Introduction

1.1 Origin of the Report:

In recent days the Small and Medium Enterprise (SME) Financing has become an
important area for Commercial Banks in Bangladesh. To align its corporate policy with the
regulation of Central Bank, banks have become more concerned about SME and opened
windows to conduct business in this particular area. This study has been conducted to
fulfill the requirements of sixth term MBM program and gain an insight about the present
condition of small and medium enterprise in the economy of Bangladesh and their
financing scenario in light of Bangladesh Bank regulation.

1.2 Background of the Study:

After Liberation of Bangladesh, intensive efforts were undertaken to accelerate the rate of
industrialization in the country. At the beginning, import substitution and subsequently
export-led economic growth strategy was pursued for industrialization. In order to attain
this objective, large amount of industrial credit was funneled to the industrial sector. But
the whole exercise of industrialization came to a halt with the massive diversion of
resources to other non priority sectors. Policy makers, of late, have come to recognize the
contribution of SME sector towards economic development in the country. Small and
medium enterprises have been recognized as one of the most important means for
providing better economic opportunities for the people of least developing countries like
Bangladesh. A developing economy like that of ours suffers from many peculiar problems
such as disproportionate pressure of population on agriculture due to lack of rural
industrialization, unemployment and underemployment of human and materials resources,
unbalanced regional development etc. The contribution of small and medium enterprises in
the solution of these problems is beyond doubt, provided they are organized and run on
scientific basis.

Small and medium enterprises are particularly suitable for densely populated countries like
Bangladesh where SME sector can provide employment with much lower investment per
job provided. Out of 11% employment of the civilian labor force provided by the
manufacturing sector, about two thirds are estimated to be provided by the small and
cottage industries sector. Again, development of small industries facilitates the effective
mobilization of capital and labor resources. They also help in raising standards of living

of people in rural areas. Contribution of SME sector to GDP remained above 4% during
the period from 1985-86 to 1999-00. Moreover, the present contribution of SME sector to
GDP is approximately 5% and SME sector employs 25% of the total labor forces, thus this
sector is the present available sector for creation of jobs (Saha, Sujit R. 2007).

Research papers developed by Bakht, Zaid (1998) and Ahmad, Salahuddin et al. (1998)
described that the policy environment within which SMEs in Bangladesh operate
accompanies legal, regulatory and administrative constraints to employment creation by
SMEs. The robustness of SME contributions to employment generation is a common
phenomenon in most developing countries in that the magnitude varies between 70% to
95% in Africa and 40% to 70% in the countries of the Asia-Pacific region (Ahmed, M.U.
1999).

Liberalization of industrial and trade regimes along with globalization are likely to have
had significant effects on Bangladesh’s SMEs (Ahmed, 2002; Bhattacharya et. al., 2000).

Various recent studies (Ahmed, M.U. 2001, ADB 2001, USAID 2001) show that SMEs
have undergone significant structural changes in terms of product composition, degree of
capitalization and market penetration in order to adjust to changes in technology, market
demand and market access brought by globalization and market liberalization. The official
data show that the share of private investment in Bangladesh’s GDP in the late 1990s,
which may be considered as the post-reform era, has remained more of less constant at
around 15% (Bhattacharya, 2002). This may be interpreted as an evidence of stagnant
private sector activities in the country.
The recent private sector survey estimates the contribution of the micro, small, and
medium enterprises (MSMEs) is 20-25% of GDP (Daniels, 2003). While SMEs are
characteristically highly diverse and heterogeneous, their traditional dominance is in a few
industrial sub-sectors such as food, textiles and light engineering and wood, cane and
bamboo products. According to SEDF sources quoted from ADB (2003), food and textile
units including garments account for over 60% of the registered SMEs.

Despite these contributions in the economy of the country, Banking sectors are not
interested in financing the small and medium enterprises; rather there is a decline in the
amount of advances by the Banking sector. There are approximately 52 Banks operating

in our country and all are serving large enterprises rather than SMEs though only the
small enterprise’s contribution is 5% in GDP of Bangladesh in 2007. But why?

What are the causes for which Banks are not interested in financing this sector? From
recent statistical data of Sonali Bank of Bangladesh, we see that the credit recovery rate is
51.44% in this sector. Why this recovery rate is not large enough? Why the SMEs are
failing to payback their credit to the lenders? We have tried to find out the answer of these
questions in this research paper.

1.3 Objectives of the Study:

Based on the above discussion the following objectives are set for the study :
•
To review the role of SMEs in the economy as well as current status of SMEs
and their financing by Banks in Bangladesh.
•
To find out the reason why the Banks are not interested (problems) to finance
the SMEs.
•
To review the present role of Regulatory Authorities in SME financing and
development.
1.4 Methodology of the Study:
The study was conducted mainly based on secondary information although some
information relating to entrepreneurs have been collected primarily. The sources of data
include Office Records, BIBM - Library, Different Research Paper regarding SMEs,
Different Publications on SMEs of different banks and some websites.

Sample banks of DNCBs, PCBs, and FCBs from the sample frame, was selected
purposively considering the amount of loan size, interest rate, loan processing fees, period
of loans, mode of finance and management.

Policies relating to SME financing such as fiscal policy, monetary policy and internal
policies of commercial banks was examined thoroughly with a view to find out the
influence of existing policies on SME financing. Trend and pattern of bank financing to
SME was analyzed by classifying the financing in terms of areas, rate of interest, types,
category, and banks.

1.5 Limitations of the Study:

Since this research is only for academic purpose, there were some limitations in this
study. These are mentioned below:
1. Discussion about the Small and Medium Enterprises is a vast subject, but only
some selected areas are covered in the research paper.
2. The study is basically based on secondary data.
3. Time was enough but it was not possible to give full concentration in this regard
due to continuous pressure from other courses.
1.6 Organization of the Report:

This paper is divided into ten chapters. The first chapter is the introduction of the report.
The second chapter focuses on the current status of SMEs in the economy. The third
chapter explains the current status of SME financing by banks in Bangladesh. The fourth
chapter explains why banks are not interested in financing the SMEs. The fifth chapter
shows minimum requirements for SME financing according to Bangladesh Bank. The sixth
chapter contains prudential regulations for SME financing by Bangladesh Bank. The
seventh chapter shows guidelines by Bangladesh Bank for SME financing. The eighth
chapter describes other developmental activities for SME financing. The ninth chapter
explains constraints of SME financing. The last chapter contains the concluding remarks of
the report.

Current Status of SMEs in the Economy

2.1 Brief Macro-economic Review:

Bangladesh, mainly backed by the growth of manufacturing, construction and service

sector has achieved a year-upon-year GDP growth of 6.51% in 2006-07, as compared with
the 6.63% in FY 2005-06, and 5.38% in 2004-05. Per capita GDP recently surpassed $500.
From 1% during the 1970s, growth rate of GDP per capita has ramped up to over 3% since
the early 1990s and, since 2003-04, even higher, to 4 off percent. Growth has been more
stable too; Bangladesh among the handful of countries that sustained positive per capita
growth in each year since the early 1990s. This performance has been underpinned by
rising agricultural and non-farm rural output and a rapid expansion in export of readymade
garments (RMG).

Faster economic growth has helped Bangladesh to reduce the poverty rate by about 1 (one)
percentage point per year since 1990. Poverty fell from 60% in 1990 to 50% in 2000.
Although the latest poverty data are still being collected, proxy indicators suggest that
good progress on poverty reduction and social development has continued in recent years.
Many MDGs are also on track for being met. (World Bank 2005)

The rate of gross investment in GDP in 2007-07 is 24.33%. The relative share of private
sector in gross investment, which has been growing secularly, is 18.73% in 2006-07.
Between 2005-06 and 2006-07, credit to the private sector grew by 11.2%. The population
growth rate averaged 1.5% or so; the literacy rate has averaged at 62% during this decade.

Growth rate of manufacturing output of Bangladesh is on an increasing trend.

Manufacturing growth during 1992-96 averaged 8.21%. In the next four years, the
corresponding growth averaged more than nine percent annually. Service sector grew at an
average rate of 4.9%, which is lower than that of industries (manufacturing) sector. The
quantum index of SMEs has grown by 5.4%. The export of readymade garments (RMG)
both woven and knitwear has picked up a commendable mode of growth, which earns over
76% export earnings.
2.2 Current Status of Small and Medium Enterprises in Bangladesh :

The Small and Medium Enterprises worldwide are recognized as engines of economic
growth. The commonly perceived merits often emphasized for their promotion especially
in the developing countries like Bangladesh include their relatively high labor intensity,
dependence on indigenous skills and technology, contributions to entrepreneurship
development and innovativeness and growth of industrial linkages.

2.2.1 Definition :
According to the latest circular of BANGLADESH BANK (Date – 26/05/2008), the
definition of Small & Medium Enterprise sector is given below:
Small Enterprises – Small enterprises refer to those enterprises which are not any
Public Limited Companies and which fulfill the following criteria-
Service Concern- Having an investment of Tk. 50,000 to Tk. 50, 00,000 excluding
land & building and / or employing up to 25 workers.
Business Concern - Having an investment of Tk. 50,000 to Tk. 50, 00,000 excluding
land & building and / or employing up to 25 workers.
Manufacturing Concern - Having an investment of Tk. 50,000 to Tk. 1,50,00,000
excluding land & building and / or employing up to 50 workers.
Medium Enterprises – Medium enterprises refer to those enterprises which are not
any Public Limited Companies and which fulfill the following criteria-
Service Concern- Having an investment of Tk. 50,00,000 to Tk. 10,00,00,000
excluding land & building and / or employing up to 50 workers.
Business Concern - Having an investment of Tk. 50,00,000 to Tk. 10,00,00,000
excluding land & building and / or employing up to 50 workers.
Manufacturing Concern - Having an investment of Tk. 1,50,00,000 to Tk.
20,00,00,000 excluding land & building and / or employing up to 150 workers.

SMEs in Bangladesh are also defined for purposes of industrial policies by Ministry of
Industries (MOI). Historically, this definition has been in terms of fixed investment
brackets, and a dual mode definition is in place, separate for manufacturing establishments,
and service establishments.

According to the Industrial policy 2005, small and medium enterprises shall be
categorized using the following definitions:
a. Manufacturing enterprise:
Small enterprise – an enterprise should be treated as small if, in current market prices,

the replacement cost of plant, machinery and other parts / components, fixtures, support
utility, and associated technical services by way of capitalized costs (of turn key
consultancy services, for example), etc, excluding land and building, were to be up to tk.
15 million;

Medium enterprise - an enterprise would be treated as medium if, in current market

prices, the replacement cost of plant, machinery and other parts / components, fixtures,
support utility, and associated technical services by way of capitalized costs (such as turn
key consultancy services), etc, excluding land and building, were to be up to tk. 100
million;

b. Non-manufacturing enterprise:
Small enterprise – an enterprise should be treated as small if it has less than 25
workers, in full time equivalents;
Medium enterprise - an enterprise would be treated as medium if it has between 25
and 100 employees.
2.2.2 Overview of the SMEs in the economy of our country:

There is a great interest in small and medium enterprises (SME) as a major plank of
poverty reduction in Bangladesh. The government has formulated a comprehensive
industrial policy 2005 by putting special emphasis for developing SMEs as a thrust sector
for balanced and sustainable industrial development in the country to help deal with the
challenges of free Market economy and globalization.

