A Comparative Analysis on SME financing in Bangladesh

Demand side problems and supply side responses.

Prepared for

Michael Hubbard

Dissertation supervisor,

University of Birmingham.

Prepared by

Zakuan Chowdhury

Student ID- 1201210.

Date of Submission

September 17, 2012

Words count-12000.

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TABLE OF CONTENTS

Abstract 4

Acknowledgement 5

Introduction 6

Methodology 8

Literature review on problems related to SME financing 9

Major Problems Faced by SME 12

Current Status of SME Financing in Bangladesh 16

Stakeholder’s role enterprises in Bangladesh 21

Small and Medium Enterprises (SME) Access to Formal Credit 24

SME access to Formal Credit: A Survey findings 28

Demand Side Problems: Survey Results 31

Responses of Supply Side 37

Gap Analysis 47

Recommendation 50

References 53

Appendix 56

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List of Abbreviation
ADB Asian Development Bank
BB Bangladesh Bank

BBS Bangladesh Bureau of Statistics

BIBM Bangladesh Institution of Banking and Management

BSCIC Bangladesh Small and Cottage Industries Corporation

CIB Credit Information Bureau

FB Foreign Bank

FI Financial Institution

FY Financial Year

GDP Gross Domestic Products

MFI Micro finance Institutions

MIDAS Micro Industry Development Assistance and Services

MoF Ministry of Finance

NASCIB National Association of Small and Cottage Industries of

Bangladesh.
NBFI Non-Bank Financial Institutions

NGO Non-Government Organisation

OECD Organisation for Economic Co-operation and Development

PCB Private Commercial Bank

SB Specialized Bank

SE Small Enterprise

SME Small and Medium Enterprise

SMESPD SME & Special Programs Department

SOB State Owned Bank

TIN Tax Identification Number

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 Abstract

For Bangladesh, Small and medium size businesses are assumed to have special
significance for poverty reduction and potential contribution to the overall industrial
and economic growth. Bangladesh government has given their strong commitment to
achieve Millennium Development Goals (MOGs) by 2015, and meet the targets for
Economic Growth, Poverty Reduction and Social development, commonly known as
the Poverty Reduction Strategy Paper (PRSP). Therefore, the development process
of Bangladesh must strive to expand employment creation opportunities very rapidly.
The scope of additional absorption of labour in agriculture is being somewhat limited,
therefore the best potential for this lies in the small and medium (SME) size
manufacturing and trading sectors. Various studies have indicated that one of the
major obstacles for the formation and development of SME is related with the SME’s
access to financing. This paper examines, the problems faced by small and medium
enterprises (SME) in obtaining loans from financial institutes, and analyse the gap
between supply and demand sides to formulate a recommendation for effective SME
financing policy implementation.

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 ACKNOWLEDGEMENT

This dissertation would not have been possible without the guidance and the help of
several individuals who in one way or another contributed and extended their
valuable assistance in the preparation and completion of this study. First and
foremost, my utmost gratitude to my dissertation supervisor Mr Michael Hubbard,
International Development Department, University of Birmingham, whose sincerity
and encouragement have inspired me to hurdle all the obstacles in the completion
of this research work. I would also like to convey my appreciation to my colleagues
and staffs in the BRAC BANK Ltd, Bangladesh for their assistance in collecting data.

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Introduction

Small and medium Enterprises (SME) has a significant economic and social
importance, which is well recognised in academic and policy literature. SMEs play a
very significant role in the welfare of an economy by creating a balanced and
sustainable growth, employment generation, development of entrepreneurial skills
and contribution to export earnings. However, Bangladesh economy is characterized
by high level of unemployment, mass poverty, low per capita income and social
deprivation. Therefore higher growth of SMEs is necessary in order to reduce
poverty to a satisfactory level by creating jobs for both skilled and unskilled
manpower. A cross-country study implies that SMEs account for over 51% of GDP
and 57% of employment in high-income countries, whereas for the low income
countries the corresponding figures are only 16% and 18% respectively (Ayyagari et
al, 2003). This statistics indicates that the small and medium business segments in
the low-income economy may be undeserved, especially in terms of finance.

Small medium enterprises (SMEs) are firms whose financial requirements are too
small to be effectively served by corporate banking model. In every country, SMEs
represents a vast and economically significant sector of potential businesses. Infect
SMEs account for over half of the national output in some middle-income countries.
Despite this importance, historically SMEs have lacked access to financial products
and longer-term debt instruments in many countries. Usually banks are keener to
focus on financing high value; low risk corporate clients.as a result there is always a
gap between the demand of SME financing and the available supply of financing by
financial institutions. However, recent global financial crisis has created an
increasing consensus that the Small and medium enterprises (SMEs) can be a
profitable segment for banks and other financial institutions. SME tailored non
lending products and credit-scoring models are very recent intervention of banks to
mitigate the SME financing risks, lower the service cost and overall increase the
benefit of SME borrowers.

In Bangladesh, SMEs are lacked of access to financial services and products. Micro
financing has been popular for financing the smallest enterprises of the market,
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whereas large banks concentrate on large corporation. Unfortunately small and
medium enterprises (SMEs) fall between these two-market segments, and this
financing gap is known as the “missing middle”. However in recent years there has
been a concern about promoting the SME financing, as this industry is growing
rapidly and banks are now forecasting that SME industry can be served profitability
and promote the overall growth of the economy.

In Bangladesh SMEs constitute the dominant form of business organisation,

accounting for over 95% of enterprises depending on the country (OECD, 2006).
Moreover Small and medium enterprises are largely intensive businesses and in
most of the cases they are able to serve niche market segments that are not covered
by the larger businesses. It makes innovative use of knowledge, experience and
simple technology to turn local market conditions into business opportunities.in many
developing countries. As a result, if the aim is to stimulate private sector
development, there is a clear demand to cater for specific needs of small
businesses. Every dollar invested in a small enterprise generated an average ten
dollars of economic activity in the local economy (SEAF, 2005). Moreover, SME
businesses have a significant contribution in regional and local development since
they accelerate rural industrialisation by linking it with the more organised urban
sector. Small businesses often succeed in transforming informal activities into formal
ones, directly contributing to economic health of the market environment. At the
same time, it assists in fostering a self- help and entrepreneurial culture by bringing
together skills and capital through various lending and skill enhancement schemes.
Studies (K.Molenaar, 2006) on the macro-economic effect of development programs
reveal that the dynamics in the economy depends on the small enterprise sector
rather than the micro enterprise sector.

In this paper, I have attempted to examine the existing SME financing gap in
Bangladesh. The specific of this paper are-

• To identify the problems faced by small and medium enterprises (SME) in

obtaining loans from financial institutes.

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• Analysis the initiatives and responses of the supply side to address the
problems faced by the demand sides.

• And to identify and analyse the gap between supply and demand side to
formulate a recommendation for effective policy implementation.

Data Methodology

To comply with the objectives of the study, data has been collected both from
primary and secondary sources. Primary data includes both interview and
questionnaire survey on the demand side and supply side stakeholders. For this
purpose, sets of questionnaires were developed for both demand and supply side.
For collecting the information from the demand side, two districts in Sylhet division
were selected on the basis of the number of SME businesses. Altogether 120 small
and medium enterprises were interviewed through the questionnaire. Among 120
small enterprises, 84 (18.71%) from manufacturing, 298 (66.3her7%) from trading
and 67(14.12%) from the service sector were randomly selected.

As one of the main objectives of the study is to identify the major financing problems
of the demand side, the entrepreneurs were selected from both the group of existing
borrowers and who are yet to get any financing facilities from the formal financial
institutions. The existing borrowers can identify the problems persisted in the formal
financial institutions. On the other hand, the other group can provide good insights
regarding access to formal finance. However, for collecting the supply side
information, a sample survey was conducted on two renowned financial institutions.
To justify the problems of the demand side, both the accepted and rejected loan
proposals of some particular banks and financial institutions were also reviewed.
Published literature, research papers, different books were reviewed to complete the
theoretical background and relevant websites were visited to collect secondary
information.

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Literature review on problems related to SME Financing

Most growth theories imply that industrialization is a carrier of economic growth.

