition of this gap, but the term is basically used tomean that a sizeable share of economically significant SEs cannot obtain financing frombanks/NBFIs, capital markets or other suppliers of finance. Furthermore, it is often allegedthat many entrepreneurs who do not currently have access to funds would have the capabilityto use those funds productively if the funds were available. But due to structuralcharacteristics, the formal financial system does not provide finance to such entities.

On the basis of the questionnaire survey, the study identified several important problems insmall enterprise financing raised by the demand side and accordingly the responses of thesupply side on those problems. The identified major problems in small enterprise financingin Bangladesh are: high interest rate, security and guarantee, complexity of documentation,loan processing time, working capital loan, unstructured financial information, bankers'negligence, high sunk cost for obtaining loan, malpractices in sanctioning loan, andmanagerial capacity. On these issues, some gaps are prevailing between the demand side andthe supply side regarding small enterprise financing that are presented in Table-9.

Table-9 summarizes the demand side problems and the supply side responses as well as theanalysis of gap. Based on the table, we are describing the gap as follows:

A large gap exists between demand side expectations and supply side responses regardingcharging of interest rate. Most of the entrepreneurs are demanding the funds with lowinterest rate (average 10.38 %) compared to the current rate (average16.5%), whereas supplyside are reluctant to provide less than the prevailing interest rate that leads to this existinggap. Moreover, the average gap between the expected and prevailing nominal interest rate isabout 6% and also there exists some gap in case of service charge and loan processing fees.

In this regard our observation is that the perception of the entrepreneurs is not alwaysjustified for some reasons. they compare SE borrowing rate with the corporateFirstly,

Gap : High Interest Rate

Giventhat small enterprises are responsible for significant levels of employment, innovation andproductivity, it is important to be well informed about the determinants of SE growth.One important determinant is the provision of growth funding. Financial problems (lack offunds) constrain the development and growth of SEs because many SEs are unable to accessthe same kinds of growth funding often available to large businesses.

38

lending rate. they compare their rate of return from business with the borrowingrate and if they fail to earn better return then perceive that the interest rate is high. On theother hand, it is challenging for banks to lend less than the current rate as their average costof fund ranges between 11% - 12%, monitoring and administrative cost is higher for SE,perceived risk in SE financing is high etc. Moreover, FIs have to maintain certain spread tocover different expenditure and contribute to the profit. Thus, by considering the wholescenario we think that the prevailing interest rate is not so high. Even in comparison to theinformal money lender current rate of interest is significantly low. But, in many cases wefound that FIs charges different fees (every category of fee may not applicable for all FIs)which significantly increase the effective rate of interest. Still FIs have the scope to reducesuch rate as well as the fees through searching for lower cost of funds.

Small enterprises have less scope to offer sufficient security and guarantee that aredemanded by the supply side, whereas the supply side is very rigid on these requirements.As a result, a significant gap is observed due to the traditional preference for security-basedlending and the absence of flexible and friendly small enterprise financing credit policies ofthe FIs. In these circumstances, we think that FIs must fulfill the minimum requirements ofmaintaining the security and guarantee as per their prescribed credit policies and guidelines.But in a few cases, some FIs are demanding excessive security for their safeguard. Thus, thecomplaint of the borrowers is significant for those cases.

Entrepreneurs complain that the FIs demand various documents which are difficult toproduce. Moreover, FIs do not have any other alternative without such documents they aredemanding. This gap arises basically for the borrowers' misunderstanding regardingdocumentation requirement of the FIs as per their credit guidelines. Besides, there existinsufficient initiatives to ease the formalities of document issuing process by the issuingauthorities. Our opinion is that, as proper documentation is really needed for the smoothoperation of credit, the list of documents that are demanded by the FIs are not avoidable.But the common problem faced by the entrepreneur is to prepare or arrange the documents inproper time; even in a few cases they operate their business in unstructured way without therequired documents.

Secondly,

15

Gap : Excessive Security and Guarantee Requirement

Gap : Complexity of Documentation

15CIB inquiry charge, Appraisal Fee, Processing fee, Renewal fee, Bill discounting charge, Documentation charge,

Security replace fee, Land valuation charge, Prepayment charge, Foreclosure fee, Issuance fees for anycertificate/statement/letter, Photocopy of land documents, Rescheduling charge, Issuance of transfer documents etc.

