1. finance

Promoting SMEs though Access to
Finance
Presented by:
M. A. Baqui Khalily
Department of Finance
University of Dhaka, Bangladesh.
Overwhelming Interest in
Access to Finance
 Seminal work of McKinnon (1973) and Shaw (1973) led to
re-emergence of the issue of “finance matters in
development”
 The classical work of Patrick (1966) – ‘demand following’
and ‘supply-leading’ finance strategy is re-visited.
 Debate on the direction of causality between finance and
growth. This is well documented (King and Levin (1993),
Levin and Zervos (1998), Arestis et. al. (2001), Gupta
(1984).
 Several conclusions are derived from the literature: Finance
follows growth in developing countries, and growth induces
finance in developed countries.
Micro Level Research on Access to
Finance
 Rajan and Zingles (1998): Industries with access to external
finance grow at faster rate.
 Wurgler (2000) and Aghian et. al. (2007) with similar
conclusion: Increase in investment in more growing
industries.
 BUT small and medium industries find it difficult to raise
funds for inherent behavioral characteristics of financial
institutions (Hutchinson and Xavier 2007; Berger and Udell
2004).
 Research on impact of microfinance reinforces the fact
‘access to finance’ matters (e.g., Hossain 1988; Khandker;
Zohir et. al.; Rahman et. al.)
SMEs in Development Agenda
 Most of the growth theories suggest that industrialization is
the engine of economic growth
 A balanced growth of both agriculture and industrialization is
very important and necessary for the economic development
of Bangladesh
 For pursuing the industrial development efforts, the main
objectives and strategies focused are optimal utilization of
resources, creating employment opportunities and catalyzing
the growth of production and exports
SMEs in Development Agenda
 The World Business Council for Sustainable Development
(WBCSD) showed that in the developing countries, more than
90% of all firms, outside the agricultural sector, are SMEs and
microenterprises and generating a significant portion of GDP
 In Bangladesh, enterprises of less than 100 employees account
for 99% of firms and 58% of employment
SMEs in Development Agenda (cont.)
 Well managed and healthy SMEs are a source of employment
and wealth as well as poverty alleviation. Moreover, there is a
positive relationship between a country’s overall level of income
and the number of SMEs per 1,000 people (IFC, 2006)
 The World Bank’s Doing Business reports indicate that a healthy
SME sector corresponds with a reduced level of informal or
“black market” activities
 Local SMEs can work as an important source of supply and
service provision to the large enterprises of both national and
internationals
 SME is also good for communities itself, because through
employment creation and growth, it will improve the standard
of living of the communities.
Sources of Finance and Stages of SME
Development
 The entrepreneurs require mainly three types of finances:
 (i) equity capital - to finance assets at the start of a business;
 (ii) debts – to refinance assets; and
 (iii) working capital – to maintain the day-to-day activities (Jesmin, 2009)
 Access to credit/financing is deemed to be one of the greatest
hurdles faced by SMEs
Financing stages (saublens)
INDUSTRIALIZATION AND SME DEVELOPMENT
IN BANGLADESH
 Bangladesh inherited a weak backbone of industrialization since
independence.
 According to Bangladesh economic review, the contribution of
the broad industry sector to real GDP:
 17.31 percent in 1980-81,
 29.95 percent in 2009-10
 SMEs witnessed very limited growth during 90s, and this was
mainly due to negative growth of the small industries
(employment size less than 20).
State of SMEs in Bangladesh
 The importance of SME especially small and cottage industries is
always recognized in every development plans of government
before and since liberation
 Recently the development partners also giving importance to
SMEs
 The government of Bangladesh is also taking a lot measures for
the improvement of the SMEs:




Targeted program for SME
Targeted for women entrepreneurs
SME Foundation
Refinancing of SME loans
 The main constraints of financing, even with continuous of effort
of government, could not resolved
State of SMEs in Bangladesh
 There were approximately 6 million micro, small and medium
enterprises (MSMEs), which included enterprises with up to
100 workers employing a total of 31 million people, equivalent
to 40 per cent of the population of the country of age 15 years
and above (MIDAS,2003)
 By the end of 2010, it has grown enormously, at least by 50
percent. Approximately around 9 milion MSMEs.
 Contribution of MFIs.
State of SMEs in Bangladesh
 There are more than 600,000 small and cottage enterprises in
Bangladesh (Ahmed, 2004) .
 Some 3 million micro enterprises are also in operation
 90 percent of all industrial units are SMEs (SEDF, 2003)
 If we accept the estimates of Ahmed (2004) and the fact
reported by SEDF, it can be estimated that there are some
900,000 industrial units in the country. Manufacturing sector
contributes only around 10 percent of total employment.
State of SMEs in Bangladesh
 Return to capital investment is higher for micro and small
enterprises (above 30 percent) compared to 13 percent for
the medium enterprises
 SMEs in Bangladesh have higher profitability than some
European countries. Operating profit of SMEs as reported in
SEDF (2006):
 Bangladesh: 12 percent
 Greece: 7 percent
 Franc 5.1 percent, and Canada: 9.2 percent
 SMEs in Bangladesh have higher potentials and can play very
significant role in growth and development, as it is Japan.