Some data with a national scope that are pertinent to characterizing SMEs in Bangladesh
as of 2001-2003 are presented in Table – 1. The highlight of this table is the following:
There are some 78,440 private sector establishments of various sizes in Bangladesh with
some 3.5 million workers employed in them. The urban Bangladesh accounts for some
60% of units and 76% of employment in the private-sector enterprises. Rural Bangladesh
accounts for the rest. 93% of all units in Bangladesh belong in the SME category, i.e. have
between 20 and 99 employees. However, SMEs account for only 44% of the total
employment of the enterprise sector.

Private companies limited by liability account for strictly a very small proportion of the
total number of SMEs in Bangladesh.

TABLE_1

2.2.3 Contribution of SMEs in the Economy:

In view of present economic development effort in Bangladesh the SME sector plays an
important role. These are reflected in the following performance /activities of this sector:
 During the Fourth Five year plan, a total of 0.35 million jobs were created against
the target of 0.4 million.
 Contribution of SME sector to GDP remained above 4.5% during the period from
2000-01 to 2004-2005 despite decline in the amount of advances by the banking
sector to this sector.
 SME sector employs 25% of the total labour force. As a result, this sector is the
present available sector for creation jobs.
 SME sector help alleviate poverty, increase income level of rural people and
promote agro-industrial linkage in Bangladesh.
 SME sector requires lower energy supply, lower infrastructure facilities and this
sector imposes less environmental risk.
 They contribute towards better utilization of local resources and skills that might
otherwise remain unutilized.

 Small industries being labour oriented are capable of generating more

employment.
 They are necessary to maintain and retain traditional skills and handicrafts.
 They are the only medium for diversification of rural economy and for peaceful
and concurrent socio-economic development of all classes of people
Table – 2 shows the average employment per establishment within each of the small and
medium classes for urban and rural Bangladesh in 2001/2003. The following results are
worth highlighting. Let it be noted that these are weighted averages.

First, the average employments per establishment for small establishments have values of
between 17 and 20 workers across all industries. We find a similar a narrow range of
between 65-69 employees for average employment size for medium enterprise.

Table – 2: Average head-count per establishment across Bangladesh’s industries, 2001-

Table-2

Table – 3 shows the percentage importance (in terms of both number of units and the
employment level) of SMEs in the overall world of enterprises. The numbers of SME units
predominate the numbers of large enterprises: typically more than 90% of all enterprises
are in the SME class-class. However, the percentages share of SMEs in total employment
controlling for the location is almost always less than for the number of units.

Table – 3: The structure of “industries” in Bangladesh with respect to size of firms,

From the above discussion, we can say that SMEs are playing an important role in our
economy in various ways
 Small industries being labour oriented are capable of generating more
employment.
 They are necessary to maintain and retain traditional skills and handicrafts.
 They are the only medium for diversification of rural economy and for peaceful
and concurrent socio-economic development of all classes of people.
From the above discussion, we can say that SMEs are playing an important role in our
economy in various ways.
Current Status of SME Financing by Banks in
Bangladesh
3.1. Current Status of SME Financing by Banks in Bangladesh

The NCBs are disbursing significant amount of credit under various programs like Small
Enterprise Development Project, Self-help Credit Program, Projects for Small
Entrepreneurs, Special Investment Program and Agro-based Supervisory Industrial Credit
etc. for the promotion and development of SMEs. The investment of private sector banks
in financing SMEs remains insignificant in Bangladesh. Of all the private sector banks,
BRAC Bank, Eastern Bank Ltd. (EBL), Prime Bank Ltd, Dhaka Bank Ltd, Mercantile
Bank Ltd, Dutch-Bangla Bank Ltd, Islami Bank Bangladesh Ltd, IFIC Bank Ltd. have the
leading role in SME financing. Bank of Small Industries and Commerce Bangladesh Ltd.
(BASIC) is entrusted with the responsibility of providing medium and long-term loans for

promotion and development of small-scale industries. The memorandum and Articles of

Association of the bank stipulates that 50% of loanable funds shall be used for financing
small scale and cottage industries. The outstanding credit of BASIC stood at Tk158.9 crore
at the end of December 2001 for small and cottage industries sector that rose to Tk178.7
crore by 12.46% at the end of December 2002.

Table-6 gives an idea of the role of small and medium enterprises as destinations for bank
credit in 2004 and 2005. Bangladesh’s classification of bank advances lumps medium
enterprises with the large enterprises, while small units are lumped with cottage-based
units. As such, unfortunately, it is not possible to speak of the access to finance issues for
SMEs per se. We know however separately that SCIs corresponds to more than 99% of all
productive establishments in Bangladesh.

Out of 3.8 million establishments of all kinds in Bangladesh, only 10,798, or just about
0.3% happen to fall in either medium or large establishment size class based on
employment size. The percentage is even much lower in manufacturing or trade---the two
sub-sectors from which the case studies in this paper are drawn. And yet, such staggering
smallness of the proportion of medium and large establishments is coupled with a
preponderance of large and medium enterprises in total credit disbursements from the
banking system. It is quite safe to assume that of total credit disbursed to large-and-
medium class, an overwhelming majority ---perhaps, 80% or so---is arrogated by large
establishments. It becomes quickly clear that SMEs, for all their numerical superiority
among establishments, receiving bank credit is the exception and not the rule.

Why is the access to finance for the SMEs in Bangladesh not even based on neutral
ground, not to speak of rosy or good? This is because the issue of bank credit is based on
the ownership of collateral: bankers insist on immoveable property for collateral. Only
about 15-20% of the owners of SMEs own any immoveable property at all in which the
bankers are interested. This automatically excludes about 80% of SMEs from being among
the privileged client of a bank loan.

Table – 6: Percentage distribution of advances made by PCBs, FCBs and DNCBs in

Table – 6: Percentage distribution of advances made by PCBs, FCBs and DNCBs in

2005-2004: By receiving Sector

NAME OF PRIVATE PRIVATE FOREIGN FOREIGN DENATIO- DENATIO-

SECTORS COMME- COMM- COMM- COMM- NALISED NALISED
AND TYPE RCIAL ERCIAL ERCIAL ERCIAL COMMERCIAL COMM-
OF Banks, Banks, Banks, Banks, Banks, ERCIAL
FINANCING 2005 2004 2004 Banks,
2005

0.8 0.6 0.1

3.2 Comparative analysis of SME Credit Scheme of Six Different Banks

currently available in Bangladesh
3.2.1 Loan documents needed for SME financing by banks

Criteria for loan selection are similar among financial institutions. Most frequently
requested documents by financial institutions as a part of the loan application process
include:

 Personal guarantee

 Business plan

 Appraisal of assets to be financed

 Purchase agreement

 Cash flow projection

 Personal financial statement

 Formal application for financing

 Business financial statement

 Tin certificate

 Citizenship certificate

 Bank solvency certificate

 Vat certificate

 Export license

3.2.2 About the Sample Banks

3.2.2.1 Dhaka Bank Ltd.

The Bank started branch operations at Belkuchi Sirajgonj in April 2003. Prior to the
Bank’s intervention, the weaving community did not have the financial strength to stock
their products till “Eid ul Fitr” when the annual sale takes place. Traders were taking
advantage to the situation by buying up entire productions at low prices and liquidating
stocks just before “Eid”. With financial services from Dhaka Bank Limited, the weavers
have converted to power looms, significantly increased profitability and reduced the
involvement of middlemen. Already they have identified several clusters and are working
on improving access to finance within these clusters.

3.2.2.2 Dutch-Bangla Bank Ltd.

Dutch-Bangla Bank Limited (the Bank) is a scheduled commercial bank. The Bank was
established under the Bank Companies Act 1991 and incorporated as a public limited
company under the Companies Act 1994 in Bangladesh with the primary objective to carry
on all kinds of banking business in Bangladesh. The Bank is listed with Dhaka Stock
Exchange Limited and Chittagong Stock Exchange Limited.

DBBL a Bangladesh European private joint venture scheduled commercial bank

commenced formal operation from June 3, 1996. The Bank commenced its banking
business with one branch on 4 July 1996. The bank opened SME windows in 2001

3.2.2.3 Prime Bank Ltd.

As per decision of the Board of Directors of Prime Bank Ltd. in its 78th meeting held on
17.11.1999, “Small & Medium Enterprise (SME) Cell” has already been established at
Head Office under the Credit Division.

Now the bank can replicate quality anywhere in the world. So, the competitive
differentiation comes from swiftness to market and innovation. And in this regard, small
companies right down to the individual can beat big bureaucratic companies ten out of ten
times.

3.2.2.4 Mercantile Bank Ltd.

Mercantile bank is a third generation commercial bank. It has opened SME windows in
1999 to encourage the small business activities.
3.2.2.5 Eastern Bank Ltd.
Small and Medium Enterprises (SME) in Bangladesh contributed 25% of gross domestic
product (GDP) and 80% of the industrial jobs of the country in 2004. According to ADB,
the country's estimated 6 million SMEs and micro enterprises firms of less than 100
employees have a significant role in generating growth and jobs. This is a sector that has its
own distinct needs and requires specialized focus. Eastern Bank Ltd. (EBL) has launched
SME Banking in early 2005 with this view in mind.

Eastern Bank Ltd. Services in SME:

•
Provide SMEs with easy access to financing.
•
Deliver products that ensure superior returns to our customers.
•
Orient customers with industry trends, regulatory issues etc, for their
success.
•
Value long-term relationship banking.
3.2.2.6 BRAC Bank Ltd.
The BRAC Bank ltd started its operation in 2001. The SME portfolio includes

 Prothoma Rin Exclusively designed for women

 Anonno Rin This is a small-scale loan

 Apurbo Rin In order to help our SME

 Supplier Finance

3.2.3 Criterion for Sample Selection :

The banks for comparative analysis have been chosen in the basis of the following
criterion:
3.2.3.1 Loan size

1. Prime Bank Ltd – Taka 1 Lac to Taka 75.00 Lacs

2. Dhaka Bank Ltd - Taka 0.50 Lac to Taka 50.00 Lacs
3. Eastern Bank Ltd- Taka 1 Lac to Taka 300.00 Lacs
4. Mercantile Bank Ltd- Taka 0.50 Lac to Taka 2.00 Lacs
5. Dutch-Bangla Bank Ltd- Taka 3 Lac to Taka 50.00 Lacs
6. BRAC Bank Ltd- Taka 3 Lacs to Taka 30.00 Lacs

Among the banks EBL offers the highest loan amount to the customers where as the
BRAC bank offers the lowest loan to its customers.
3.2.3.2 Rate of interest

1. Prime Bank Ltd – 13% to 15% p.a.

2. Dhaka Bank Ltd - 12% to 13% p.a.
3. Eastern Bank Ltd- 14% to 15% p.a.
4. Mercantile Bank Ltd- 15% p.a.
5. Dutch-Bangla Bank Ltd- 13% to 15% p.a.
6. BRAC Bank Ltd- 18% to 24% p.a.