39

Gap : Long Loan ProcessingTime

Gap : InsufficientWorking Capital Loan

Gap : Unstructured Financial Information

Gap : Financial Institutions' Negligence

Entrepreneurs are claiming that FIs' loan processing time is high but supply side do not agreewith them in this regard. FIs require sufficient time for obtaining CIB report, properappraisal of loan proposal and approval. Regarding the loan processing time, the average gapis about 5 days between the demand side expectation and the time taken by the supply side.This gap exists as borrowers do not have clear idea about the loan processing and decisionmaking procedure of the FIs. We found that some FIs' credit decision is centralized whereasothers are following decentralized credit approval process. So the decentralized FIs needslightly high time for loan processing. Therefore, the complaint in regard to long time FIs aretaking is not always meaningful to us.

FIs are reluctant to provide working capital funds to the borrowers with whom they have theinsignificant relationship which deters proper assessment of their credit worthiness. On theother hand, sometimes entrepreneurs fail to fulfill the working capital loan requirements anddemand higher amount than their need. However, in some cases FIs were also observed toreject proposals or sanction lower amount than the required amount because of inadequatesecurity as well as the conservative approach of their assessment.

Therefore, the gap between demand side expectation and supply side response in regard toworking capital loan is arising because of over-emphasis by the FIs on prior/existingrelationship with the borrowers as well as borrowers' misconception and lack of awarenessabout the FIs' working capital assessment mechanism.

Small borrowers might be the good business-people, but not necessarily good bookkeepers.It is observed that the small enterprises have limited knowledge about the transactionrecording process and some them do not have the transaction recording knowledge at all.Moreover, they have lack of understanding about the requirements of structured financialinformation by the FIs. Even a few enterprises which maintain structured financialstatements are not found audited. As a result FIs face severe problems while assessing thefinancial aspect of the borrowers.

On the issue of bankers' negligence, most of the entrepreneurs claimed that many financialinstitutions do not co-operate them properly while trying for getting finance and sometimes

40

officials of FIs reject their proposals without any appraisal or investigation. On the otherhand, FIs opined that from their preliminary screening if they realize that furtherinvestigation is not needed, they reject the proposal. Moreover, FIs stated that they haveSME dedicated desks which are programmed for better services to the SME clients.Thus there exists some gap regarding the issue mainly due to borrowers' misconceptionabout the borrower selection process of FIs. In some cases, FIs are reluctant due to theirperceived high risk in small enterprise financing. In this context, we found that except for afew FIs, most of them are not enthusiastically interested to finance small businesses ratherthey are financing only for complying with regulatory policy requirements.

Regarding high sunk cost for obtaining loan, it is evident that the borrowers had to collectdifferent documents from different issuing authorities in fulfilling the loan requirementswhich ultimately increases their cost. In addition to that, some time they fail to fulfill the loanrequirements which causes them to move different FIs. Therefore, the demand side incurshigh sunk cost. However, we observed that FIs take only service charge and loan processingfees which are clearly mentioned in their documents that ultimately raise the effective rate ofinterest of the borrower but not the sunk cost. FIs in this respect are not really liable for suchhigh sunk cost.

Due to involvement of some bank officials in unethical practices while sanctioning loan tothe small enterprises and inability to discover such practices due to the inefficiency ininternal control and compliance mechanism of the FIs are the causes for malpractices insanctioning loan. In this respect, the gap between the demand side and the supply side isminimum. We found that malpractices in sanctioning loan are still prevailing.

On this issue, there exists significant gap between the demand side and the supply side.The supply side or the FIs believe that many of the small enterprises lack managerial capacityin terms of formal education, experience, succession requirement etc. However, the demandside perception about their managerial capacity is very positive. In this regard ourobservation mostly coincides with the FIs' responses.