Nonetheless, for a developing country such as Bangladesh, whose economy is still
very much agrarian, the emphasis on industrialization should not be stressed by
undermining the role of agriculture in the economy, rather a complementary balance
has to be established between these two sectors to reap the relative benefits
accruing to each other, resulting in acceleration of the economic growth. While
pursuing the industrial development efforts, the major objectives and strategies are
focused on optimum utilization of resources, creating employment opportunities and
catalysing the growth of production and exports. The development strategies in the
last fifty years centred on two models of industrialization: the import substitution
model and the export oriented manufacturing production model. In any case, it is
now recognized that the small and medium enterprises (SMEs) are playing an
increasingly important role as engines for economic growth and employment in many
regions of the world. Therefore, policies and initiatives to develop SMEs and to
increase their competitiveness are a priority for these countries. Ahmed (2006)
opined that SME development, as instruments of employment and income
generation, human development and poverty alleviation, export promotion,
stimulation of private ownership, competition and entrepreneurship and hence the
driving forces behind the growth of a vibrant industrial market economy, has
generated considerable interest among the policymakers, academics, business circle
and the international donor agencies in recent times. Nevertheless, the small scale
industries (SSIs) including the cottage industries are of special consideration as
these industries mainly serve the domestic market. In addition, the strategy for
development of SSIs merits special attention of the policymakers in accelerating
industrial development in countries such as Bangladesh.

However, many literature review and surveys give a deeper insight into the problems
of the demand side and the activities of the financial institutions (supply side) in
solving with the SME financing problems. For most of the developing economies, the
common challenge that SMEs typically confront include financing barrier,

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institutional, legal and administrative barriers, and barriers related with the access to
finance in the formal financial sector. Small enterprises throughout the world, for their
heterogeneous characteristics face severe problems. In this regard Levy (1991)
highlighted some of the common problems faced by the most developing countries
such as the financing constraints; regulatory constraints; technical, marketing and
other non-financial input constraint.

Most of the small businesses are family based and lack appropriate financing for
their start-up and maintaining the operations. Their access to formal credit is not
easier compared to the medium and large enterprises. Some studies (EBRD 2004,
Hossain 1998, PECC 2003) concluded that the inability to access to credit is one of
the major bottlenecks of SME, as almost all developing countries have poorly
developed banking sectors. Empirically, it has been tested and found (Beck,
Demirgtic-Kunt, and Maksimovic 2005) that lack of access to external finance is a
key obstacle for growth of Small and medium businesses, In addition, Small
entrepreneurs face several difficulties in obtaining finance from the formal sector.
Interest rate and collateral requirement are among the major problems inhibiting their
access to finance from the financial institutions. Haque and Mahmud (2003) reveal
that, high interest rate, collateral requirement and lack of skills and attitude of
bankers are among the most significant for small and medium entrepreneurs to
receive financing from the formal institutions. Quader and Abdullah (2008) ranked
high lending rate and collateral requirement as most significant financing problem for
the demand side. On the other hand, financial institutions also encounter several
problems while financing the small enterprises. A RAM consultancy services (2005)
report revealed that collateral requirements, lack of credit skills and practices,
cumbersome loan processing and documentation are considered as the major
supply side problems in the most of the Asian countries for.in addition, Beck, Kunt &
Peria (2008) revealed that banks in developing countries are less exposed to SMEs,
and tend to provide a smaller share of investment loans, and charge higher fees and
interest rates to SMEs.

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Availability of required working capitals at appropriate time is another significant
problem for most of the small businesses. For the day to day business operation,
timely availability of working capital is essential. This kind of problem arises mainly
due to the delay in payments made by the debtors. In his study, Hossain (1998)
revealed that SMEs encounter great difficulties while receiving fixed and working
capital because of the reluctance of banks to provide loans to SMEs. In many cases,
it is found that financial institutions take long time for processing the working capital
loan even after taking the positive credit decision. Moreover, Low quality financial
statements, lack of quality information, and lack of adequate guarantees often hinder
small enterprises to have access into the formal financial sectors.

However, most of the literatures (Demiruc-Kunt, and Maksimovic,2005 and Beck,

Demirgtic-Kunt, Laeven, and Maksimovic, 2006) showed that around the world
informality and low quality balance sheets, lack of quality information and lack of
adequate guarantees stand out as SME-specific factors that banks perceive as
obstacles in serving SME businesses. Using a survey of banks in Argentina and
Chile, Torre and others (2008) stated that informality and low quality balance sheet
in Argentina , lack of quality information in Chile , and lack of adequate guarantees in
both countries stand out as SME-specific factors that banks perceive as obstacles in
serving these firms, Stephanou and Rodriguez (2008) pointed out some problems
related with the demand side as informality, unavailability and unreliability of financial
statements, low managerial capacity of owners, their family-owned nature and credit
worthiness, RAM consultancy (2005) depicts that lack of information about the SMEs
to the lending institutions is also a great problem to ensure access to finance.

In Bangladesh, most of the entrepreneurs are illiterate and are unable to prepare
proper business plan that may help them to achieve their goal easily. Improper
documentation creates major problems for obtaining funds from the formal sectors.
Many SME linked products and services are available in different financial
institutions but in many cases small businesses are not aware about these products
and services. RAM consultant’s (2005) identified some problems from the demand
side such as lack of well-developed business plan, problem related to

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documentation, lack of knowledge about the available SME financing products
provided by different financial institutions. OECD (2006) study pointed out several
problems on both the demand and supply side as the difficulties that SMEs
encounter when trying to access for financing. These can be due to an incomplete
range of financial products and services, regulatory rigidities or gaps in the legal
framework, lack of information on both the bank’s and the SME’s side. In the same
paper, the study also focus on the problems relating to attitude of the banks, in
particular, start-ups and very young firms that typically lack sufficient collateral, or
firms whose activities offer the possibilities of high returns but at a substantial risk of
loss. With the financial problems there are some non-financial problems such as
managerial capacity, willingness to pay, lack of motivation to grow and lack of using
money efficiently etc. In this context, Brkanovic (2005) provides insight about the
non-financial obstacles of SME financing in Siberia, like lack of modern mechanisms
in deploying finance for the SMEs.

After reviewing different literature and studies, it is evident that small enterprises (the
demand side) are encountering multidimensional problems while obtaining finance
from the formal financial sectors. Moreover, there exist many barriers in this sector in
the form of underdeveloped or inefficient legal and administrative framework. Bakht,
Zaid (1998) and Ahmed, Salahuddin et al (1998) revealed in their study that the
policy environment within which SMEs in Bangladesh operates imposes legal,
regulatory and administrative constraints. Sometimes the entrepreneurs need to
produce various papers and documents to be eligible for loan and therefore they
need the support from the different regulators and administrators. But in many cases
they face difficulties in this regard.

A survey result to identify major Problems Faced by Small Enterprises in

Bangladesh

In my questionnaire survey, I provided a list of tentative problems faced by small

businesses to rank them according to their merit as per the entrepreneurs' real
experiences, in my list, I also provided one option for 'other problems- if any' and in
this regard they pointed out three other problems which are high sunk cost for

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obtaining loan, malpractices in sanctioning loan and lack or managerial capacity. The
detailed list is exhibited in table- 1 according to their importance.

Table 1: Main obstacles citied by entrepreneurs for accessing formal financial

sector.

Obstacles Importance
High Interest rate 3.67

Excessive Security Requirement 2.90

Insufficient Working Capital 2.81

Complexity of documents 2.42

Long Loan processing time 2.17

Unstructured financial information 1.88

Financial institutions negligence 1.29

High sunk cost Loan 1.11

Malpractice in sanctioning loan 0.83

Lack of Managerial Capacity 0.36

From above table, it is clear that high interest rate is the most- significant problem
according to the perception of the entrepreneur’s followed by security and
guarantee, working capital requirement, Complexity of documentation etc. However,
Choudhury & Raihan (2000) conducted a similar survey on SME access to credit
and found some different results as barriers for access to credit which are shown in
table 2. In their survey they identified collateral as the prime barrier followed by

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bribe, delays, high interest rate, bankers disinterest etc.