In terms of interest rate the Dhaka Bank Ltd offers the lowest rate of interest to its
customers. The highest rate is charged by BRAC Bank Ltd. The Mercantile Bank Ltd. have
the only bank that offers fixed rate for any loan customers.

3.2.3.3 Loan processing fees

1. Prime Bank Ltd – .50 % of the loan amount.

2. Dhaka Bank Ltd - .00 % of the loan amount.
3. Eastern Bank Ltd- not available
4. Mercantile Bank Ltd- not available
5. Dutch-Bangla Bank Ltd- not available
6. BRAC Bank Ltd- .50 % of the loan amount

All the banks do not provide data about loan processing fees to their customers. The
prime bank and BRAC bank limited only charges .50% as loan processing fess
3.2.3.4 Period of loan
1. Prime Bank Ltd – 1 to 5 years.
2. Dhaka Bank Ltd – 1 to 3 years.
3. Eastern Bank Ltd- up to 1 year.
4. Mercantile Bank Ltd- up to 2 years.
5. Dutch-Bangla Bank Ltd- 1.5 to 5 years.
6. BRAC Bank Ltd- 1 to 3 years.

Among the banks the highest loan maturity date is offered by DBBL and Mercantile Bank
Limited offers the lowest maturity period
3.2.3.5 Mode of Finance

1. Prime Bank Ltd – Term loan and working capital loan

2. Dhaka Bank Ltd – Term loan and working capital loan
3. Eastern Bank Ltd- Only working capital loan
4. Mercantile Bank Ltd- Only term loan
5. Dutch-Bangla Bank Ltd- Only term loan
6. BRAC Bank Ltd- Only term loan

All the Banks providing SME financing facilities do not provide long-term loan to its
customers. Among the banks Prime and Dhaka Bank limited both provides term loan and
working capital loan to their customers. Other bank either provides term loan or working
capital loan to its customers.
3.2.3.6 Management

Overall the management of the banks engaged in SME banking is efficient and have
diverse knowledge of banking sector. BRAC bank has initiated to provide training of staffs
for well managing the SME customers.

3.2.4 Portfolio Size of different banks in SME Sector

(Tk in crore)
Serial No Name of the Bank
Portfolio Size
1
BRAC Bank Ltd.
950.00
2
Eastern Bank Ltd.
300.00
3
Prime Bank Ltd.
108.44
4
Dutch-Bangla Bank Ltd.
16.38
5
Mercantile Bank Ltd.
6.63
6
Dhaka Bank Ltd.
5.72
Total
1,387.17
Source: Annual Repots of Prime Bank Ltd., Dhaka Bank Ltd., Eastern Bank Ltd.,
Mercantile Bank Ltd., Dutch-Bangla Bank Ltd. and BRAC Bank Ltd. 2007

From the table we can see that the BRAC bank has the highest investment in the SME
sector followed by Eastern Bank Ltd. in second position. While the Prime Bank Ltd.,
Dutch-Bangla Bank Ltd., Mercantile Bank Ltd. and Dhaka Bank Ltd. are third, forth, fifth
and sixth respectively.

In the next page the following points are analyzed in the tabular form for the better
understanding.
 Comparative analysis of SME credit scheme of six different banks (Policy part)
for year the 2007.
 Comparative analysis of SME credit scheme of six different banks (Example of a
loan) for year the 2007.
 Comparative analysis of SME credit scheme of six different banks (Performance
part) for year the 2007.

Why Banks are Not Interested in Financing the

SMEs
4.1 Why Banks are not interested in financing the SMEs

In Bangladesh, several Banks are financing the SME sector but as mentioned earlier, many
of them do not have good experience regarding the loan servicing in this sector. Banks lend
the projects for making profit, but if the principal amount does not come back to the bank,
then there will surely be adverse affect in the balance sheet of the bank. This is because of
bank’s general function. A Bank’s general function is intermediation between borrower
and lender. Bank takes deposit from the surplus unit i.e. lender and deploy fund or credit to
the deficit unit i.e. borrower. It is very clear that the amount that a bank provides to the
deficit units may not be its own. So, it must repay the amount to the depositors on demand.
But if the disbursed amount does not come back to the bank, then it may incur loss.

This is the reason why banks are so conscious while lending any project. In recent years, it
is observed that there are many defaulters in the SME sector. Many banks are facing this
default problem today. Still many banks are willing to invest in this sector.

Though mentioned earlier, from the table – 07, we see that Sonali Bank’s credit recovery
rate from Small and Cottage Industry sector is only 51.44% compared to the Industrial
Credit. The bank has a huge outstanding of credit in the SCI sector.

Actually this is the main reason behind why banks are not interested in financing in SME
sector. Banks feel unsecured in financing this sector. Because the credit recovery rate from
this sector is not good enough.

4.2 Problems for financing SMEs:

SME sector faces a number of problems (Ahmed, 2000) to facilitate institutional credit.
These problems were looked into from the perspective of both borrower and lenders.
4.2.1 Problems from borrowers perspective:

 Access to loan

 Collateral

 Complexity increases cost of loan

 Extremely short grace period

 Absence of comprehensive guidelines

 Longer loan processing time and associate cost of uncertainty

 Lack of basic infrastructure, inputs, managerial efficiency and inadequate sanction

4.2.2 Problems from lenders perspective:

 Lack of information on loan application requirement among the SME loan seekers
 Absences of an appropriate and clear-cut legal framework for enforcing quick
recovery.
In addition, the following problems are identified in the SME sector:

a. Inadequate allocation of fund for public sector.

b. Lack of co-ordination among lending agencies.
c. Shortage of long-term credit.
d. Unstable share market.
e. Lack of technological information.
f. Lack of uniform delivery model and training.

g. Absences of utilization of BSCIC services of NCBs for utilization of surplus

fund.
h. Lack of technology assessment, innovation and adaptation of technology.
i. Lack of marketing effort and exploring new markets.
j. Competitive product market because of market economy.

As we see from the pints noted above, borrowers of SME loans are facing some severe
problems that are discussed below:
4.3.1 Access to loan:

SMEs encounter great difficulties while rising fixed and working capital because of the
reluctance of banks to provide loans to SMEs. Banks are shy to lend to SMEs because of
high processing and monitoring costs of loans to SMEs. The loan application forms for
investment financing from banks are long, tedious, and redundant. Since the removal of the
interest rate subsidy without the removal of interest band, financial institutions find
little incentive to lend to SMEs. SMEs find it difficult to use non real estate assets as
collateral to obtain loans from the banks. In the past, the government has attempted to
provide SMEs with access to finance through targeted lending. There was a government
directive that 5 per cent of a bank's loan portfolio be set aside for small and cottage
industry financing. A new bank, namely, the Bank of Small Industries and Commerce
Bangladesh Ltd (BASIC) was set up in 1988 with the objective of financing the small and
cottage industries. There were also attempts to channelize fund received from international
agencies such as the Asian Development Bank (ADB) to the sector through private banks.
There were provisions of favorable debt equity ratio, special interest rates and credit
guarantee scheme. The central bank also issued directives to both public and private
commercial banks regarding working capital loans, use of standardized documentation
procedure and time limits for credit sanctioning and loan disbursement.

4.3.2 Collateral:

The main problem of SMEs is that, they do not have enough collateral for getting fund
from the bank. The banks have some regulation of taking a minimum amount of collateral
against credit, but many small and medium entrepreneurs cannot fulfill the requirement.
That’s why banks are also reluctant to provide credit to them, as it would be violation of
their policy regulation.

4.3.3 Lack of experience:

Small and Medium Industry Entrepreneurs, in Bangladesh, have lack of experience in the
business field. They do not have any training programs and they do not even have any
business exposure. As a result, they cannot follow the right way of entrepreneurship in the
related field. So they incur loss in many cases.

4.3.4 Extremely short grace period:

In our country, grace period of repaying any credit is very low. According to the SME
entrepreneurs, almost all the Banks structured the loan in such a way that entrepreneurs
have to start the repayment of credit within a very short time after disbursement of credit.
This is really a big problem for the entrepreneurs because the entrepreneurs are bound to
generate profit instantly to fulfill the Banks requirement. But this is impossible, as a
business needs a minimum time to be in a stable position and to generate profit.

4.3.5 Cost of loan:

Another problem is that extremely high interest rate for the entrepreneurs. Many
entrepreneurs is having problem because of high interest rate. Banks, in many cases

maintain high spread as a result there remains reckless competition of making more profit
from the Banks perspective. And, sufferers are general entrepreneurs who borrow from the
Bank.

4.3.6 Absence of comprehensive guidelines:

Another problem is that, there is an absence of comprehensive guidelines in the SME

sector. Most of the SMEs do not have any guidelines for controlling their business. They
do not maintain any deliberate procedure in managing the enterprise; rather they go on
with the time-to-time changes in the business operation. As a result they cannot generate
expected profit from the business and fail to payback credit to the banks. Hence, Banks are
reluctant to provide credit to them.

4.3.7 Longer loan processing time and associate cost of uncertainty:

Credit in this sector requires longer processing time. Though it is Small and Medium
Enterprise Sector, processing time for loan is not short. As a result banks are unwilling to
enter in this sector. Moreover, associate cost of uncertainty is also another issue and banks
do not want their funds to be invested in an area where recovery of the fund is uncertain.

4.3.8 Lack of basic infrastructure, inputs, managerial efficiency:

Most of the SMEs do not have basic infrastructure of their own i.e. there is a lack of
planned infrastructure in this sector. Inputs of the production are also not planned and
insufficient. Moreover, managerial efficiency is also a big issue in this regard. If there is
poor managing efficiency, then the organization will never prosper in associate field. For
better performance, good managing efficiency is needed.

4.3.9 Inadequate sanction:

And, inadequate sanction of loan should also be stated here. The loan provided to this
sector is inadequate. As almost all SMEs do not have enough capital to start the business,
they need adequate amount of fund in order to support the unexpected loss initially. But as
they do not get that, they cannot absorb the initial loss and eventually fail to payback the
bank credit.