Gap : High Sunk Cost for Obtaining Loan

Gap : Malpractices in Sanctioning Loan

Gap : Lack of Managerial Capacity

43

8. Recommendations

The study has pointed out a number of demand side problems while obtaining finance fromthe formal financial sector and also identified the supply side responses accordingly. Afteranalyzing both sides, we found some gaps prevailing in regard to many issues, as mentionedearlier. Based on the observations and findings, to minimize the gaps and to reduce theproblems of demand side in getting finance from the financial institutions, we recommendthe following actions:

In regard to , there exists a large gap between the entrepreneurs'expectation and the prevailing interest rate. Although the prevailing interest rate ofthe FIs is not so high in comparison to the informal money lenders and their cost offunds but the effective interest rate is slightly high for some additional fees orcharges. Still FIs have the scope to reduce such rate by searching for low cost funds.In this context, Bangladesh Bank, Government and other stakeholders can providelow cost fund to FIs and enable them to finance small enterprises at a lower interestrate. Although Bangladesh Bank and SME Foundation have taken some initiativesbut these are insufficient relative to the demand. So, they should intensify theirefforts (refinancing and pre-financing) to provide low cost funds to the commercialbanks. Besides, FIs may offer lower interest rate to the borrowers who havewillingness to accept a collateralized loan contract relative to unsecured loans.In addition, FIs may keep an SE database and should practice credit scoring modelthat may reduce their monitoring cost which ultimately help to reduce interest rate.

is identified as one of the most seriousimpediments to the extension of credit in small business sector. Financial institutionsmay take care for the collateral free loan where personal guarantee is strong and theproject has good future prospects. Moreover, FIs can concentrate on findingcollateral substitute such as cash flow based lending, extensive monitoring, socialsecurity etc.

To minimize the problems related with the FIsshould not consider the prior relationship with the borrower only; rather they shouldalso put emphasis on the business prospects of the borrowers. Besides, FIs shouldmake them understand about the process of working capital assessment and theminimum time required for the approval of such capital.

g

g

g

high interest rate

Excessive security and guarantee requirement

insufficient working capital loan,

44

g

g

g

g

g

is a serious barrier for the entrepreneurs to getaccess to formal finance. To eliminate this problem, business owners should beencouraged to use proper accounting records on their business transactions byeducating them to know the benefit of accounting and financial information, bygiving them incentives such as tax holidays and easier access to bank loans, and bysetting up simple SEs accounting standards. Not only the FIs but also the otherstakeholders such as SME Foundation, NASCIB, and different business bodies canorganize training activity to educate the SE entrepreneurs in recording businesstransactions and preparation of structured financial statements.

The survey provides a few instances of in dealingwith the SE clients. Although it is few, but the information is very significant forbetter access to credit. In this case, banker should have good customer relationship,positive and caring attitude towards the small entrepreneurs. The bankers have tonourish the small entrepreneurs to become successful. This relationship should belike partnership.

To address the issue, of the small entrepreneurs,government as well as the other stakeholders can take capacity building projects andimpart quality training to the small entrepreneurs. This may help the entrepreneurs tomanage their businesses more efficiently and become sustainable. In addition to thatthe FIs can provide different support services to the small entrepreneurs for bettermanagement of their businesses, such as: consultancy services, counseling etc.

Frequent visits of the clients to the FIs for getting loans raise their in termsof money, energy and time. At the first interaction, the relationship official shouldprovide the prospective borrower a so that the borrower might visualize allthe requirements of the loan clearly. Moreover, the relationship officer should bevery friendly in explaining the terms, documentation process and other aspects of thecredit. To reduce the knowledge gap of the borrower in fulfilling the loanrequirements, FIs should undertake extensive skill development program of theiremployees in delivering services to the SE clients. The relationship officials mayprepare the prospective borrower and make him / her ready for establishingrelationship with the bank which will reduce the risk.

may be reduced by adopting standard loan approvingprocedures based on information technology and maintaining better informationmanagement.

Unstructured financial information

financial institutions' negligence

lack of managerial capacity

sunk costs

check list

Long loan processing time

45

g

g

g

g

g

To address the issue of (taking bribe, nepotism etc.) in sanctioning loanto small enterprises, the FIs have to adopt better internal control and governancemechanism to identify such activities, and if found, involved officials must getexemplary punishment.