State of SMEs in Bangladesh
 There is no precise estimate of the contribution of SMEs to GDP.
Serder (2000) reported around 20 percent contribution of small-scale
enterprises to GDP.
 Daniels (2003): Contribution of MSMEs - around 25 percent to GDP.
The contribution is expected to increase with the inclusion of public
sector enterprises.
 Rabbani and Sulaiman (2005) show that SMEs with relaxed liquidity
constraint because of bank finance tend to create more employment
than the SMEs with lesser or no access to credit
 Despite lack of adequate data, empirical evidences suggest that SMEs
perhaps contribute around 25 percent to GDP
SME Financing in Bangladesh
 Dismal pictures of SME financing:
 Khan, Imam and Khatun (1998)
 Khan, Imam, Khatun and Ahmed (2003)
 Daniels (2003)
 SEDF (2006)
 All these studies report same findings: Around forty percent of the
SMEs do not approach banks for loans. Around fifteen percent of
the loan applications are rejected on the ground of guarantee or
collateral, asymmetric information and high transaction cost
 In Bangladesh, SMEs are largely financed by own funds.
 Equity fund through capital market is not a widely used source for
small and medium entrepreneurs.
SME Financing in Bangladesh
 The recent study of SEDF (2006) reinforces the earlier
findings that SMEs have limited access to bank financing
 It shows that about two-third of the SMEs did not approach
banks for loans
 Most of them approached banks for working capital loans.
Not all of them were granted loans
 It takes about two months on an average to get loan
sanctioned. The findings are similar to the earlier studies.
Finance is a constraint
 Access of the small enterprises to credit has not improved
over the past 30 year – access to finance is still a dominating
constraint.
 All previous studies reported the same:
 SEDF (2006)
 Task Force report 2004
 Ahmed 2004
 Khan et.al. (2003)
 Daniels (2003)
 Serder (2000)
 Khan et. al. (1998)
 Rahman et. al. (1979)
What is the Present Trend? Small
have little access
Trend in Industrial Finance by Size
Industrial Term Credit Working Capital
As % of Total credit
Year
LME
SE
LME
SE
Industrial Working
Credit
capital
2009
89.08
4.04
95.47
2.33
21.30
17.59
2005
93.06
3.04
93.75
5.46
17.87
20.43
2004
93.35
3.52
92.88
6.34
18.59
19.49
2003
94.26
2.95
93.56
5.72
19.51
16.97
Source: Bangladesh Bank Publications
What restricts banks to finance SMEs?
 Literature on industrial finance and entrepreneurship
development amply document two factors that restrict banks to
extend sufficient credit facilities to the SME sector.:
 Collateral,
 High transaction cost
• Empirical evidences suggest that banks do not sanction credit to
the SMEs for lack of collateral and high transaction cost (SEDF
2006; Khan et. al., 2003; Khalily et. al. 1994, Rahman et. al.
1979).
• SEDF (2006) reports that even 16 percent of loans sanctioned
did not take loan for lack of sufficient collateral.
What Do We learn?
 Small enterprises are largely excluded. They are the “Missing
Middle’. This group has nether access to formal credit market
nor do they have access to micro credit market.
 Collateral is a constraint for promoting SMEs, in particular
small enterprises.
BRAC Bank and “Missing Middle”
 BRAC bank initiated SMEs lending in 2001
 BRAC Bank emerged through a process of learning. BRAC
 They probably perceived that while the ‘big push’ was required
for taking micro enterprises to the next phase of development, it
was important that small enterprises are promoted as they are
the ‘missing middle’ in the path of development
 In the private banks, the SMEs did not get sufficient access to get
loan as the large corporation did.
 BRAC bank came to break that tradition, and started providing
different types of SME loans, particularly small business, since
inception
Total number of borrowers by year (in thousands)
1.92
1.03
59.39
2.84
65.42
60.42
Total
67.34
Female
1.26
52.12
53.38
77.49
80.33
Male
2007
2008
2009
2010
Industry mix of SME customers
Agriculture
40,687
9351
8,960
1,418
2008
Service
8881
12,554
1,891
2007
Manufacturing
44,007
2161
1,063
356
2,225
13389
12,439
49,791
52,285
Trade
2009
2010
BRAC Bank, as a Development Bank,
follows Triple Bottom Line
 Although BRAC Bank finances SMEs, its focus has been on the small
enterprises with average loan size around TK 5 lacs. WHY?
 They are largely left out in the credit market
 Small entrepreneurs are essentially the people within lower 50th percentile of





income distribution
These entrepreneurs learn through doing, and/or learning from the experience of
others in the same profitable business
They have potentials to grow with backward and forward linkages
These enterprises are generally family enterprises with participation of qualified
family members and hired laborers
They will be effective agents of change at the community level
promoting small enterprises will in fact help others with homogeneous
characteristics to learn from the experiences of these arguably successful
entrepreneurs.
 BRA Bank not only provides credit to small business, they promote social
and environmental dimensions of credit as well.