In addition, some problems identified as these are from lenders perspective:

4.3.10 Lack of information on loan application requirement among the
SME loan seekers:
As credit application requires availability adequate information, most of the SMEs do not
have adequate information. They do not maintain their financial statement appropriately

of the business; even they do not feel the necessity of doing so. That’s why Banks are not
getting appropriate information regarding their business and themselves as well.
4.3.11 Absence of an appropriate and clear-cut legal framework for
enforcing quick recovery:

Even Banks do not have appropriate legal framework in order to recover their disbursed
credit. Their recovery framework is not clear-cut as a result they fail to control the
servicing of loan.

These are the reasons why Banks are reluctant to finance the SMEs in Bangladesh.
Minimum Requirements for SME Financing
according to Bangladesh Bank
5.1. Minimum Requirements for SME Financing according to
Bangladesh Bank:
Apart from the specific regulations given under each mode of financing separately, the
banks while undertaking Small Enterprise financing should also follow general
requirements laid down here. It may by noted that these are the minimum requirements and
should not in any way be construed to restrict the role of the management processes
through establishing comprehensive credit risk management systems appropriate to their
type, scope, sophistication and scale of operations. The Board of Directors of the banks are
required to establish policies, procedures and practices to define risks, stipulate
responsibilities, specify security requirements, design internal controls and then ensure
strict compliance with them.

5.2 Pre-Operation:

Before embarking upon or undertaking Small Enterprise financing, the banks shall
implement/follow the guidelines given below. The banks already involved in Small
Enterprise financing will ensure compliance with these guidelines within six month of the
date of issuance of Small Enterprise Financing Prudential Regulations.

Banks shall establish separate Risk Management capacity for the purpose of Small
Enterprise financing, which will be suitably staffed by personnel having sufficient
expertise and experience in the field of consumer finance/business.

The banks shall prepare comprehensive Small Enterprise credit policy duly approved by
the Board of Directors, which shall interalia cover loan administration, including
documentation, disbursement and appropriate monitoring mechanism. The policy shall
explicitly specify the functions, responsibilities and various staff positions,
powers/authority relating to approval/sanction of consumer finance facility.

For every type of Small Enterprise finance activity, the bank shall develop a specific
Product Program Guide (PPG). The program shall include the objective/quantitative
parameters for the eligibility of the borrower and determining the maximum permissible
limit per borrower. The PPG will also indicate the maximum permissible exposure banks
will take against each product.

Bank shall put in place and efficient computer based MIS for the purpose of Small
Enterprise finance, which should be able to effectively cater to the needs of Small
Enterprise financing portfolio and should be flexible enough to generate necessary
information reports used by the management for effective monitoring of the bank's
exposure in the area. The MIS is expected to generate the following periodical reports:

Reports interrelating delinquencies with various type of customers of various attributes of

the customers to enable the management to take important policy decisions and make
appropriate modifications in the lending program.

Quarterly product wise profit and loss account duly adjusted with the provision on account
of classified accounts. These profit and loss statements should be placed before the Board
of Director in the immediate next Board Meeting. The branches of foreign banks in order
to comply with these conditions shall place the reports before a committee comprising of
Chief Executive Officer, Chief Finance Officer and Head of Small Enterprise.

The banks shall develop comprehensive recovery procedures for the delinquent loans. The
recovery procedures may vary from product to product. However, distinct and objective
triggers should be prescribed for taking pre-planned enforcement/recovery measures.

The institutions starting consumer financing are encouraged to `impart sufficient training
on an ongoing basis to their capability regarding the various aspects of Small Enterprise
financing.

The banks shall prepare standardized set of borrowing and recourse documents (duly
cleared by their legal counsels) for each type of Small Enterprise financing.
5.3 Operations:
Small Enterprise financing, like other credit facilities, must be subject to the Bank's risk
management process setup for this particular business. The process may include,
identifying source of repayment and assessing customer' ability to repay his/her past
dealings with the bank, the net worth and information obtained from a Credit Information
Bureau approved by Bangladesh Bank.

At the time of granting facility under various modes of Small Enterprise financing, banks
shall obtain a written declaration from the borrower divulging details of various facilities
already obtained from other institutions. The banks should carefully study the details given
in the statement and allow fresh finance/limit only after ensuring that the total exposure in
relation to the repayment capacity of the customer does not exceed the reasonable limits as
laid down in the approved policies of the banks. The declaration will also help banks to
avoid exposure against an enterprise having multiple facilities from different institutions.

Internal audit and control function of the bank, apart from other things, should be designed
and strengthened so that it can efficiently undertake an objective review of the Small
Enterprise finance portfolio from time to assess various risks and possible weaknesses. The
internal audit should also assess the adequacy of the internal control and ensure that the
required policies and standards are developed and practiced. Internal audit should also
comment on the steps taken by the management to rectify the weaknesses pointed out by
them in their previous reports for reducing the level of risk.

The banks shall ensure that their accounting and computer systems are well equipped to
avoid charging of mark-up. For this purpose it should be ensured that the mark-up charged
on the outstanding amount is kept separate from the principal.

The banks shall ensure that any repayment made by the borrower is accounted for before
applying mark-up on the outstanding amount.
5.4 Disclosure/Ethics:
The banks must clearly disclose all the important terms & conditions. Fees, charges and
penalties, which are internal including interest rate, pre-payment penalties and the
conditions under which that apply. For ease of reference and guidance of their customers,
banks are encouraged to publish brochures regarding frequently asked questions.

Prudential Regulations for SME Financing By

Bangladesh Bank
6.1 Prudential Regulations for SME Financing By Bangladesh
Bank:

Prudential regulation establishes the outside limits and constraints placed on banks to
ensure the safety and soundness of banking system. They are the key elements to prevent,
limit or stop the damage caused by poor management. The establishment of an
appropriate regulatory framework is essential to ensure that government supervisors can
carry out and enforce their responsibilities. In the following prudential regulation of
Bangladesh Bank has been given by which supervisors can smoothly check and balance
the operation of SME in Bangladesh.

Regulation -1
6.1.1 Source and capacity of repayment and cash flow backed lending:

Banks shall specifically identify the sources of repayment and asses the repayment
capacity of the borrower on the basis of assets conversion cycle and expected future cash
flows. In order to add value, the banks must assess conditions in the particular sector /
industry they are lending to and its future prospects. The banks must be able to identify the
key drivers of their borrowers businesses, the key risks to their businesses and their
risk mitigates.
The rationale and parameters used to project the future cash flows shall be documented
and annexed with the cash flow analysis undertaken by the bank. It is recognized a large
number of SMEs will not be able to prepare future cash flows due to lack of
sophistication and financial expertise. It is expected that in such cases banks shall assist
the borrowers in obtaining the required information and no SE shall be declined access to
credit merely on this ground (for details, refer Regulation – 10).

Regulation -2
6.1.2 Personal guarantees:

All facilities to SMEs shall be backed by the personal guarantees of the owners of the
SMEs. In case of limited companies, guarantees of all directors other than nominee
directors shall be obtained.

Regulation -3
6.1.3 Per party exposure limit:
The minimum and maximum exposure of a bank on a single SE shall remain within the
range of Tk 2 lac and Tk.50 lac respectively subject to the following:
 In case of working capital finance - Maximum up to 100% of the net required
working capital or 75% of the sum total of inventory and receivables whichever is
lower.
 In case of fixed assets purchase - Maximum up to 90% of the purchase price.
Regulation -4
6.1.4 Aggregate exposure of a bank on small enterprise sector:
The aggregate exposure of a bank on SE sector shall not exceed the limits as specified
below:
Regulation -2
6.1.2 Personal guarantees:

All facilities to SMEs shall be backed by the personal guarantees of the owners of the
SMEs. In case of limited companies, guarantees of all directors other than nominee
directors shall be obtained.

Regulation -3
6.1.3 Per party exposure limit:
The minimum and maximum exposure of a bank on a single SE shall remain within the
range of Tk 2 lac and Tk.50 lac respectively subject to the following:
 In case of working capital finance - Maximum up to 100% of the net required
working capital or 75% of the sum total of inventory and receivables whichever is
lower.
 In case of fixed assets purchase - Maximum up to 90% of the purchase price.
Regulation -4
6.1.4 Aggregate exposure of a bank on small enterprise sector:
The aggregate exposure of a bank on SE sector shall not exceed the limits as specified
below:
%
OF CLASSIFIED SE ADVANCES TO TOTAL
PORTFOLIO OF SE ADVANCES
MAXIMUM LIMIT
a.
Below 5%
10 times of equity
b.
Below 10%
6 times of the equity
c.
Below 15%
4 times of the equity
d.
Up to and above 15%
Up to the equity
Source: Prudential Regulations by Bangladesh Bank for SME Financing, Bangladesh Bank
Quarterly April-June 2006
Regulation -5
6.1.5 Limit on clean facilities:

In order to facilitate growth of smaller loans, banks are free to determine security
requirements for loans up to Tk.5 lac. Guidelines for security requirements for loans of
amounts more than Tk.5lac are given in Regulation-6.

Regulation - 6
6.1.6 Securities:
Consequent to the regulation stated in Regulation -5, facilities provided to SEs shall be
secured by banks as follows:
For loan amounting Tk. 2 lac to Tk. 5 lac
 As a minimum banks must take charge over assets being financed.
For loan amounting Tk. 5 lac to Tk. 50 lac
a) Hypothecation on the inventory, receivables, advance payments, plant &
 machineries.
b) Equitable mortgage over immovable properties with registered Power of
Attorney.
c) Personal Guarantees of Spouse/Parents/other family members.
d) One third party personal guarantee,
e) Post dated cheques for each installment and one undated cheque for full loan
value including full interest.
Regulation - 7
6.1.7 Loan documentation:
For all facilities, banks must obtain (as applicable) and not limiting to following
documents before disbursement of loan can be made:
1) Loan Application Form duly signed by the customer.
2) Acceptance of the terms and conditions of Sanction Advice.
3) Trade License.
4) In case of Partnership Firm:
vvvvCopy of Registered Partnership Deed duly certified as true copy or partnership
Deed on non-judicial stamp of Tk.150 denomination duly notarized.
5) In case of limited company:

a) Copy of Memorandum & Articles of Association of the company including Certificate of

incorporation duly certified by Registrar Joint Stock Companies (RJSC) and attested by the
Managing Director accompanied by an up-to-date list of Directors,

b) Copy of Board Resolution of the company for availing credit facilities and authorizing
Managing Director/ Chairman/Director for execution of documents and operation of the
accounts,

c) An Undertaking not to change the management of the company and the memorandum and
articles of the company without prior permission of the bank.

d) Copy of last audited financial statement up to last 3 years (as applicable and
subject to Regulation-10)
e) Personal Guarantee of all the Directors including the Chairman and
Managing Director,
f) Certificate of registration of charges over the fixed and floating assets of the
company duly issued by RJSC,
g) Certificate of registration of amendment of charges over the fixed and floating assets of the
company duly issued by RJSC in case of repeat loan or change in terms and condition of
Sanction Advice regarding loan amount, securities etc.,

6) Demand Promissory Note

7) Letter of hypothecation of stocks and goods
8) Letter of hypothecation of book debts & receivables
9) Letter of hypothecation of plant & machinery
10) Charge on fixed assets.