There is an urgent need to adopt a new business model for financing SEs. Because,applying the same model for financing corporate and small business would notprovide the desired benefits. Although most of the FIs are starting their journey withthe separate SME dedicated desk with some other initiatives, these are notsubstantial. Thus, FIs should re-engineer (business process re-engineering) theirexisting financing process of SEs to take special care for them.

There are many financial products and services available for the small businesses butthe entrepreneurs, most of whom are running businesses in the rural areas, could notavail it because they do not have the information about them. As a result, they areborrowing from the local moneylenders and micro finance institutions whichincrease their cost of doing business. Thus, small entrepreneurs in the rural area arelosing their competitive advantage against the small entrepreneurs borrowing fromthe formal financial institutions especially in regard to the price. The localgovernment bodies can operate the rural information centers in a better way toprovide information to the small entrepreneurs. Moreover, many of theentrepreneurs do not know about the different sources of refinancing orpre-financing scheme available in our country. In this regard, FIs should takeintensified efforts to disseminate information about their products and services to thetargeted people that may reduce the information gap between the borrowers andlenders.

To address the problems of getting documents from different issuing authorities,government and other relevant authorities can ease the documents-obtaining processby establishing separate counter for the SE clients in various departments across thecountry. This initiative will help the entrepreneur to meet the documentationrequirements of the financial institutions.

To enhance their effective contribution in the sector NASCIB can organize moreeffective training for the skill development of the entrepreneurs, can take initiativesto establish business links of the small businesses with large corporations for bettermarketing of Small, Medium and Cottage Industries (SMCI) products. Along withthis, the institution can bargain with the government on different policy issues to

malpractices

46

facilitate the activities of the small entrepreneurs. NASCIB can also play an activerole for the market expansion of the products of SMCI across borders specifically inSouthAsian region through different products fair.

Government and trade associations may initiate building a good relationshipbetween businessmen and bankers by participating in discussions, seminars, andsymposiums. By developing a close and good relationship among these players, eachside will understand and be able to sensitize the problems and constraints of the otherside. This is the best way to reduce lack of understanding banking procedures by thebusinessmen and use of onerous and unfriendly banking procedures on the part ofbanks in making loans to business.

In order to reduce the information asymmetry, a very good relationship between theFIs and its SEs should be established by which SEs can identify the potentialsuppliers of financial services and evaluate the cost of the financial services that arebeing offered by FIs as well as the financial service providers can easily receive thefeedback of managerial attributes and evaluate the risk and prospects of the SEs.

Many of the small entrepreneurs operating in the rural areas claimed that, they are notgetting access to the formal financial sector due to the absence of the FIs' network. Inthis connection, banks may take proper initiatives to cover larger geographical area.In order to meet the rural requirements banks can establish branches in the ruralareas. If it is not possible, they may establish extensive credit linkage programs withthe NGO/MFIs of the country for covering larger area.

NBFIs may also diversify their SE financing portfolio by offering more innovativefinancing products throughout the country such as small lease or micro lease. Thereis a great need for improving different aspects of financial services for SEs such asseed money, leasing, factoring, invoice financing, venture capital, investmentfunding etc.

NGO/MFIs can extend financing facilities for the small enterprises because it canreduce their administrative costs and enhance the quality of their portfolio. Theycan also enter in the small enterprise financing market by forming strategicpartnerships with the FIs.

g

g

g

g

g

g

16

16Since administrative cost of microfinance is higher than the SE financing.

47

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49

Appendix

Appendix 1:

Appendix 2:

Descriptive Statistics of Major Demand Side Problems

One way ANOVA of Ranking

Source:

Source:



Highint. rate

Exc.Sec.and Guar.

Uns. Fin.Info

LoanProcess

Time

ComplexDoc

Man.Cap

Fin. Ins.Neg.

Work.Cap.