Table 2: Barriers of access to credit: overall perception of demand side

Obstacles Importance
Collateral 79.4

Bribe 66

Delays 54.6

High Interest rate 39.2

Bankers Disinterest 27.8

Guarantee required 27.8

Inadequate volume of credit 22.7

Harassment 11.3

High sunk cost 8.2

Lack of information 6.2

On the other hand, my survey (2011) result showed high interest rate as the prime
barrier. So it is evident that the dimension of the prime barrier has been changed
significantly. The reasons for their perception may be due to the lower interest rate
charged for corporate loan compared to SME loan, lower return from the business
compared to the borrowing rate, lower bargaining capacity etc. Moreover, nowadays
the borrower is more conscious about the rate of interest than before. In connection
with the collateral, both the studies found approximately similar result But in case of
bribe, previous study found it as the second most significant barrier while the current
study found it as a very insignificant barrier of access to credit. My study found
working capital as the third important problem although the previous study did not

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recognize it as a problem at all. Both the studies have identified sonic other common
barriers that are illustrated in table 1 & 2.

I have- also summarized my survey results through the descriptive statistics

(Appendix 1). Among the problems high interest rate has the highest mean
3.67(Appendix I) signifying the major obstacle in the opinion of the respondents. The
values against high interest rate have the lower standard deviation which indicates
consistency in ranking the problem. The second highest mean is 2.91 (Appendix I)
with the security and guarantee.

Although it has been repeatedly emphasized by the central bank to lend money to
the small enterprises with little or no collateral, financial institutions are reluctant to
lend without collateral securities which is observed from the table where the
respondents put higher values in regard to the excessive security and guarantee
requirements. The third highest mean remains with the problem of working capital
which is consistent with the prior researches in the field. The small entrepreneurs
suffer a lot due to lack of available working capital. The fourth important problem is
documentation. As evident in earlier literatures, small entrepreneurs cannot
approach the formal financial institutions due to rigid documentation requirement.

The next important problem, I identified is the processing time required to disburse
the credit. The respondents opined that the average loan processing time should be
around 15 days. Although during the survey I have found that a few of the financial
institutions are taking as little as 5 working days to disburse the credit but most of
the institutions, due to lack of their internal capacity, cannot deliver the services so
promptly. In a few instances, I have found some of the institutions are taking even
more than a month to disburse their credit In case of PCBs, loan processing time is
much shorter than the SOBs and SBs. The reality is that if the institutions take
longer time for loan processing, it would not serve their purpose especially for the
clients who need immediate finance according to the opinion of the respondents; the
other two problems are less significant as they have given lower score against them.
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The mean score for the lack of management capacity is 1.48 (Appendix I) and
unstructured financial information 1.88 (Appendix I). Regarding the unstructured
financial information, the responses have lower standard deviation indicating less
variation of their opinion. But regarding management capacity there is significant
variation among the rankings provided by the respondents. My survey indicates that
higher standard deviation among the problems goes for .managerial capacity which
is 1.0608 (Appendix I) that reflects the higher variation of the responses.

I have performed one way ANOVA (Appendix i) to see whether values assigned by
the entrepreneurs against the problems show uniformity or not.

Data analysis on the Current Status of SME Financing in Bangladesh

Small and medium enterprises excluding agricultural sector comprise about 92.85%
business enterprises in Bangladesh (Rubayat, 2009; Shamsul, 2006). Ahmed
(2010) contemporary development survey on economic development in Bangladesh
implies that the relative shares of the SMEs in term of loan were fluctuating around
2-5%, and working capital loan was stayed between 4-12% during 1992-2007.
Financial Express report indicates that, despite having huge potential contribution of
Small and medium enterprises to the Bangladesh’s GDP have been lower than
those of many other countries in last two decades.

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 Table-1: Current Status of SME Loan Compared to Total Loan (Tk. in Crore1)

Banks/NBFI 2010 2011 (January-June)

s
Total Bal. % of SME Total Bal. % of SME
Loans & Outstandin outstandin Loans & Outstandin outstandin
Advances g of SME g to Total Advances g of SME g to Total
Loan Loans Loan Loans
SOB 68702.48 21839.54 31.79 78557.74 21845.81 27.81
SB 20578.15 4247.31 20.64 22462.76 4541.94 20.22
FB 18486.44 1887.54 10.21 20812.24 1936.08 9.30
PCB 204442.2 39083.85 19.12 219788.2 41332.98 18.81
2 4
Total Banks 312209.2 67058.24 21.48 341620.9 69656.81 20.39
9 8
NBFIs 17741.02 2468.34 13.91 18943.22 2883.44 15.22
Total Banks 329950.3 69526.58 21.07 360564.2 72540.25 20.12
& NBFIs 1 0
Source: SME & Special Programmes Department, Bangladesh Bank.

Above Table summarizes the status of the outstanding loan compared to the total
loan taken by Small and Medium enterprises in year 2010/11. According to the
Data, State Owned Bank’s outstanding loan was the highest (31.79%) compared to
Specialized Banks (20.64%) and Public Commercial Banks (19.12%). The average
outstanding loan in the SME sector was 20.12%, whereas the outstanding loan in
Foreign Banks was the lower (10.21%), which clearly indicates that foreign banks
are performing better than domestic ones in term of default loans. However the total
outstanding SME loan compared to both total loans and advances was 13.91% in
Non-Bank Financial Institutions, whereas the average outstanding loan is 21.07%.

1
1 crore is equal to 10 million
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 Table-2: Targeted SME Loan and Achievement.

Banks/NBFIs 2010 2011 (January-June)

Total Total % of %of SME to Total Bal. % of SME %of SME to
Target Disbursement achievement total SME Loans & Outstanding outstanding total SME
to targets Disbursement Advances of SME to Total Disbursement
Loan Loans
SOB 5083.10 7523.98 148.02 14.05 7668.00 2107.98 27.49 8.06
SB 1210.00 2694.66 222.70 5.03 3365.00 1225.89 36.43 4.69
FB 731.69 1133.93 154.97 2.12 1197.43 592.12 49.45 2.26
PCB 30144.67 40494.57 134.33 75.63 42325.90 21302.00 50.33 81.42
Total Banks 37169.46 51847.14 139.49 96.83 54556.33 25557.99 46.24 96.42
NBFIs 1688.66 1696.79 100.48 3.17 2393.80 935.35 39.07 3.58
Total Banks 38858.12 53543.93 137.79 100 56950.13 26163.34 45.94 100
& NBFIs
Source: SME & Special Programmes Department, Bangladesh Bank.

Above table (Table-2) depicts the overall status of total loan disbursement, loan
target, achievement of target and percentage of SME loan disbursement by banks
and NBFIs' for the year of 2010/11. The individual bank in consultation with the
Special Programmes Department of Bangladesh Bank jointly set the loan targets.
However, specialized Banks Are the highest target achievers (222.70%) and the
Non-Bank Financial Institutions are the lowest target achiever (100.48%). On the
other hand in 2010, Private Commercial Banks had the highest disbursement rate at
75.63% and Foreign Banks had the lowest disbursement rate at 2.12%. Total SME
loan disbursement by the banking sector was 96.83% and by the Non-Bank
Financial Institutions was 3.17%. Which indicates the leading position of the banking
sector in disbursing the SME loans.in addition, table-2 is showing that there was a
significant decline in the achievement of targeted SME loan in 2011. The total SME
loan disbursement by banks (96.42%) and Non-Bank Financial Institutions (3.58%)
indicates that the Private Commercial Banks dominated in disbursing SME loan at
81.42% of total.