11) Personal Letter of Guarantee

12) Wherever practical, insurance policy for 110% of the stock value covering all
risks with bank’s mortgage clause in joint name of the bank and client.
Regulation -8
6.1.8 Margin requirements:
Banks shall adhere to the minimum margin requirement as prescribed by Bangladesh
Bank (if any).
Regulation -9
6.1.9 Credit information bureau (CIB) clearance:

While considering proposals for any exposure, banks should give due weightage to the
credit report relating to the borrower and his group obtained from a of Bangladesh Bank.
The condition of obtaining CIB report will be governed by rules & regulations as
prescribed by Bangladesh Bank from time to time.

Regulation -10
6.1.10 Minimum conditions for taking exposure:

Banks shall, as a matter of rule, obtain a copy of financial statements duly audited by a
practicing Chartered Accountant, relating to the business of every borrower who is a
limited company or where exposure of a bank exceeds Tk.40lac, for analysis and record.
However, financial statements singed by the borrower will suffice where the exposure is
fully secured by liquid assets.

It is recognized that a large number of enterprises other than limited companies (i.e., sole
proprietorship/partnership firms etc.) may not have proper books of accounts including
balance sheet, profit & loss account and they may not be able to prepare current and future
cash flows due to lack of sophistication and expertise. It is expected that in such cases,
banks shall assist the borrowers in obtaining/developing such books of accounts as per
forms/formats prescribed by each bank. Reference with regard to how the formats should
be prepared has been made in the development guidelines.

Each Bank shall develop its own Loan Application Form and ‘Borrowers Basic Fact Sheet.
Banks shall not approve and/or provide any exposure (including renewal, enhancement and
rescheduling) until and unless the prescribed Loan Application From is

accompanied by a ‘Borrower’s Basic Fact Sheet under the seal and signature of the
borrower.
Regulation -11
6.1.11 Proper utilization of loan:

The Bank should ensure that the loans have been properly utilized by the SEs and for the
same purposes for which they were acquired / obtained. Banks should develop and
implement an appropriate system for monitoring the utilization of loans.

Regulation -12
6.1.12 Restriction on facilities to related parties:

Banks shall not take any exposure on a SE in which any of its director; shareholder,
employee or their immediate family members is holding 5% or more of the share capital of
the SE.

Regulation -13
6.1.13 Classification and provisioning for assets:
Loans / Advances
Banks shall observe the prudential guidelines given at in the matter of classification of
their SME asset portfolio and provisioning there-against.

In addition to the time-based criteria, subjective evaluation of performing and non-

performing credit portfolio shall be made for risk assessment and, where considered
necessary, any account including the performing account will be classified, and the
category of classification determined on the basis of time based criteria shall be further
downgraded. Such evaluation shall be carried out on the basis of credit worthiness of the
borrower, its cash flow, operation of the account, adequacy of the security, inclusive of its
realizable value and documentation covering the advances.

Apart from specific provisioning requirement as prescribed above, banks will create
adequate general provision over the entire credit portfolio of Small Enterprise business.
Therefore, all banks shall maintain at all times a general provision of 5% of SE assets
outstanding in its books.

Submission of returns
Banks shall submit the borrower-wise annual statements regarding classified loans/
advances to the Banking Inspection Department.
Timing of creating provisions

Banks shall review, at least on a quarterly basis, the collectibles of their loans / advances
portfolio and shall properly document the evaluations so made. Shortfall in provisioning, if
any, determined, as a result of quarterly assessment shall be provided for immediately in
their books of accounts by the banks on quarterly basis.

Reversal of provision
The provision held against classified assets will only be released when cash realization
starts exceeding.
 In case of loss category the net book value of the assets.

 In case of doubtful category 50% of the net book value of the assets; and

 In case of sub-standard category 25% of the net book value of the assets.

Further, the provision made on the advice of Bangladesh Bank will not be reversed
without prior approval of Bangladesh Bank.
Verification by the Auditors

The external auditors as a part of their audits of banks shall verify that all requirements of
Regulation- 12 for classification and provisioning for assets have been complied with.
Bangladesh Bank shall also check adequacy of provisioning during their on-site
inspections.

Guidelines by Bangladesh Bank for SME

Financing
7.1 Guidelines by Bangladesh Bank for SME Financing:

The purpose of the Development Guidelines is to provide directional guidelines to the

banks that are considering introduction of Small Enterprises financing to entrepreneurs all
across Bangladesh. These Guidelines will assist banks to develop and implement pragmatic
and value added products, efficient Credit Approval & Risk Management processes, sound
organization structure, strong credit administration and robust collection procedures.

It may be noted here that these are the minimum requirements and should not in any way
be construed to restrict the role of the management processes through establishing
comprehensive credit risk management systems.
The Process Guidelines have been organized into the following sections:
Policy Guidelines
1. Product Program Guidelines
2. Segregation of Duties
3. Credit Approval
Procedural Guidelines

1. Approval Process
2. Credit Administration
3. Risk Management

4. Collection & Remedial Management

Preferred Organizational Structure & Responsibilities

Senior executives of retail banking from different foreign, private sector and nationalized
commercial banks prepared these guidelines. It is the expectation of Bangladesh Bank that
these guidelines will assist banks towards creating a long term sustainable and a

profitable Small Enterprises business in Bangladesh.

7.2 Policy Guidelines:

Before embarking upon Small Enterprises financing, banks shall develop fully documented
product program guidelines. These guidelines shall include objective/quantitative
parameters for the eligibility of the borrowers and determining the maximum permissible
limit per borrower.

These fundamental guidelines will be the key elements that would support each banks
credit culture and they will dictate bank’s behavior when dealing with customers and
managing lending portfolio of such loans. Any deviations from these guidelines must in all
cases, will require approval from competent authority.

Fundamentally, credit policies and procedures can never sufficiently capture all the
complexities of the product. Therefore, the following credit principles are the ultimate
reference points for all concerned bank staff making consumer-financing decisions:
•
Assess the entrepreneur’s character for integrity and willingness to repay
•
Only lend when the entrepreneur has capacity and ability to repay
•
Only extend credit if bank can sufficiently understand and manage the risk
•
Use common sense and past experience in conjunction with thorough evaluation
and credit analysis.
•
Do not base decisions solely on customer’s reputation, accepted practice, other
lender’s risk assessment or the recommendations of other officers
•
Be proactive in identifying, managing and communicating credit risk
•
Be diligent in ensuring that credit exposures and activities comply with the
requirement set out in Product Program

A generic Product Program Guideline (PPG) has been developed for Small Enterprises
Financing. Banks should take this as a reference and have the right to alter/amend these
guidelines in terms of their own policy with out compromising the fundamentals of credit
principles.

7.2.1 Product Program Guideline

Banks have the right to alter / amend these guidelines in terms of their policy with out

compromising the fundamentals of credit principles. While developing Product Program

Guidelines (PPG) for any product - the following guidelines must be included in the PPG
documents. The guidelines are suggestive but not limited to this list, based on the
requirements further guidelines to be incorporated in the PPG to ensure that the PPG is
covering all the aspects of risk and return for the particular product.

 PPG Guideline No. 1: Customer Segment

 PPG Guideline No. 2: Purpose

 PPG Guideline No. 3: Nationality

 PPG Guideline No. 4: Age Limit - Minimum age (years) / Maximum age(years)

 PPG Guideline No. 5: Minimum Income

 PPG Guideline No. 6: Loan Size

 PPG Guideline No. 7: Loan to Price Ratio

 PPG Guideline No. 8: Security/ Collateral

 PPG Guideline No. 9: Legal Documents

 PPG Guideline No. 10: Interest Rate

 PPG Guideline No. 11: Maximum Term of Loan

 PPG Guideline No. 12: Repayment Method

 PPG Guideline No. 13: Disbursement Mode

 PPG Guideline No. 14: Disbursement pre-condition

 PPG Guideline No. 15: Debt Burden Ratio (DBR %)

 PPG Guideline No. 16: Verification of Personal Details and Quotation

 PPG Guideline No. 17: Substantiation of Income

7.2.2 Segregation of Duties

Adequate segregation of duties is a prerequisite of an effective system of internal control.

To be adequate, segregation must ensure that persons independent of each other perform
the following functions, although, within limits, certain may be combined so long there is
adequate supervision:

 Credit approval, monitoring and recovery – by Credit unit

 Credit documentation and administrations – Loans processing and disbursement
unit
 Sales and marketing – Sales and Branch
 Credit recovery – by Credit unit

The credit approval team will be independent from the sales and branch team who will
evaluate and approve the loan. The Credit Administration under Operations department
will check and ensure the documentation and disburse the loans. This will ensure the better
control of the bank asset and mitigate the risk of compromise of the duties.

7.2.3 Credit Approval

Applications are received at Credit Approval unit from sales team / branches. As
mentioned in Regulation- 10 part 2, banks should develop their own set of comprehensive
Loan Presentation Forms (LPF), which should at minimum include the following
documents:

a) Credit Memorandum
b) Work sheet for Working Capital Requirement
c) Income Statement
d) Balance Sheet
e) Cash Flow Statement
f) Financial Ratios
g) Checklists

Applications will bee evaluated / assessed by Credit Analysts / Managers on the basis of a
fully documented Loan Presentation Forms (LPF). The evaluation process is carried out
based on the agreed and standard guidelines for different loans product and the documents
checklist as per the PPG. The detailed credit and risk assessment should be conducted prior
to the approving of any loans.

The sales team / branch staff responsible for loan sales and should be the owner of the
customer relationship, and must be held responsible to ensure the accuracy of the loan
application submitted for approval. They must be familiar with the bank’s Lending
Guidelines and should conduct due diligence on new borrowers, purpose of the loans and
guarantors.
All banks should have established and Money Laundering guidelines, which should be
adhered to at all times.
Credit Applications should include, as a minimum, the following details:
•
Amount and type of loan(s) proposed.
•
Purpose of loans
•
Loan Structure (Tenor, Covenants, Repayment Schedule, Interest)
•
Security (if any)
7.2.4 Credit Approval Authority

Lending Authority is delegated to individual credit analysts and credit manager or senior
credit executives by the Head of Consumer banking responsible for the Consumer
business. Records of such authority are retained with country credit manager. Copies of all
Delegation of Lending Authorities are also retained by Loan Administrations Department.