HighSunkCost

Mal-practices

Mean 3.69 2.92 1.85 2.16 2.47 1.23 1.74 2.81 1.59 1.41

Stand Error 0.03 0.04 0.04 0.05 0.05 0.03 0.04 0.04 0.03 0.03

Median 4.00 3.00 2.00 2.00 2.00 1.00 2.00 3.00 2.00 1.00

Mode 4.00 3.00 1.00 1.00 2.00 1.00 2.00 3.00 2.00 2.00

Stand Dev 0.61 0.87 0.93 1.10 1.05 0.73 0.85 0.94 0.73 0.76

Sample Var 0.37 0.75 0.87 1.21 1.11 0.53 0.73 0.88 0.53 0.57

Kurtosis 2.48 -0.75 -0.41 -1.13 -1.04 -0.96 -0.35 -0.74 0.13 -0.27

Skewness -1.87 -0.31 0.47 0.44 0.03 -0.33 0.23 -0.38 0.15 -0.10

Range 3.00 3.00 4.00 4.00 4.00 3.00 4.00 3.00 4.00 4.00

Minimum 1.00 1.00 0.00 0.00 0.00 0.00 0.00 1.00 0.00 0.00

Maximum 4.00 4.00 4.00 4.00 4.00 3.00 4.00 4.00 4.00 4.00

Sum 1880.00 1484.00 944.00 1097.00 1256.00 627.00 884.00 1431.00 808.00 717.00

Count 509.00 509.00 509.00 509.00 509.00 509.00 509.00 509.00 509.00 509.00

ANOVASource of Variation SS df MS F P-value F crit

Between Groups 2779.563065 9 308.8403405 408.79633 0 1.88172234

Within Groups 3837.874263 5080 0.75548706

Total 6617.437328 5089

50

Appendix 3: Questionnaire for the Survey of Small Enterprises

Name of the Business:………………………………………………………………………Name of the Respondent: .………………………………………………………………Business Address with Mobile/PhoneNo:………………………………………………………

1. In which year you have started your business? …………………..………………….

2. Type of business Manufacturing Trading Service

3. What is the size of your total business (total value of asset in Tk.)? ………………………

4. What is the current capital structure of your business (Tk.)?

i) Own: ………………………………..ii) Borrowing from Bank/FIs: …………………………..iii) Borrowing from others (friends, relatives, samiti etc): ……………………………

5. Please mention the loan amount you had applied and actually received.

i) Applied for (TK): …………………………………...ii) Amount Received (TK):

a) Term Loan ……………………………………………b) Working Capital……………………………….……..

6. How many times you had to visit the bank/FIs for obtaining loan?

7. Are you satisfied with the bank loan? Yes No

8. Are you willing to take further loan in future from the bank/FIs? Yes NoIf no; why …………………………………………………………………………………….

9. If you applied for bank/FI's loan but failed to obtain it, what were the reason(s) for such rejection?………………………….........................……….…………………………………………………10. If you are not willing to borrow from banks/FIs, what are the reason(s)? Please tick in thefollowing box.

Could not fulfill the loan conditions

Complicated loan procedures

Bank's negligence or lack of interest on the borrower

51

Lack of collateral security

Easy availability of funds from other sources ( )

Being afraid to involve with a financial institutions

Borrowing is disgraceful

High interest rate

High sunk cost for obtaining loan

Others (if any)11. Do you think that the interest rate charged against the small enterprise loan is high?

Yes No

12. What is your expectation regarding the interest rate?13. Do you think bank/FI's loan processing time in small enterprise is longer?

………………………….......………………………………………………………………………

Friends, relatives, samity, informal money lender etc.

Yes No14. In your opinion how many days is optimum?

15. Do you think that security and guarantee are the major problems in obtaining finance frombank/FI?

Yes No

16. What alternative(s) bank/FI can do as against the security and guarantee?……………………………………………………………………………………………………17. Do you think that documentation is one of the major obstacles in obtaining finance from theformal sector?

Yes No

18. What kinds of documents create major problems for you to have the loan from bank/FI?……………………………………………………………………………………………………19. What kind of problems (if any) do you face for obtaining working capital loan?………………………………………………………………………………………………………20. Do you keep good record of your daily transaction?

Yes No

21. Mention your current practices for recording financial information.

52

22. Rate the following factors (Given in the table) according to the following scale.

Please put tick mark in the blank cells according to your opinion

Remarks, if any.……………………………………………………………………………………………………………………………………………………………………………………………....