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Table 3- Segregation of SME loan in small and Medium Enterprises (Tk in
Crore)

Banks/ 2010 2011

NBFIs
Small % of Total Medium % of Total Small % of Total Medium % of Total
Disbursement Disbursement Disbursement Disbursement
SOB 3458.23 45.96 4065.75 54.04 1242.64 58.95 865.34 41.05
SB 923.01 34.25 1771.65 65.75 526.18 42.92 699.71 57.08
FB 537.40 47.39 596.53 52.61 274.17 46.20 317.95 53.8
PCB 17281.86 42.68 23212.71 57.32 9053.66 42.50 12248.34 57.5
Total 22200.50 42.82 29646.64 57.18 11095.65 43.99 14131.34 5.01
Banks
NBFIs 834.39 49.17 862.40 50.83 588.39 62.91 346.96 37.09
Total 23034.893 43.02 30509.04 56.98 11685.04 44.66 14418.3 55.34
Banks &
NBFIs

Source- SME and special programme department, Bangladesh Bank

Above table (Table-3) shows the segregation of total SME loans into small
and medium businesses disbursed by the banks and NBFIs in 2010/11. The
disbursement of loans into small enterprise ranges from 34.25% to 47.39%
among the SOBs, SBs, FBs and PCBs compare to total SME loan
disbursement The total SMEs loan disbursement by all banks and NBFIs to
small enterprises was 43.02% (2010) and 44.66% (2011). In 2010, the
aggregate loan disbursement to small enterprises by all banks was 42.82%
and by NBFIs was 49.17%. On the other hand, the total SMEs loan
disbursement by all banks and NBFIs to medium enterprises was 56.98%
(2010) and 14478.3% (2011). Comparing with the small enterprises, loan
disbursement rate to medium enterprises was significantly in 2011. In 2011,
the aggregate loan disbursement to small enterprises by all banks was
43.99% and by NBFIs was 62.91%, which indicates that NBFIs has increased
the loan disbursement rate to medium enterprises, whereas for small
enterprises it has remained the same. However, in recent years Bangladesh

Page 19
 government has adopted a strategy to increase the financial support for small
businesses in rural areas, and assist the small businesses to graduate from
small to medium category. Therefore, The State Owned Banks concentrated
more in lending loans to small enterprises (58.95%) than medium enterprises
(41.05%). The Non-Bank Financial Institutions also concentrated in disbursing
more loans to small enterprises (62.91%) compare to medium enterprises
(37.09%).

Table-4: Sector-wise Disbursement of SME Loan.

Banks/NBFIs 2010 2011 (January-June)

Total % to % to %to Mfg Total % to % to %to Mfg
Disbursement service trading Sector Disbursement service trading Sector
Sector sector Sector sector
SOB 7523.98 3.05 61.50 35.45 2107.98 3.37 55.24 41.39
SB 2694.66 1.65 49.86 48.49 1225.89 2.04 52.16 45.79
FB 1133.93 12.81 47.93 39.27 592.12 12.05 49.22 38.73
PCB 40494.57 5.11 69.59 25.30 21302.00 6.08 66.12 27.80
Total Banks 51847.14 4.94 67.35 27.72 25227.99 5.80 64.13 30.07
NBFIs 1696.79 24.07 47.92 28.01 935.35 21.12 46.80 32.07
Total Banks 53543.93 5.59 66.69 27.73 26163.34 6.35 63.51 30.14
& NBFIs
Source: SME & Special Programmes Department, Bangladesh Bank.

Above table (Table 4) has categorized total disbursement of SME loan by the banks
and Non-Bank Financial Institutions (NBFI) into service, trading and manufacturing
sector. The composition of SME loan disbursement by total banks in 2010 was as
follow- 67.35% in trading sector, 27.72% in manufacturing sector and only 4.94% in
service sector. However, NBFIs had also disbursed largest proportion of their loan
(47.92%) into trading sectors, and lowest proportion into (24.07%) service sectors.
trading sector (66.69%) had also the highest aggregate average of SME loan

Page 20
disbursement by both banks and NBFIs, whereas the aggregate average for
manufacturing sector was (27.73%) and service sector was (5.59%). On the other
hand in 2011, the aggregate average of total loan disbursement by the banks and
non-Bank Financial Institutions was 63.51% in trading sector, 30.14% manufacturing
sector and only 6.35% in service sector. This loan disbursement trend clearly
indicates that trading sector was getting more financing from both banks and NBFIs.
Historical data suggest that trading sector has least loan default risk and provides
the highest profitability for SME loan financing, but from Bangladesh perspective,
manufacturing sector should be given the highest priority, as it is the country’s
largest exported sector. Bangladesh is at present largely engaged in the
manufacturing of common consumer goods, and this sector in Bangladesh are
largely depend on simple technologies that are predominantly labor- intensive and
that do not require a very high degree of skills, therefore Banks and NBFIs should
increase the small and medium size loans for manufacturing sector to increase the
country’s productivity.

Stakeholder’s role and their initiatives for financing Small and Medium
enterprises in Bangladesh

There are few important stakeholders involved in developing SME businesses in

Bangladesh. It is vital that all these stakeholders work together to ensure the robust
economic growth through their financing in small and medium business in
Bangladesh. Bangladesh Government has already declared their commitment to the
millennium development goals, and alleviates poverty through promoting the small
and medium business in rural areas.in 2009, the Ministry of Industry has taken
various initiatives to create better platform for the financial institutions (Banks and
non-Banks) to take part in the SME financing activities. “The Industrial Policy 2010”
was a very recent initiative by the government to keep pace with the continuous
efforts of the government to fortify the SME sector. Thorough this policy, the
Bangladesh government has specifically emphasized for the sustainable growth and
balanced expansion of SME businesses. Moreover, “The industrial policy 2010” also

Page 21
identified the core responsibilities of the government such as:

(a) Motivation, loan allocation and training of the entrepreneurs will be the three
pillars for the government initiatives to promote SME industry in Bangladesh.

(b) Government will collaborate with the Bangladesh Bank for financing the SME
sector.

(c) Women employment will be achieved through SME financing, and women
entrepreneurs will be encouraged and given priority in the SME sector. Government
has capped only 10% loan interest for women entrepreneurs and restricted financial
institutions to sanction at leas15% of total SME loans for the women entrepreneurs.
Moreover government has also created BSCIC (Bangladesh Small and Cottage
Industries Corporation) to identify small and medium entrepreneurs all over the
country and providing them finance, training and other related services. In addition
BSCIC also work for arranging fairs to ensure selling of the products produced by
their registered small and medium organizations.

However, Bangladesh Bank has taken many initiatives to assist the SME financing
in Bangladesh. It has recently enacted “Prudent Regulations 2010” to regulate the
small enterprise financing in Bangladesh. In addition, it has also developed “SME
Credit Policies and Programmes 2010” to enable the banks to actively participate in
the small enterprise financing. The major success of this policy publication is the
identification of potential SME clusters of Bangladesh across industries; which
assists financial institution for financing the small enterprises. Moreover,
Bangladesh Bank has been continuing its refinancing facilities against the existing
disbursed SME loan since 2010/11, this initiatives has been believed to assist small
enterprises to get more low cost fund from banks and other financial institutions.
According to SMESPD Bangladesh Bank report, the total amount of the disbursed
SME loan was Tk. 29092.61 crore in December 2010. However, below table (Table-

Page 22
6) highlights that, thirty-two financial institutions and thirty-one banks have already
received Tk. 1806.00 crore from the refinance scheme as against 19,339
enterprises during 2010-11. Bangladesh Bank has included Tk. 1185.8 crore into
the refinance scheme from their own fund. This fund has provided loan to 13,146
enterprises among which 2,554 are women entrepreneurs received Tk. 182.77
crore. In addition, IDA fund has financed Tk. 284.92 to 2929 enterprises 2929,
whereas ADB fund has provided Tk. 334.94 to 3264 enterprises.

Table 6- summary information on SME Refinancing

Name of Amount Refinanced No. of Beneficiary Enterprises

Banks and (In Crore Taka) (Sector wise)
FIs
Refinanced
Working Mid- Long Total Industrial Commercial Services Total
capital term term loan Loan
loan loan
Bangladesh 266.99 638.40 280.49 1185.88 3600 7616 1930 13146
Bank
IDA 69.09 119.15 96.67 284.92 1137 1306 486 2929
ADB 144.48 132.27 58.19 334.94 800 2096 368 3264
Total 480.56 889.83 435.36 1805.74 5537 11018 2784 19339
Source: SME & Special Programmes Department, Bangladesh Bank.

However, according to the SME policy 2010 Bangladesh Bank has given the
refinancing priority to the service and industry sector in order to create a friendly
environment for higher employment and production. Despite this policy priority,
Table-6 implies that most of refinanced funds go to the trading sector. Total 19,339
enterprises received Tk. 480.56 as working capital loan, 889.83 medium term loans
and Tk. 435.36 as long-term loan During 2010/11.