7.3 Procedural Guidelines:

This section outlines the main procedures that are required to ensure compliance with the
policies contained in Section 1.0 of these guidelines.
7.3.1 Approval Process

Credit approval authority must be delegated in writing from the Head of Small Enterprise
responsible for the Small Enterprise business, acknowledged by recipients and records of
all delegation retained.

The credit approval function should be separate from the marketing / sales function.
Approvals must be evidenced in writing, or by electronic signature. Approval records must
be kept on file with the Credit Applications.

Credit approval should be centralized within the Credit function. Regional credit centers
may be established, however, all large loans (as defined in the PPG) must be approved by
the Head of Credit or delegated Head Office credit executive. Any credit proposal that does
not comply with Lending Guidelines, regardless of amount, should be referred to Head
Office for Approval.

Any breaches of lending authority should be reported to MD/CEO, Head of Internal

Control, and Head of Credit.

It is essential that executives charged with approving loans have relevant training and
experience to carry out their responsibilities effectively. As a minimum, approving
executives should have:

•
At least 5 years experience working in Branch / Sales team as a relationship
manager or account executive.
•
Training and experience in financial statement, cash flow and risk analysis.
•
A good working knowledge of Accounting.
•
A good understanding of the local market.

A monthly summary of all new facilities approved, renewed, enhanced, and a list of
proposals declined stating reasons thereof should be reported by Credit Team to the
Business Head.

Duplication of Check
All approved applications must be checked against bank’s database to identify whether
the applicant is enjoying any other loan in other account apart from the declared loans.
Maintenance of Negative Files

Two negative files – one listing the individuals and the other listing the employers - are to
be maintained to ensure that individual with bad history and dubious integrity and
employers with high delinquency rate do not get loan from banks.

7.3.2 Credit Administration

After approval, Credit Team will send / forward the approved application along with the
security and other documents to the Credit Administration Department under Operations
Unit for processing. The Credit Administration function is critical in ensuring that proper
documentation and approvals are in place prior to the disbursement of loan facilities.
Under Credit Administration there may be two-sub unit, Documentation & QC and Loan
Administration Dept who will process the document and disburse the loan.

Credit Documentation
Credit Documentation dept is responsible:
•
To ensure that all security documentation complies with the terms of approval.
•

To control loan disbursements only after all terms and conditions of approval have been
met, and all security documentation as per the checklist of approved PPG is in place.

•
To maintain control over all security documentation.
•
To monitor borrower’s compliance with agreed terms and conditions, and general
monitoring of account conduct/performance.
•
Upon performing the above, Documentation dept will forward the Limit Insertion
Instruction to the Loan Administration unit for limit and other information to input
into the bank’s main system.
Disbursement
Loan Administration dept will disburse the loan amounts under loan facilities only when
all security documentation is in place. CIB report is obtained, as appropriate, and clean.
Custodial Duties

Loan disbursements and the preparation and storage of security documents should be
centralized in the regional credit centers. Security documentation is held under strict dual
control, in locked fireproof storage.

Compliance Requirements
•
 All required Bangladesh Bank returns are submitted in the correct format in a
timely manner.
•
Bangladesh Bank circulars/regulations are maintained centrally, and advised to all
relevant departments to ensure compliance.
•
All third party service providers (valuers, lawyers, insurers, CPAs etc.) are
approved and performance reviewed on an annual basis.
7.3.3 Risk Management
Credit Risk

The credit risk is managed by the Credit & Collections unit (CCU), which is completely
segregated from business/sales. The following elements contribute to the management of
credit risks:

The credit risk associated with the products is managed by the following:

1. Loans will be given only after proper verification of customer’s static data and after proper
assessment & confirmation of income related documents, which will objectively ascertain
customer’s repayment capacity.

2. Proposals will be assessed by independent Credit division (CCU) that is

completely separated from business/sales.
3. Every loan will be secured by hypothecation over the asset financed, and
customer’s authority taken for re-possession of the asset in case of loan loss.
4. The loan approval system is encouraged to be parameter driven as much as

possible which will substantially eliminate the subjective part of the assessment
procedure.
5. There will be dedicated ‘collection’ force that will ensure timely monitoring of
loan repayment and its follow up.

6. The Credit & Collection activities will be managed centrally and loan approval authorities
will be controlled centrally where the branch managers or sales people will have no
involvement

Contact Point Verification:

Contact Point Verification should be done wherever possible for all applicants. The
external CPV includes residence, office and telephone verifications. All verifications are
done to seek/verify/confirm the declared/undeclared information of the applicant.

Third Party Risk

In case of third party deposits/security instruments, banks should verify third party’s
signature against the specimen attached to the original instrument and bank will also send
the instrument to the issuing office for their verification and written confirmation on lien
marking and encashment of the instrument. Therefore, any inherent risk emanating from
accepting third party deposits/security instruments is minimal.

Fraud Risk
There is an inherent fraud risk in any lending business. The most common fraud risks is:
Application Fraud

The applicant’s signature may not be verified for authenticity. However, the applicant’s
identity should be confirmed by way of scrutiny of identification and other documentation.
A Contact Point Verification (CPV) agency should be in place to verify applicant’s
residence, office and contact phone numbers etc.

There always remains the possibility of application fraud by way of producing forged
documents. Considering the current market practices and operational constraints, it may
not always be feasible to validate the authenticity of all documentation. However, banks/
NBFIs should be aware of this threat and may consider validating the bank statement (the
most important and commonly provided income document) through CPV agent.

Liquidity And Funding Risk

This risk should be managed and the position monitored by the Asset Liability Committee

headed by the Managing Director / CEOs of the banks.

Political And Economic Risk
Political and economical environment of a country play a big role behind the success of
business. Banks should always keep a close watch in these areas so that it is able to
position itself in the backdrop of any changes in country’s political and economical
scenario.

Operational Risk
For consumer loans, the activities of front line sales and behind-the-scene maintenance
and support are clearly segregated. Credit & Collections Unit (CCU) will be formed.

CCU will manage the following aspects of the product: a) inputs, approvals, customer file
maintenance, monitoring & collections; b) the Operation jobs like disbursal in the system
including raising debit standing orders and the lodgment and maintenance of securities.
Type ‘a’ jobs and type ‘b’ jobs will be handled by separate teams within CCU; therefore
the risk of compromise with loan / security documentation will be minimal.

It will ensure uncompromising checks, quick service delivery, uncompromising

management of credit risks and effective collections & recovery activities.
Maintenance Of Documents & Securities

CCU or Operations Unit will hold the applications and other documents related to SE loans
in safe custody. All this documents will go under single credit file per customer developed
before launch of the product.

The physical securities and the security documents will be held elsewhere inside fireproof
cabinets under CCU’s or Operation’s custody. The dual-key system for security placement
and retrieval will have to be implemented.

Internal Audit

All Banks should have a segregated internal audit department who will be responsible with
performing audits of all departments. Audits should be carried out on a regular or
periodically as agreed by the Management to assess various risks and possible weaknesses
and to ensure compliance with regulatory guidelines, internal procedures, Lending
Guidelines and Bangladesh Bank requirements.

7.3.4 Collection & Remedial Management

Monitoring

A banks loan portfolio should be subject to a continuous process of monitoring. This will
be achieved by regular generation of over limit and overdue reports, showing where
facilities are being exceeded and where payments of interest and repayment of principle are
late. There should be formal procedures and a system in place to identify potential credit
losses and remedial actions has to be taken to prevent the losses. Besides that the systems
should be in place to report the following exceptions to relevant executives in Credit / sales
and branch marketing staff:

•
Past due principal or interest payments;
•
Timely corrective action is taken to address findings of any internal, external or
regulator inspection/audit.
•
All loan facilities are reviewed annually.
Computer systems should be able to produce the reports for central / head office as well
as branch review.
Recovery

The collection process for SE loans will start when the borrower has failed to meet one or
more contractual payment (Installment). It therefore, becomes the duty of the Collection
Department to minimize the outstanding delinquent receivable and credit losses.
This procedure has been designed to enable the collection staff to systematically recover
the dues and identify / prevent potential losses, while maintaining a high standard of
service and retaining good relations with the customers. It is therefore essential and critical,
that collection people are familiar with the computerized system (where applicable),
procedures and maintain effective liaison with other departments within the bank.

Collection Objectives

The collector’s responsibility will commence from the time an account becomes delinquent
until it is regularized by means of payment or closed with full payment amount collected.

The goal of the collection process is to obtain payments promptly while minimizing
collection expense and write-off costs as well as maintaining the customer’s goodwill by

a high standard of service. For this reason it is important that the collector should
endeavor to resolve the account at the first time worked.
Collection also protects the assets of the bank. This can be achieved by identifying early
signals of delinquency and thus minimizing losses.

The customers who do not respond to collection efforts - represent a financial risk to the
institution. The Collector’s role is to collect so that the institution can keep the loan on its
books and does not have to write-off / charge off.

Identification And Allocation Of Accounts

When a customer fails to pay the minimum amount due or installment by the payment due
date, the account is considered in arrears or delinquent. When accounts are delinquent,
collection procedures are instituted to regularize the accounts without losing the customer’s
goodwill whilst ensuring that the bank’s interests are protected.

Collection/Monitoring Steps
To identify and manage arrears, the following aging classification is adopted:
As and when an account become delinquent, collection system works together to achieve
business objectives. At the beginning of the month collection unit has taken the total asset
portfolio from the system. Then all X to 149 DPD account has to identify and allocate
those accounts to the individual collectors to collect the over dues on a set target basis. The
respective collector has got one-month time to recover the overdue on a target-based
matrix. During the month, officer collection will generate the fresh arrival to X DPD
accounts once in a week and hand over those to the collectors of front end to minimize the
delinquency as well as the flow rate.

business objectives. At the beginning of the month collection unit has taken the total asset
portfolio from the system. Then all X to 149 DPD account has to identify and allocate
those accounts to the individual collectors to collect the over dues on a set target basis. The
respective collector has got one-month time to recover the overdue on a target-based
matrix. During the month, officer collection will generate the fresh arrival to X DPD
accounts once in a week and hand over those to the collectors of front end to minimize the
delinquency as well as the flow rate.

Supportive Activities for SME Financing

8.1 Policies of SME Financing:

The development of small and medium enterprises (SMEs) in developing countries is

generally believed to be a desirable end in view of their perceived contribution to
decentralized job creation and generation of output. SMEs constitute the dominant source
of industrial employment in Bangladesh (80%), and about 90% of the industrial units fall
into this category. The actual performance of SMEs, however, varies depending on the
relative economic efficiency, the macro-economic policy environment and the specific
promotion policies pursued for their benefit.