InsignificantLightlySignificant

Significant Most Significant

4

Moderate

3210

Problems Scoring 0 1 2 3 4

High Interest rate

Security and Guarantee

Unstructured Financial information

Longer Time taken for Loan Processing

Complexity of Documentation

Lack of Managerial capacity

Working capital requirement

Other problems, if any

53

Appendix 4: Questionnaire for the Survey of Banks/NBFIs

Name of theBank/NBFI…………………………………………………….............……………………Name of the Respondent:………………………………………………...…………………Designation:………………………………………………………………....……………...

1. How do you define “Small Enterprise” at your organization?

4. Sector-wise concentration of small enterprise loans

………………………………………………………………………………………………

(Please provide separate sheet, if required.)

2. In which year you have started SME banking?3. What is the size of Small and Medium Enterprise loan in regard to total loan portfolio

(volume) for last 4 years? Please fill up the following table.(Tk. In Million)

(In million Tk.)

5. Is there any initiative in your organization to provide better customer service to SME clients?If yes list the services below.

The selected problems were identified from the questionnaire survey on the small enterprisesand listed bellow along with specific questions for each problem. Please read the problemscarefully and answer the questions.

Trading Concern Manufacturing Concern Service Concern

Particulars 2007(Dec) 2008(Dec) 2009(Dec) 2010(Dec)Total Loan Amount

Small Enterprise Loan Amount

Medium Enterprise Loan Amount

Name of the Major Sectors 2007(Dec) 2008(Dec) 2009(Dec) 2010(Dec)

Manufacturing

Trading

Service

54

6.1 High Interest Rate

6.2 Security and Guarantee

6.3 Quality of Financial Information

6.4 Loan Processing Time

i) Do you think that the interest rate charged against the SME loans is high? Yes No

ii) If yes, what are the factors responsible for this high interest rate?……………………...……………………………………………………………………iii)What kindof initiatives entrepreneurs can take thatmay help you to reduce the interest rate?…….......…………………………………………………………………………………iv) Have your bank taken any initiative to reduce the high interest rate? Is there any plan in

such case?………….......……………………………………………………………………………

i) Do you think that security and guarantee is one of the major problems in SMEfinancing? If Yes/No, why?

...…………………………………………………………………………………………ii) Is collateral mandatory according to your bank's lending policy for financing small

enterprises?Yes No

iii) What are the steps your bank is undertaking to minimize these problems?...…………………………………………………………………………………………iv) Cash flow based lending is getting popularity all over the world. In this context, do you

think cash flow can be a substitute of Security and Guarantee? IfYes/No, why?...........……………………………………………………………………………………

i) What kind of problems are you facing regarding quality of financial information?Please list the problems.

………………………...…………………………………………………………………ii) What are the steps your bank has taken to solve this problem?…………...………………………………………………………………………………iii) How the record keeping practices of the small businesses can be improved?……...……………………………………………………………………………………

i) What is the average length (in days) of loan processing for small enterprise?a) 0 to 7 days b) 8 to 15 days c) 16 to 25 days d) more than 25 days

ii) Do you think your bank's loan processing time in small enterprise is longer?Yes No ; If Yes/No, why?

…………………………………………………...………………………………………iii) Most of the entrepreneurs think that loan processing time in small enterprise is

very high. How could you address the problem?………………………………………………...…………………………………………

55

6.5 Documentation

6.7 Malpractices in Sanctioning Loan

6.8 Non-availability of Information on Banking Products

7. Remarks, if any.

i) Do you think that documentation is one of the major obstacles in financing smallenterprises?

Yes No

ii) Most entrepreneurs think that documentation requirement is very rigid. How could youaddress the problem?

…………………………………………………………………………………………iii) Is there any alternative to minimize the documentation requirement? If yes, what are those?……………………………………………………………………………...…………

i) Many entrepreneurs' claimed that some bankers have negative attitude in financingsmall enterprises. Please comment.

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i) As per the entrepreneurs' opinion, many bankers are involved malpractices whilesanctioning loan in small enterprises. Please comment.

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i) Many entrepreneurs said that they are not well informed about the existing bankingproducts and its facilities. How would you resolve this problem?

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6.6 Bank's Negligence or Lack of Interest in Financing Small Enterprises

SME FINANCING : DEMAND SIDEssadmin.bibm.org.bd/notice/02-07-19/Monograph 03.pdfBSCIC Bangladesh...

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