In Addition, Bangladesh government has established SME foundation in 2001 to

develop small and medium size entrepreneurs by increasing adequate training and
education, reducing information asymmetry establishing the distribution mechanism

Page 23
of SME products. The SME foundation has adopted a “credit wholesaling operation”
to work as a lender for major banks and non-financial institutions that provides low
cost funds to the SME sector. Through “credit wholesaling operation”, SME
foundation provides low cost fund to the financial institutions, which enable them to
finance the small and medium enterprises at a lower interest rate. In 2010 SME
Foundation has disbursed Taka 7.75 crore to different financial institutions for
lending to the manufacturing sectors at the interest rate of 4%. Currently most of the
renowned banks in Bangladesh are using this facility ex- EBL, MIDAS, NCCBL, and
MTBL. SME foundation has undertaken a few brand new projects for developing
SME database, SME cluster mapping in collaboration with National Association of
Small and Cottage Industries of Bangladesh (NASCIB).

However, the National Association of Small and Cottage Industries of Bangladesh

(NASCIB) was established in 1984 to operate as a trade association and deal with
the issues related to small and medium cottage industry. It broadly works for the
development of small and cottage industries in Bangladesh by organizing SMCI
fairs, conducting research for the development of this sector and providing
countrywide consultancy and training to the entrepreneurs. NGOs and micro finance
institutions are also considered as important stakeholders. These institutions in the
financial system of Bangladesh are considered as the semi-formal financial
institutions, and hold a large portfolio of customers in rural areas. Through micro
financing, NGOs/MFIs are meeting the demand of financial services of the rural
small and medium enterprises, where formal banks or other institutions have limited
access. Therefore, NGOs and microfinance institutions are playing a playing a
pivotal role to promote Small and medium businesses.

Small and Medium Enterprises (SME) Access to Formal Credit

Two recent surveys have been compared in order to get a precise understanding
about the access of Small and Medium enterprises to formal credit,. According to
the survey conducted by Choudhury & Raihan (2000) on SME access to credit
under SAPRI study found that, only 35.79% of SME businesses enjoy unrestricted

Page 24
access to the formal credit, whereas approximately 50.53% SME businesses don’t
have any access to formal credit is not available to 50.53% of the stakeholders. The
rest (13.68 percent) of them have restricted access to the formal credit.

Financial institutions' exposure to SMEs has grown significantly in recent years and
currently comprises an important part of their commercial loan portfolio. In the year
2010 the state of SM11 loans to total loans was 21.07 percent where the
contribution of state owned banks was 31.79% and specialized banks, foreign
banks, private commercial banks and NBFIs are 20.64%, 10.21%, 19.12% and
13.91% respectively (table- I). As per the figure depicted in table- 2, banks and
NBFIs total achievement was more than 100 percent compared to their total targets.
PCBs and 1-713s already (up to June 2011) reached 50% of their total targets for
the year 2011.

Figure 1- SME Enterprises Access to Finance in Banks and NBFIs

2010% 2011%
SOB 45 60
SB 35 45
FB 45 42
PCB 40 40
Total Banks 40 40
NBFIs 50 65
Total Banks and NBFIs 45 47

Page 25
From figure- 1 it is observed that, in 2011, the disbursement of loans to the small
enterprises increased for every group except FB and PCB groups. This indicates
that FIs are coming forward with their financing package in small business sector.
But it is important to note that, small enterprises access to credit compared to
medium enterprises is lower. In 2010 all banks and NBFis disbursed 43% to small
business and 57% to the medium enterprises of their total SME loan.

Figure 2- Sector wise SME Access to Finance in Banks and NBFIs

2010
Service % Trading% Manufacturing|%
SOB 2 60 35
SB 0 50 50
FB 15 48 50
PCB 5 65 70
Total Banks 5 60 68
NBFIs 25 50 50

Page 26
 2011
Service % Trading% Manufacturing|%
SOB 5 55 41
SB 0 50 45
FB 15 48 40
PCB 5 65 30
Total Banks 5 63 32
NBFIs 25 50 35

Page 27
For achieving the mid and long term goal, manufacturing sectors' access to credit
should be emphasized as it can generate more employment to reduce poverty and
contribute directly to GDP, Whereas, financial institutions mostly serve the trading
sectors in Bangladesh than the manufacturing sectors. In 2010, total loan
disbursements for both banks and NBFs was 66:69% in the trading sectors, 27.73%
and 5.59% for manufacturing and service sectors respectively (Fig.- 2).

SME access to Formal Credit: A Survey findings.

I have conducted a sample survey on 449 small enterprises of which 18.71% Are
from manufacturing concerns, 66.37% Are from trading concerns and 14.92% from
the service concerns. The survey result (Fig-3) showed that 63.92% enterprises
received loans from banks and other financial institutions, while 36.08% enterprises
did not receive any loan from the formal financial institutions. Out of those
enterprises that received loan, 65.85% enterprises received the full amount they had
applied for and the other 34.15% enterprises received a part of their total
requirement.

Page 28
In comparison to the previous study (Choudhury Raihan, 2000), BIBM study found
that 63.92% of the small enterprises got the access into the formal credit while the
other 10.24% enterprises did not have their access at all. On the other hand, 25.84%
of enterprises did not apply for formal credit as they managed their funds by
themselves.

Among the enterprises that received loans from the formal financial institutions,
61.32% enterprises are satisfied in terms of loan covenants and, of them, 90.34%
enterprises are willing to take further loan. But 9.66% enterprises are not willing to
take further loan from the financial institutions mainly due to the fact that the
requirement of borrowing was over. Again, among the enterprises who received loan
from banks and financial institutions, 38.68% enterprises are not satisfied with the
loan covenants and requirements. From the questionnaire survey and interview of
different entrepreneurs, I have found that interest rate is the major reason for their
dissatisfaction. About 29.72% of the not satisfied respondents gave the priority on
interest rate. Process is complex and long, deposit of blank cheque against loan; too
much paper work was also highly emphasized by them. Total survey results are
shown in figure-4.

figure 4: Reasons for Dissatifaction with Bank Loan

No response 11.91%
Depositblank cheque against loan 17.71%
Banker's negligence 31.31%
Interest rate is high 73.72%
Too much paper work 21.81%
Sanctioned less than required amount 33.10%
Profit goes to the bank for high interest 14.50%
Repayment schedual is not in favour 24.30%
Process is complex and long 28.61%

Page 29
It is important to note that, from the unhappy enterprises, 80.18% enterprises Are
willing to take further loans from banks and financial institutions and I 9.82%
enterprises Are not willing to take further loan. Again from the satisfied respondents,
9.66% enterprises are not willing to take further loan. Thus, 13.59% enterprises
should their unwillingness to take further loan from the formal sector and the reasons
they identified are: requirements are fulfilled, business is not profitable, religious
restrictions, loan is burdensome, negative attitude of bankers, harassment by the
financial institutions, interest rate and service charge is high, obtaining loan from
informal sector is easy, security and guarantee requirement is high.

Page 30
Figure 5: Reasons for not obtaining Loan from Formal sector: Entrepreneurs
perception

Demand Side Problems: Survey Results

From the survey and interview, some major problems of the demand side are
elaborated bellow:

I) High Interest Rate

Page 31
High interest rate has greater negative impact on SEs borrowings as my current
survey indicated. Banks and other financial institutions often perceive that SEs
represent a greater risk than larger enterprise, and therefore, they are charging
higher interest rates. This makes it more difficult for SEs to borrow than that of large
enterprises. From the survey, it’s evident that about 91.54% entrepreneurs claimed
existing interest rate is high. They also informed that many banks and financial
institutions impose different service charges and hidden cost in addition to existing
interest rate. Table 8 indicates that this variable is most significant with the rank
score 3.67. Besides, 5.57% entrepreneurs do not that the rate of interest is high.
However, 2.89% enterprises did not mention anything about the interest rate.

ii) Excessive Security and Guarantee Requirement

Collateral is typically an obligatory condition for granting a loan. As a result, it is one

of the major obstacles for obtaining loan from the formal financial sector. Most of the
financial institutions are reluctant to sanction credit to those firms who might fail to
offer collateral. They typically agree to accept collateral in the form of real property,
products or valuable assets. They are less inclined to accept the balance of a
checking account, finished commodity, guarantees of another company or a bank
and securities as collateral. Thus small businesses often have difficulty in providing
sufficient and good-quality collateral to banks: My survey results show that 57.47 %
of the respondents think that Security and Guarantee is the real problem for
obtaining loan from the formal sector. On the other hand, 39.42% of the
entrepreneurs do not take it as part of their problems. It is to be noted that 3.11% of
the respondents did not offer any opinion in this regard.