For the JOBS Program, Bakht, Zaid (1998) and Ahmad, Salahuddin et al. (1998) developed
research papers that describe the policy environment within which SMEs in Bangladesh
operate. The reports also discuss the accompanying legal, regulatory and administrative
constraints to employment creation by SMEs. This paper attempts to highlight the findings
of those two studies. To complement the issues discussed in those two papers, a summary
of industrial problems, as perceived by entrepreneurs during the past one decade (HIID,
1988; MCCI 1992; World Bank 1994; JOBS 1998), is also presented in this report.

8.2 SME Development in Bangladesh:

Historically, Bangladesh followed a development strategy in which private investment was

controlled through a host of regulations involving investment sanctioning, credit
disbursement, import licensing, foreign exchange allocation, etc. While these regulatory
barriers thwarted private investment in general, the impact fell unevenly on SMEs. This
was because of the relative inability of the SMEs to cope with the regulations compared to
their large-scale counterparts. Thus, the policy regime was largely biased against the SMEs
although, paradoxically, promoting SME development was a stated objective of successive
governments. In a bid to render its industrial sector internationally competitive and to
move towards greater efficiency in its production structure, Bangladesh implemented a
number of economic reforms during the 1980's, underwritten by the familiar structural
adjustment policy. These included deregulation of sanctioning procedure and relaxation of
other regulatory barriers, easing of import procedure, reducing trade barriers, following a
market oriented exchange rate policy, and implementation of fiscal, monetary and public
enterprise reforms. These reforms helped remove a large part of the policy bias against
SMEs that prevailed earlier. Recent studies confirm that these reforms had positive impacts
reflected in a fairly rapid growth of the sector during the past decade. However, because of
their 3 structural weaknesses, the SMEs may need more pro-active policies for their
development in addition to the further removal of the policy biases.

8.3 Policy Issues:

8.3.1 Public Development Outlay

Although successive five-year plan documents have mentioned development of small,

medium and cottage enterprises as priority area, public development expenditure in this
sector has not been commensurate with this declared policy. Thus, in the Fourth Five Year
Plan, the revised public allocation to this sector was Tk. 2,016 million, which was a meager
0.58 per cent of the total public development outlay in the plan. What is even worse, only
about 69 per cent of this small allocation were actually invested during the plan period. In
the current Fifth Five-Year Plan, the share of the sector in total public development
expenditure has gone down even further. If the sector has to make much headway, there is
need for substantial increase in public investment in the sector

particularly in the area of training, extension, research, market promotion, etc. A

collaborative effort of the government with business associations, non-governmental
organizations NGOs and other development partners is recommended in such public
outlays.

8.3.2 Trade Policy

During the past decade, substantial reforms have been carried out in the external trade
regime of Bangladesh. The import procedure has been greatly eased and deregulated.
Import tariffs have been lowered and quantitative restrictions virtually eliminated. All
these have facilitated greater access of domestic producers to imported raw materials. This
has particularly benefited SMEs as they were affected more adversely by the regulated
trade regime. However, import liberalization has also exposed domestic producers to
competition from foreign goods. To ensure a level playing field and to enable domestic
SMEs to compete effectively with imports, the following policy concerns need to be
addressed.

8.3.3 Prior Announcement of Policy Changes

To enable domestic producers, particularly the SMEs, to prepare themselves to face external
competition there is need for adequate forewarning about impending policy direction. This is
particularly true of trade policy measures. If the government makes prior announcements of
its impending trade policy changes, particularly with respect to tariff schedules, investors
will be aware of the degree of competition they will be facing with the changes and will
make adjustments in their investment and production plans accordingly.

8.3.4 Tariff Rationalization

To encourage domestic production, there should be adequate gap between duty on raw
materials and duty on finished products. In fixing duty on finished products, possible
under-invoicing and dumping should be taken into account, as otherwise, effective duty
rates on finished goods will turn out to be lower than that on raw materials in spite of the
higher statutory rate on the finished item.

8.3.5 Appropriate Tariff Valuation

To avert the problem of under-invoicing, a system of tariff value has been put in place for
certain categories of imports. There are complaints that these tariff values are often not in
line with the going world price of these items which sometimes puts domestic producers
at a relatively disadvantaged position.
8.4 Fiscal Policy:
8.4.1 Value Added Tax

The main components of indirect tax in Bangladesh are Value Added Tax (VAT),
Supplementary Duty and Excise Duty. VAT is imposed on producer; manufacturer,
importer, exporter or service rendered under the Value Added Tax Act, 1991, on goods or
specified services, at the rate of 15% at every stage of transfer. VAT paid against the input
is adjustable against the VAT on output to be collected from the buyers and the net sum
stands payable on delivery of goods or specified services to the VAT authority. Exemption
is allowed to certain goods or service or certain taxpayers. All cottage industries, except
those producing particular products, are exempted from VAT. But, manufacturer, producer
or service rendered (other than cottage entrepreneurs), whose annual turnover does not
exceed Tk.1.5 million are required to pay Turnover Tax at the rate of 2.5 per cent in lieu of
15 per cent VAT. This limit is too low for small industries. As a result, small industries are
subjected to the same 15 percent VAT as their large-scale counterparts. In addition,
supplementary duty is imposed at variable rates on certain categories of consumption
goods across all size categories. Finally, excise duty applies to a limited number of items
irrespective of size classification. Thus, in terms of indirect taxes, there is virtually no
differentiation between SMEs and their large-scale counterparts, which is considered
inequitable by most SMEs.

8.4.2 Tax Holiday

Similarly, there are no differentiated treatments of SMEs either with respect to duty on
capital machinery or direct taxes. There are provisions of tax holidays for enterprises of all
size categories subject to rules and procedures set by the National Board of Revenue. To
avail themselves of tax holiday, enterprises recommended by the relevant sponsoring
agencies have to get the approval of the National Board of Revenue, which is a
cumbersome and lengthy process. The tax holiday, however, is not available to sole
proprietorship enterprises which are the usual form of small and cottage industries in
Bangladesh.

8.4.3 Wealth Tax

Wealth tax is payable by an individual if his net wealth exceeds Tk.2.5 million. As per
existing law, no wealth tax is payable by a company, the usual legal form of a large
industry. On the other hand, the legal form of small industries is usually sole
proprietorship, and hence these enterprises have to pay wealth tax on their business capital.

Thus, fiscal policy in Bangladesh is not particularly tailored to provide support to SMEs,
which is pointed out by most SME entrepreneurs as a critical policy constraint hindering
SME growth.

Constraints of SME Financing

9.1 Constraints of SME Financing:

SMEs undoubtedly play a very important role in the economy of Bangladesh in terms of
output, employment, and private sector activities. In recent years, structural changes
suggest a shift from traditional to relatively modern product categories with higher
capitalization and use of better production techniques. But implementing SMEs have faced
the following constraints. They are:
1. Legal, Regulatory, and Administrative Constraints
2. Financial Constraints
9.2 Legal, Regulatory, and Administrative Constraints:

As mentioned earlier, policy reforms of the past decade have brought about substantial
relaxation in the investment sanctioning procedure. No prior approval is now required for
investments involving own finance. However, there is scope for further improvement in the
following procedural aspects relating to investment regulations:

9.2.1 Trade License

Investors are required to procure trade license from local government bodies by paying
statutory fees. The process involves unnecessary delays, harassment and side payments.
The procedure needs to be simplified and the issuance of the license made automatic
subject to payment of requisite fees and declaration by the investor that the proposed
investment is in conformity with the rules and regulations and zoning restrictions of the
local government authority.

9.2.2 Registration under Factories Act

According to the Factories Act 1965, all manufacturing units employing 10 or more
workers are required to be registered with the office of the Chief Inspector of Factories and
Establishments. The job of the Factory Inspector is to oversee the working condition and
safety measures in the factory. In practice, the regulation has proved to be a major source
of delay, harassment and unofficial payments for the investors particularly for those in the
SME sub-sector as the existing regulations do not differentiate between different size
categories with respect to safety and working conditions requirements. To relieve the
investors of these problems the requirements relating to safety and working conditions
should be defined separately and realistically for the SMEs and the discretionary powers of
the Inspector should be minimized. Registration should be automatic once the investor has
declared that the requirements have been complied with.

9.2.3 Clearance from the Department of Environment

All industries are also required to obtain a certificate from the Department of Environment
in respect of proper arrangement for anti-pollution and safety measures. Here again, the
requirements should be clearly stated for the type and size categories of industry and the
investor should be allowed to go ahead with investment on the basis of the undertaking that
the requirements will be complied with.

9.2.4 Registration with Sponsoring Agency

Registration with sponsoring agencies such as the Bangladesh Small and Cottage Industries
Corporation (BSCIC), Board of Investment (BOI) or Bangladesh Export Processing Zone
Authority (BEPZA) is voluntary unless an enterprise wants to avail itself of government
incentives. To keep track of private investment in various sub-sectors, it would be useful to
make registration with the sponsoring agency mandatory. However, to

relieve the investors of possible hassles, registration procedure should be simplified

requiring minimum information to be provided by the investor, and registration should not
be held up until the proof of investment has been produced, as the current practice appears
to be.

9.2.5 Contract Enforcement and Resolution

This is a constraint, which is faced by both large and small firms. Inadequacy in the system
for contract enforcement and resolution arises from archaic legal system where procedure
of adjudication is long drawn out and cumbersome and the system is corrupt. As a result it
is not difficult to delay a scheduled date for hearing. SMEs with low sustaining power
often lose out in the long drawn out court battle.

9.3 Financial Constraints:

9.3.1 Access to Finance

SMEs encounter great difficulties while rising fixed and working capital because of the
reluctance of banks to provide loans to SMEs. Banks are shy to lend to SMEs because of
high processing and monitoring costs of loans to SMEs. The loan application forms for
investment financing from banks are long, tedious, and redundant. Since the removal of the
interest rate subsidy without the removal of interest band, financial institutions find little
incentive to lend to SMEs. SMEs find it difficult to use non real estate assets as collateral
to obtain loans from the banks. In the past, the government has attempted to provide SMEs
with access to finance through targeted lending. There was a government directive that 5
per cent of a bank's loan portfolio be set aside for small and cottage industry financing. A
new bank, namely, the Bank of Small and Cottage Industries (BASIC) was set up in 1988
with the objective of financing the small and cottage industries. There were also attempts
to channelize fund received from international agencies such as the Asian Development
Bank (ADB) to the sector through private banks. There were provisions of favorable debt
equity ratio, special interest rates and credit guarantee scheme. The central bank also issued
directives to both public and private commercial banks regarding working capital loans,
use of standardized documentation procedure and time limits for credit sanctioning and
loan disbursement. Notwithstanding all these arrangements for financing of SMEs, the
actual delivery of institutional credit to

this sector has been grossly inadequate. The following seem to be the key factors
inhibiting flow of institutional finance to the sector.
9.3.2 Extremely short grace period

In our country, grace period of repaying any credit is very low. According to the SME
entrepreneurs, almost all the Banks structured the loan in such a way that entrepreneurs
have to start the repayment of credit within a very short time after disbursement of credit.
This is really a big problem for the entrepreneurs because the entrepreneurs are bound to
generate profit instantly to fulfill the Banks requirement. But this is impossible, as a
business needs a minimum time to be in a stable position and to generate profit. Proper
loan restructuring is needed in this regard.