How Effective is BRAC Bank?
 A recent study shows that BRAC Bank has made impact at the
enterprise and household level of the borrowers.
 The study was conducted over randomly selected 525 enterprises of
21 SME unit offices of BRAC bank
 Of the enterprise borrowers, 35 percent were repeat borrowers.
The other samples included enterprises who did not apply for repeat
loan or rejected for the repeat loan.
 The basic characteristics prior to accessing Brac Bank credit were
homogenous in terms of number of employees, assets size, initial
capital size.
Results
Table: General characteristics of the borrowers
Types of
Borrowers
Educational
Experience Experience in
Age of the qualification of
in Current
Family
entrepreneur
the
business
business
entrepreneurs
New
38.11
(8.48)
[134]
9.49
(2.97)
[134]
12.13
(7.12)
[134]
11.00
(13.22)
[7]
Repeat
40.01
(8.60)
[286]
9.54
(3.31)
[286]
15.01
(8.30)
[286]
8.05
(10.48)
[19]
Total
39.41
(8.60)
[420]
9.53
(3.20)
[420]
14.09
(8.04)
[420]
8.85
(11.08)
[26]
Table: PSM estimates of financial indicators
Variable
t-test
Accumulation
of Assets
Total Assets at cost (USD)
4.34
Difference as % of
Control
62.08
Total Assets at Market Price (USD)
4.77
50.12
Growth rate of Total Assets (USD)
3.69
111.85
3.04
98.95
Utilization of
resources
Growth rate of Fixed Assets at cost
Growth rate of Fixed Assets at
market price
Ratio of Fixed assets to Total Assets
Sales-fixed Assets
6.37
157.75
-2.49
2.16
-12.75
66.3
Growth Sales
Sales (US Dollar)
Profit (USD)
Growth rate of Profit
ROA
Rate of Return
Total Capital (USD)
3.19
4.43
1.81
2.68
-4.69
-6.38
4.1
98.24
76.3
2.82
75.02
-22.97
-27.43
33.44
Total Debt (USD)
Equity Capital (USD)
3.68
3.45
31.89
33.82
Indicators
Long Run
profitability
Profitability
Financial
Structure
Employment creation
Economic indicators
Table: Matrix of Economic Indicators
Specific
measurement
indicators
% of
Repeat
New
change
Difference t-stat
over
Borrowers Borrowers
control
(N=134)
(N=286)
Number of full
time male
employees
2.26
1.62
0.64
3.27
Number of full
time female
employees
0.31
0.29
0.02
0.23
39.64
Table : Matrix of Economic Indicators:
reflection of Perceptions (percent)
Economic
indicators
Repeat
New
Differenc
Borrowe Borrower
e
rs
s
t-stat
Percentag
e change
Generation of
savings
75.95
72.24
3.70
0.37
-
Income
enhancement
52.21
30.88
21.34
6.60
69.12
Business
expansion
71.71
35.03
36.68
8.84
104.70
Creation of
competitive
environment
or business
74.68
71.51
3.17
0.49
-
Table : Matrix of Social indicators
Social indicators
Use of child labor
(Number)
Education of
children
(Percentage
increase in
expenditure)
Health
(Percentage
increase in
expenditure)
Television
(percentage
increase in
expenditure)
Repeat
Repeat
Percentage
Difference t-value
Borrowers borrowers
of change
(N=134)
(N=286)
0.09
0.04
51.88
28.52
45.99
26.33
15.64
6.53
0.05
23.35
19.66
9.11
1.57
14.20
4.30
81.89
6.81
74.69
4.04
139.46
Table : Matrix of Market Development
Indicators
Market development indicators
Growth rate
Backward linkage
167 percent
Forward linkage
127.8 percent
Expansion of similar business
98.67
Table: Matrix of effectiveness indicators
Effectiveness
indicators
Specific
measurement
indicators
First time Repeated
borrower borrower
Di
P>|z|
Communication
by bank staff
Bank
advertisement
47.27
(121)
3.91
(10)
47.95
(281)
2.73
(16)
0.68
0.9004
-1.18
0.530
Proximity to the
unit office of
BRAC Bank
9.77
(25)
14.68
(86)
4.91
0.528
Cost of fund
Low interest rate
2.76
(7)
4.45
(25)
1.69
0.421
Accessibility
to BRAC loan
Borrower-friendly
flexible lending
system
50.00
(127)
45.20
(254)
-0.048
0.376
Creating
awareness
DiD
P>|z|
BRAC BANK is effective
 BRAC Bank is effective in reaching the long ignored “missing
middle” with average loan size of around Taka350,000.
 They do provide collateral free loans.
 Their loan programs have positive impacts at the enterprise
and household level. Most interestingly, it has contributed to
backward and forward linkages.
 The bank operates largely in rural areas, and therefore
playing a critical role in rural financial market
Can MFIs play a role in reaching
out ‘missing middle’?
 MFIs are largely financing micro enterprises in Bangladesh.
 Missing middle can be financed by MFIs if lateral entry is
permitted. Microcredit Regulatory Agency should think
about it.
 This will also create competition in rural credit market.