In my questionnaire survey I asked the entrepreneurs, "What alternatives can

banks/NRFIS accept against the security and guarantee?" Every respondent
answered the questions with different suggestions. They suggested considering
several factors as alternative to security and guarantee requirement, such as:
hypothecation of goods, group or social guarantee, minimum security and guarantee
requirements,

Page 32
iii) Complexity of Documentation

Documentation is another barrier for small business. Most of the businesses are
family oriented and they do not maintain proper documents necessary for their
business. From my survey it is observed that 55.24% of the entrepreneurs claimed
documentation as the obstacle for accessing finance from the formal sector.
However, 40.53% respondents do not face any problems for such variable for their
financing and 4.23% have no comment in this regard.

During the interviews some of the entrepreneurs mentioned that (specially the new
business) for the lack of some documents they are not getting access in finance to
the banks and NRFls. However, some old business also face severe problem for the
same reasons. In response to the question, "What kinds of documents create major
problems for you?", the entrepreneurs identified the reasons as: RS problems
created by surveyor, property related documents, bank statements, deed of
business, rental agreement with the house owner, TIN and VAT registration
certificate, C17Vir071111elli clearance certificate etc.

iv) Long Loan Processing Time

Loan should be disbursed when needed. Some time it is found that, due to the time
lag of loan requirement and disbursement many businesses cannot continue their
operation in line with the market demand. In many cases especially for the
businesses that are seasonal in nature face this problem arises seriously. In my
survey results it was found that 66.15% of the total sample businesses claimed that
commercial banks and their closest financial institutions take longer time in their
decision making regarding loan approval and disbursement, while other 27.61% of
the respondents do not considered it as long. The 6.24% did not answer the same
question. Through the questionnaire survey, I have collected the opinion from the
entrepreneurs

v) Insufficient Working Capital Loan

Page 33
In Bangladesh obtaining working capital loan is one of the major problems for small
enterprises. Most of the entrepreneurs explained that .financial institutions are
reluctant to provide working capital loan if the clients do not have prior relationship
with them. On the other hand, small businesses fail to accommodate this loan if they
need it on an emergency basis. Even some of them mentioned that they do not get
the required amount from the supplier of funds. Entrepreneurs rank this variable as
the significant one which bears the score of 2.81 (Appendix-1).

For the lengthy documentation process and in some cases, because of the
harassment they failed to finance the actual amount of working capital. I interviewed
several business owners regarding the issue and found that in-spite of having all the
organizational set up with modern equipment and ready market demand they could
not run their businesses due to the working capital problem (Box-3).

Vi) Unstructured Financial Information

Financial information is the key to access into the better financial services. However,
small enterprises do not maintain the structured financial information that is required
by the supply side to appraise their proposals. According to the survey, very few
businesses maintain their recordings through formal financial statements. Moreover,
most of the accounts are not adequately maintained as per the financial institutions
requirement. The summary of the survey presented in Figure-6. From my
constructed interview most of the entrepreneurs acknowledged that due to the lack
of their accounting knowledge and expert accounting people, they are unable to
keep their record as per standard. Moreover, they rank this variable as moderately
significant with the average score of 1.88 out of 4 (appendix 1).

Page 34
figure 6: Current Practices of Recording the Financial Information by the Entrepreneurs

Computer software based recording 1.15%

Maintain monthly and yearly records 7.21%
Formal financial statements 3.00%
Daily register 42.45%
Monthly statement 13.51%
Cash memo 9.35%
Transaction recorded comoputer 4.42%
Daily sales record 18.91%

Vii) Financial institutions negligence

Banks and other financial institutions should provide their support regarding
financing and some other ancillary services like consultancy and advisory support for
enhancing the growth potential of small businesses. But many businesses owners

Page 35
complained that many officials from FIs don’t co-operate them in timely and
appropriate manner. My survey result showed that the weighted average rank score
is 1.29 (Table 7), which reflects that the variable is marginally significant. Moreover a
few business owners claimed that bankers have rejected their proposals without any
appraisal or investigation of their business condition where they strongly advocated
that their businesses have the merits to receive the loan from the formal sectors.

viii) High Sunk Cost for Obtaining Loan

In order to enter into the formal credit sector small enterprises have to incur more
sunk cost (Box¬!) than the large firm. Because, financial institutions do not easily
provide their services to the small firms to fulfil their financial needs, small
businesses try to get the loan from different financial institutions one after another
which increases their sunk cost in various forms. From my survey I found that the
average rank is 1.14 (Table 7) indicating the variable as marginally -significant which
is supported by one of the remarkable study (Choudhury Raihan 2000) based on 190
enterprises survey in my country that presented about 8.2% of the respondents (both
borrowers and non-borrowers) mentioned high sunk costs as barrier of access to
credit.

ix) Malpractices in Sanctioning Loan

Sometimes malpractices in sanctioning loan hinder small enterprises to have access

in the formal credit. Malpractices in sanctioning loan bearing the rank score 0.83
(Table 7) signifies the importance of the variable. From my survey through
unstructured interview, a few of the entrepreneurs claimed that some officials of
financial institutions demand extra money other than the stipulated fees or charges in
order to get the required loan amount which they called bribe in their opinion (Box-3).
On the other hand, some entrepreneurs mentioned that sometimes ineligible
borrowers also get the loan with the collaboration of FIs and in a few cases nepotism
is also evident.

x) Lack of Managerial Capacity

Page 36
Managerial capacity to operate the business is the other obstacle for my country.
Most of the businesses' managements do not have any degree/training either from
the formal institutes or vocational learning canters. In many cases I found that they
are not well experienced regarding the business or production process. Many
proprietors have no successor to operate the business in case of their absence.
However, my survey result (rank score 0.36, Appendix-1) indicates that
entrepreneurs do not consider this variable as one of the significant problems.

Besides the problems discussed above, there are a lot of problems my Small
enterprises face. The technological requirements, the methods anti skills of
production, marketing of products and services, quality of manpower needed for
production, absence of SME information data base, management capacity,
willingness to pay, availability of information regarding the financial products and
services are some of the highly crucial issues.

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

In order to justify the problems that small enterprises encountered, I have conducted
another survey on the financial institutions that are supplying the funds to the small
enterprises. Financial institutions responded strongly against all the problems
differently that are summarized below:

i) High Interest Rate Financial Institutions' Disagreement over the Issue

Banks and other financial institutions often perceive that SEs represent a greater risk
than larger enterprise, and therefore, they are charging higher interest rates
compared to the corporate lending. Survey result showed that financial institutions
are charging on an average 15 – 18% interest against the small enterprises loan
while the corporate lending goes with 13 – 16%. From my survey it is found that 65%
of the 26 financial institutions responded that existing interest rate is not high, while
35% indicates that the rate of interest is high. They also alleged that many lenders of

Page 37
the informal sectors charge much higher than their rate. Accordingly they had
identified several factors responsible for charging such rate which are exhibited in

Most of the financial institutions suggested that small enterprises can enjoy lower
interest rate compared to prevailing market interest rate if the borrowers repay the
instalment regularly, maintain significant savings with them channelize their sales
transaction through Fls, has sound credit ratings, etc. However, Fls also took some
initiatives in this regard to reduce the interest rate like searching for low cost funds
(refinancing facilities), building better customer relationship that may reduce the
default risk and ensuring proper utilization of investment etc.