9.3.3 High interest rate

Another problem is that extremely high interest rate for the entrepreneurs. Many
entrepreneurs is having problem because of high interest rate. Banks, in many cases,
maintain high spread as a result there remains reckless competition of making more profit
from the Banks perspective. And, sufferers are general entrepreneurs who borrow from the
Bank. This issue must be in consideration regarding loan structuring.

9.3.4 Project Preparation and Evaluation

The first problem entrepreneurs face in seeking institutional finance is with regard to
preparation of the project proposal. In spite of directives from the central bank to follow
standardized procedure, the loan application process has still remained lengthy and
cumbersome. The entrepreneur often lacks the ability to formulate a proper project
proposal. Even when he prepares the proposal drawing on outside expert services, there is
no guarantee that the proposal will be evaluated properly as the financial institutions
themselves lack adequate capability for proper project evaluation.

9.3.5 Collateral Requirements

One of the main factors that have hampered flow of institutional finance into SMEs is
banks' pre-occupation with collateral based lending. Traditionally banks have used fixed
asset ownership, particularly land ownership as the basis for judging credit-worthiness.
This puts SMEs at a relative disadvantage, as large entrepreneurs are often able to get

around the problem because of their influence and contacts by putting up collateral of
dubious valuation. The solution to this problem lies in banks seeking deposit relationship
with owners of SMEs and using cash flow rather than asset ownership as the criterion for
credit-worthiness. An expanded credit guarantee scheme will have to play a vital role in
this regard.

9.3.6 Bureaucracy and Corruption

Because of lack of proper autonomy and accountability the public sector financial
institutions are beset with inflexibility, inefficiency, political interventions and corruption.
Since the performance of the bank officials is not properly evaluated they lack the
incentive to bring a large number of suitable borrowers, particularly those in the SME
sector, within the fold of institutional financing. They adopt a passive and inflexible
attitude towards the borrowers either to avoid the risk of making an inappropriate lending
or to force the borrower to make side payments for more favorable handling of the loan
application. Until necessary reforms in the public financial institutions are carried out, the
SMEs will continue to bear the brunt of this institutional malice.

Conclusion and Recommendations

10.1 Conclusion:

As the experiences of SME finance in Bangladesh suggest, there is critical need for putting
in place a credit delivery system that evaluates the credit worthiness of borrowers, on a
basis other than fixed asset ownership. The evaluation may require examining transaction
records of the borrowers, assessing the value of movable assets etc. There will also be the
need for enhanced post disbursement monitoring. An effective SME finance policy will
have to cover such enhanced cost of credit administration. In addition to credit guarantee or
refinancing facility there will have to be adequate rediscount facility for the primary lender
to accommodate these costs. The financing scheme should also include special provisions
for women entrepreneurs. Indeed, the Implementation of appropriate policies and strategies
is a prerequisite to harness sustainable competitiveness of SMEs around the country.
Suggestive remarks have been stipulated in this write up. With that paradigm, proactive
policy is essential to enact them. The first step this regard is to make firm’s filly aware of
the competitive challenges they have to face. The next step is to help SMEs prepare to
meet the challenge by understanding their strengths and weaknesses and providing the
inputs they need to help them upgrade. The main inputs are finance, market

information, training, infrastructure development, R&D, management tools, technology,

skills and links with institutions for support services.
SMEs are considered to be the seedbed for the development of entrepreneurial skills and
innovation. Small capital requirement makes easy entry and exit possible and private sector
entrepreneurial activities have many important spillover and positive externality effects.
However, liberalization of the economy along with rapid globalization has posed severe
challenges to SMEs not only in international markets but also in the domestic economy.
Since SMEs are based on relatively small investment, their survival depends on readily
available markets with easy access. In today’s world, market development is a much more
challenging task, which requires coordinated efforts by individual business enterprises and
the Government.

Bangladesh has failed to maximize the benefits derived from the SME sector, which
promises and needs to play a pivotal role in promoting and sustaining the industrial as well
as overall economic growth. The failure can be attributed to various reforms and trade
liberalization measures that have squeezed the sphere of Government’s activity in business.
Consequently, the private sector has to lead the economy in a dynamic growth path.

The role of SMEs in providing productive employment and earning opportunities has
emerged as an important concern among policy makers, donor agencies and researchers.
Regardless of the correct magnitude, SMEs undoubtedly play a very important role in the
economy of Bangladesh in terms of output, employment, and private sector activities. They
are quite predominant in the industrial structure of Bangladesh comprising over 90% of all
industrial units. Together, the various categories of SMEs are reported to contribute
between 80-85% of industrial employment and 23% of total civilian employment (SEDF,
2003). However, serious controversies surround their relative contribution to Bangladesh’s
industrial output due to paucity of reliable information and different methods used to
estimate the magnitude. The most commonly quoted figure by different sources (ADB,
World Bank, Planning Commission and BIDS) relating to value added contributions of the
SMEs is seen to vary between 45-50% of the total manufacturing value added.

10.2 Recommendations:
1. Seed Money, Leasing, Venture Capital and Investment Funding:

There is a need for improving different aspects of financial services of SMEs, such as seed
money, leasing, venture capital and investment funding. There is a lack of long-term loans;
interest rates are high, Guarantee/Security issues, exchange risks etc. All these limit the
development of SMEs. Finance, both short and long term, should be provided at market
cost of capital. Fund should be made available through encouragement for setting up
‘Venture Capital’ organization in Bangladesh. The concept of venture capital (VC) has
successfully operating in the USA, EU countries, and Canada.

2. Establishment of Small Business Investment and Lending

Corporation (SBILC):

We should start with ‘something effective’ for industrial development in general and the
SMEs sector in particular. Such a step, for example, could be the establishment of a
separate corporate body. That means a separate financing institution could be developed,
with joint ownership of the public and private sector. To make the proposed initiative
effective in achieving its goals, government may set up a Small Business Investment

and Lending Corporation (SBILC). The SBILC can be formed under Small Business

Investment and Lending Act passed through the Parliament. Under SBILC there may have
external and Internal Financing policies. Taken from the different countries experiences the
different types of financing policies and programme that can be introduced through SBILC,
is enumerated below:

 Low Doc Loan Programme, which may allows small business to use a simple

one-page application for loans up to Tk.50, 000; loans between Tk.50, 000 and Tk.1,
00,000 may require the one-page application plus personal tax returns for three years and a
personal financial statement from entrepreneur.

 Direct loans, this type of loan may be provided directly to the small business with
public funds and no participation. The interest rate charged on direct loans depends on the
cost of money to the government and it changes as general interest rates fluctuate. It can be
limited to a fixed ceiling.

 Immediate participation loan can be made from a pool of public funds and
private loans.
 Guaranteed loan. When private lenders extend loans to small businesses, SBILC

in those cases can provide guarantee for repayment in case the borrower defaults on the
loan, which may be given for a defined amount of loan and up to certain percentage e.g.,
80% or 75% of loans.

 Seasonal line of credit programme, may be offered for short-term capital to

growing companies needing to finance seasonal buildups of inventory or accounts

receivable. The maturity period cannot be exceeding 12 months and the company must
repay it form cash flow. Accounts receivables and inventory can be collateral for the loan.

 Contract loan programme, is another short-term loan guarantee, but it is

designed to finance the cost of labour and materials needed to perform a contract.
Maturity times are up to 18 months.
 Export working capital programme. Under this prgramme the SBILC may give
guarantee 90 percent of bank credit line up to a certain limit. In such case Loan
proceeds must be used to finance\e small business exports.
 Disaster Loans. As their name implies, disaster loans can be provided to small

businesses devastated by some king of financial or physical losses (such as tremendous

flood, earthquakes). Disaster loan may carry below-market interest rates.

 Greenline revolving line of credit programme. Greenline programme can be

designed to increase small companies’ access to working capital by providing them with
revolving lines of credit. It can be different than traditional loans, which may require fixed
monthly payments; the Greenline programme may employ highly flexible revolving loans,
in which cash-hungry small businesses able to draw on a credit line only when they need
the money. This loan prgramme can be designed to provide short-term credit to allow small
businesses to finance the sale of their products and services until they can collect payment
for them.

3. Periodical Professional Training Courses for SMEs & for

Entrepreneurship Development:
Periodical professional training courses should be arranged for technical staff of SMEs.
Moreover training in management of small enterprises and efficient marketing can also

provided. Islamic Chamber regularly organizes training workshops on management,

marketing, procurement of technologies, quality control system and financing of SMEs, for
the benefit of representatives of private enterprises and staff of member chambers in
different regions of the Islamic World. Training programme / workshop should be
organized for the development of SMEs capabilities to acquire enhanced knowledge and
skills about how to choose, use and improve technology. At present, no such institution
exists except a project of the BSCIC called ‘SCITI (Small and Cottage Industries Training
Institute). Training on different aspects of SMEs activities for entrepreneurs is crucial for
the development of an entrepreneurial.

4. Establishment of R&D Institute for Enterprise and Entrepreneurship

Development, Training and Research Institute:

In a country like Bangladesh, where entrepreneurial initiative is rare and shy, a separate
institute for enterprise and entrepreneurship development, training and research should be
developed. To make it a ‘centre of excellence’ in SMEs development, it should be
designed, involving educational institutions, business associations, relevant government
bodies, private research agencies, and individual consultants having experience in SMEs
development.

5. Establishment of a separate bank for women entrepreneurs:

Establishment of a separate bank for women entrepreneurs will accelerate the development
of women SME through their increased access to formal financial institutions.
6. Minimum quota for women entrepreneurs:
Maintaining a minimum quota for loan disbursement to women entrepreneurs and
proactively seek out female clients.
7. Training program for women entrepreneurs:

Increase the capacity of women entrepreneurs through training and awareness raising
activities on financial management, business procedures and other regulatory process such
as trade license, tax and VAT, etc. At the same time, initiatives should be undertaken to
sensitize the people working with respective regulatory institutions so that women SME
can easily arrange necessary documents for loan application and other procedures.

8. Implementation and Monitoring of Policy Measures for SMEs:

Only policy prescription is not the end, if it is not implemented through different measures
timely and properly. How far policy measures are implemented, along with, what effect -
desired or not - such policy measures has had on the development of SMEs should also be
monitored from time to time. This monitoring will provide feedback for taking corrective
actions, if necessary, to ensure desired effect of the policy adopted.