Figure 7.

figure 7: Reasons for Charging High Interest Rate

High monitoring and recovery cost 88%
Smaller range of credit limit 19%
Rate of provision is high 15%
Required collateral is not available 35%
High cost of maintaining relationship 77%
Risk is high 96%
High cost of fund 73%

Page 38
II) Excessive Security and Guarantee Requirement: Mixed Response

Security and guarantee is one of their major obstacles for obtaining finance from the
formal financial sector. Because, financial institutions perceive that small enterprise
lending characterize greater risk and in this case collateral could be one effective
way of mitigating such risk. Small businesses often have difficulty in providing
sufficient and good-quality collateral to banks. As a result, the supply side
considered this sector less attractive to them. My survey results show that 58 % of
the respondents think security and guarantee is the real problem for providing loan to
this sector. On the other hand, 42% of the financial institutions do not consider if as a
problem (Fig- 8).

figure 8: Responses of Fis against Excessive Security and Guarantee Requirement

yes 58%
no 42%

Page 39
figure 9: Responses of Fis whether Security and Guarantee is mandatory or not
yes 23%
no 77%

Page 40
Throughout the world, cash flow-based lending is getting popularity for large as Ill as
small businesses. If the enterprises can generate better cash flows, it is easy for the
lender to provide loan with minimum collateral. Survey among the FIs regarding the
cash flow based lending as a substitute of security and guarantee requirement
shows both positive- and negative responses Form the Fls. 57% respondents
answered positively and they identified the following reasons:

• It reduces the default risk.

• Regular cash flow enhances the repayment capacity.
• Suitable for those customers having prior relationship and good business
record.
• Suitable for the borrowers receiving consistent and frequent order from the
large reputed and credit worthy firms.
• However, 43% of the respondents answered negatively and they showed their
opinion differently which are as follows:
• It may increase credit risk.
• Market is not yet matured for cash flow based lending.

Page 41
 • Integrity and willingness to pay of the borrowers is also important even though
cash flow is sufficient.
• My market is so volatile that the prediction of future cash flow is very difficult.
• Small businesses are not maintaining good record of their transaction that is
needed for the determination of future cash flow.
• Cash flow of small businesses is more inconsistent.

ii) Complexity of Documentation: Mixed Responses

Proper documentation sometimes hinders small enterprises to .get access to the

formal financial sector. From my survey it is observed that 46% of the respondents
do not think that complexity of documentation is the barrier for accessing finance
from their institutions. However, 54% respondents complained that documentation
really create some problems while taking their credit decision (Fig-10). They argued
that, there are many businesses, mostly in the rural area, operating without
registration, and thus they do not have the trade Licenses. Beside the trade License,
sometimes small businesses cannot fulfil the criteria of other documents like
business deed, bank statements, TIN, VAT registration certificate etc. and as a
consequences financial institutions do not find them eligible for sanctioning the loan.
In addition to that, the respondents claimed that due to the lack of their knowledge
regarding the required documents sometimes entrepreneurs submit their proposals
without attaching the every required document. In this circumstance, it takes longer
time for arranging the needed documents that leads to the deviation from serving
their original purpose.

figure 10: responses of Fis agianst Complexity of Documentation

yes 46%
no 54%

Page 42
In response to the claim of the entrepreneurs that the financial institutions'
documentation requirement is very rigid, most of the respondents answered that they
do not have any other alternatives without maintaining such documentation. Some of
the respondents mentioned that, as per the regulatory guidelines, they must follow
the documentary requirement. But, depending on the nature of their relationship and
future business prospect sometimes they may minimize the documentation
requirements. In this regard, financial institutions cited that a strong data base about
the borrowers can help them to make the documentation requirement flexible.

xi) Long Loan Processing Time: FIs' Disagreement

The common perception of the demand side indicates that financial institutions take
much time for processing the loan. But my survey result shows that, supply side
does not meet the perception of demand side, rather all the financial institutions in
my sample strongly stated that their loan processing time is not high. Their
responses range from 12-25 days which is on an average 15.13 days. Whereas the
demand side expected to have the loan within 10.77 days (on an average), supply
side required 15.13 days (on an average) to disburse the loan. Financial Institutions
also cited the reasons for this required time which are: absence of required
information from borrower’s insufficient documentation, time required to obtain CIB

Page 43
report (branches where there is no interne! facilities), time required for proper
appraisal of loan proposal and time required .for loan approval.

v) Insufficient Working Capital Loan: Mixed responses

Working capital is the major requirement for the day to day operation of the small
businesses. But most of the entrepreneurs claimed that financial institutions are
reluctant to provide working capital loan and even if they obtain the loan, they do not
get the required amount from the financial institutions. Most of the financial
institutions explained that they are providing working capital loan to the small
enterprises provided that the borrowers fulfil their requirements. In addition to that,
for addressing these complaints, respondents highlighted the same reasons
regarding the problems relevant for accessing to finance in the formal sector.

vi) Unstructured Financial Information: Strong Agreement of the FIs over the Issue

Small enterprises are required to provide accurate and qualitative information to the
Fls for them to undertake a reliable risk assessment. Accurate risk assessments
obviously depend on the availability of good information regarding the business and
its prospects. From my survey result I found that, all of the FIs (supply side) revealed
that small businesses do not maintain good record of their transactions as per their
requirement. In most of the cases financial institutions have to produce the
entrepreneurs' financial statements which increase their operating, cost also.
Besides, all of the respondents cited that they are facing severe problems while
assessing the financial risk of the borrowers which are illustrated in Figure-- 11.

figure 11: problems faced by Fis regarding Unstructured Financial Information

No regular transactions record 56%
Fabricated financial statements 29%
Unstructured financial statements 93%
Un-audited financial information 77%
Different record for different stockholders22%
Negligence to keep accurate record 34%
Non-separation of own business account 37%
Insufficient information 41%
Page 44
In my survey, I have also asked the FIs, "How can the record keeping practices of
the small businesses be improved?' in response to the question, they provided the
following suggestions to the entrepreneurs who may ensure the quality of financial
information

- Do transaction through their bank account.

- Record keeping habit should be developed.

- Appointment of experienced employee or outsourcing good accountants.

- May use inventory management software.

- Computer base record keeping system may be started.

- Should participate in different trainings on record keeping practices.

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

Page 45
In response to Bankers' 'Negligence about small enterprise financing, banks and
other 'financial institutions strongly opposed the demand side claim and mentioned
that, as it is the government's priority sector and central bank's regulatory
requirement as Ill as their own interest, they do not show their negligence in this
respect. In order to provide better support regarding financing and some other
ancillary services most of the respondents enumerated their SME dedicated desk
and other consultancy and advisory support for enhancing the growth potential of
small businesses. Some respondents also revealed that sometimes entrepreneurs
fail to provide all necessary documents and cannot fulfil the loan requirement that
leads the FIs reluctant for financing them. Some other respondents informed that
sometimes they reject loan, as the enterprises are not eligible to obtain the loan. In
such cases, FIs do not require further investigation because loan proposal is itself
sufficient to justify its merits. It creates misunderstanding among the loan applicant
and they sometimes interpret as banker's negligence.

viii) High Sunk Cost for Obtaining Loan: Mixed Response

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

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

Financial institutions did not agree at all against the complaint of demand side
regarding their malpractices in sanctioning loan. Although the respondents do not
take this complaint on their own shoulders, a few of them mentioned that it may be
true for some other F.'s. They also suggested that if there are some instances in this

Page 46
regard then establishing centralized credit system with best internal control
techniques may reduce such malpractices.

While taking unstructured interview most of the FIs told that they are always ready to
accept qualified small enterprises to sanction credit provided that they fulfil the loan
requirements. They also highlighted that borrowers' managerial capacity to run the
business, willingness to pay, honesty and integrity, commitment to grow, motivation,
readiness to accept change, technological innovation, capacity to face competition
etc. are much more important to have access to the formal financial sector.

Gap Analysis between Demand Side and Supply Side and Some Observations

Many academician and the policy makers have asserted that there exists a
"financing gap’ for SE's. There is no commonly agreed definition of this gap, but the
term is basically used to mean that a sizeable share of economically significant SEs
cannot obtain financing from banks, capital markets or other suppliers of finance.
Furthermore, it is often alleged that many entrepreneurs who do not currently have
access to funds would have the capability to use those funds productively if funds
are available. But due to structural characteristics, the formal financial system does
not provide finance to such entities. Given that small enterprises are responsible for
significant levels of employment, innovation and productivity, it is important to be Ill
informed about the determinants of SE growth. One important determinant is the
provision of growth funding. Financial problems (lack of funds) constrain the
development and growth of SEs because many SEs are unable to access the same
kinds of growth funding often available to large businesses.

On the basis of the questionnaire survey, the study identified several important
problems in small enterprise financing raised by the demand side and accordingly
the responses of the supply side on those problems. The identified major problems
in small enterprise financing in Bangladesh are: high interest rate, security and
guarantee, complexity of documentation, loan 'processing time, working capital loan,
unstructured financial information, bankers' negligence, high sunk cost for obtaining
loan, malpractices in sanctioning loan, and managerial capacity. On these issues,

Page 47
some gaps are prevailing between the demand side and the supply side regarding
small enterprise financing that are presented in Table- 9. Based on the table, I have
describing my observations as follows:

Gap: High Interest Rate

In this, regard my observation is that the perception of the entrepreneurs is not so

justified for several reasons. Firstly, they compare SE borrowing rate with the
corporate lending rate. Secondly, they compare their rate of return from business
with the borrowing rate and if they fail to earn better return than perceive that the
interest rate is high. On the other hand, it is challenging for banks to lend less than
the current rate as their average cost of fund ranges between 11% - 12%, monitoring
and administrative cost is higher for SE, perceived risk in SE financing is high etc.
Moreover, FIs have to maintain certain spread to cover different expenditure and
contribute to the profit. Thus, by considering the whole scenario I think that the
prevailing interest rate is not so high. Even in comparison to the informal money
lender current rate of interest is significantly low. But, in many cases I found that FIs
charges different fees (every category of fee may not applicable for all Fls) which
significantly increase the effective rate of interest. Still Fls have the scope to reduce
such rate as Ill as the fees through searching for lower cost of funds.

Gap: Excessive Security and Guarantee Requirement

Fls must fulfil the minimum requirements of maintaining the security and guarantee
as per their prescribed credit policies and guidelines. But in a few eases, some FIs
are demanding excessive security for their safeguard. Thus, the complaint of the
borrowers is significant for those cases.

Gap: Complexity of Documentation

Proper documentation is really needed for the smooth operation of credit, the list of
documents that are demanded by the FIs are not avoidable. But the common
problem faced by the entrepreneur is to prepare or arrange the documents in proper

Page 48
time; even in a few cases they operate their business in unstructured way without the
required documents.

Gap: Long Loan Processing Time

Some Fls credit decision is centralized whereas others are following decentralized
credit approval process. So they need slightly high time for loan processing but the
complaint against the average time FIs are taking is not so meaningful to us. But in a
few cases it was found that some financial institutions are taking excessive time than
the usual loan processing time.

Gap: Insufficient Working Capital Loan

Gap arises due to over-emphasis by the FIs on prior/existing relationship with the
borrowers as well as borrowers' misconception and lack of awareness about the FIs
working capital assessment mechanism. In this regard, the reality is that FIs are
reluctant to provide funds to the new enterprises as Ill as the borrowers with whom
they have the insignificant relationship due to difficulty in proper assessment or their
credit worthiness. On the other hand, sometimes entrepreneurs fail to fulfil the loan
requirements and demand higher amount than their need. Thus the claim basically
derive for their failure to fulfil the loan condition or if they get the less amount than
their proposed amount. However, Fls sometimes reject their proposals or sanction
lower amount than the required amount for excessive reliance on the security, prior
relationship as Ill as the conservative approach of their assessment.

Gap: Unstructured Financial information.

On the basis of my observation, I have found that a very few enterprises maintain
structured financial statements even though these are not audited. But the other
enterprises, to the large extent, do not maintain structured financial statements. As a
result FIs face severe problems while assessing the financial aspect of the
borrowers.

Page 49
Gap: Financial Institutions' Negligence

On the issue of bankers' negligence, the gap arises due to high risk perception of Fls
about the sma.11 enterprise financing and also due to borrowers' misconception
about different formalities required by the FIs in processing the loan applications. In
this connection, I found that except for a few Fls, most of them are not
enthusiastically interested to finance small businesses rather they are financing only
for complying with regulatory policy requirements.

Recommendation

In order to minimize the SME Financing gap and reduce the problems of demand
side in receiving finance from banks and other financial institutions, the following
steps can be taken.

There is a large gap between the SME entrepreneur’s expectations and the
prevailing interest rate offered by the various banks and financial institutions.
Nevertheless, the interest rate offered by financial institutions is still lower than the
rate offered by informal money lenders and the total cost of funds. However, financial
institutions still need to reduce the interest rate in order to assist small and medium
size businesses to survive under current adverse economic condition. Monetary
market is currently suffering for significant liquidity crisis, which has made harder for
financial institutions to acquire low cost fund from the market and offer it to the SME
borrowers for low interest rate. Therefore, Bangladesh Bank (BB) should take the
initiatives. First of all, BB should keep the inflation in the desired target range, which
will promote high employment and decrease the business’s expenditures. Moreover
stable inflation will keep the real interest under desirable rate and will enable the FIs
to offer less nominal rate for their products.

Required for excessive security is identified in the survey as one of the most
significant barriers to obtain SME financing. In order to mitigate this problem,
financial institutions should provide more collateral free loan where SME businesses

Page 50
have a positive future prospect and reliable personal guarantee. Like other countries,
Bangladesh should concentrate on establishing collateral substitute lending decision
such as lending based on social security, lending on current cash flow etc. moreover
financial institutions can also increase their continuous monitoring on SME
businesses, which will allow them to be less dependent on amount of collateral while
making lending decision. Moreover continuous monitoring will help to build a
“Partnership building approach” between lenders (FIs) and borrowers (SME
businesses), which will make financial institutions to provide sufficient working capital
to new small and medium size businesses. At the same time, government should
attempt to improve a reliable, adequate and easily accessible database of existing
SME businesses, which will assist to reduce the loan processing cost and build
lenders confidence on small businesses.

Moreover, government should also emphasis on providing vocational training

programme for SME entrepreneurs in rural areas to increase their financial
knowledge, managerial capacity, so that these entrepreneurs will be able to
understand loan processing procedures, establish proper accounting system and
conduct a cost benefit analysis of their businesses. Financial institutions should also
conduct regular staffs training to make them capable to provide prompt and useful
service to SME clients. Government as well as other SME trade associations may
initiate building a partnerships relationship between SME business owners and
bankers by participating in discussions, seminars, and symposiums. By developing a
close and good relationship among these players, each side will understand and be
able to sensitize the problems and constraints of the other side. This is the best way
to reduce lack of understanding banking procedures by the businessmen and reduce
the long loan processing time, excessive sunk cost and lack of entrepreneurs
managerial capacity.

In addition, contribution from various donors and NGOs is a crucial factor to improve
the SME financing environment in Bangladesh. Therefore, government should also
establish a sector base funding facilities for assisting the donor’s countries and
NGOs to concentrate more in SME sector. Government should also emphasis on

Page 51
maintaining the co-operation and collaboration between different ministries to ensure
that all the ministries are functioning in line with government’s policy to improve the
SME financing.

Page 52
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APPENDIX I:

Descriptive Statistics of Major Demand Side Problems

High Mt. Sec. unit Uns.F1.1 Loan Docu Man. . Work,

7, Cap__
Mean 3.6726 2.9042 1.8886 2.1759 2.4209 Cap.
Standard Error 0.0293 0.0409 0.0431 0.052 0.0497 0.05 0.0444
Median 4 3 2 2 2 2 3
Mode 4 3 1 1 2 2 3
S. D. 0.6211 0.8671 0.9142 1.103 L0537 1.0608 0.9412
Sample . 0.7.519 0.8357 1.2167 1.1103 1.1253 0.8859
Kurtosis 2.0931 -0.7157 -0.4664 -1.1662 -1.0218 -0.8289 -0.7328
Skewness -1.772 -0.3088 0.5038 0.3989 0.083 0.1056 -0.3886
g
Ran e 3 3 A 4 4 4 3
Minimum 1 1 0 0 0 0 1
Maximum 4 4 4 4 4 4 4
Sum 1649. 1304 848 977 1087 667 1262
Count 449 . 449 449 449 449 449
Source calculation from survey questionnaire

APPENDIX ii

One way ANOVA of Ranking

ANOVA
Source ofss df MS F P-value F oil
p
Between Grou s 1413.0857 7 201.8693 195.2251 6.6265E-246 2.0121
Within Groups 3705.9777 3584 1.03403
Total 5119.0634 3591
Source: calculation from survey questionnaire

A One-Way Analysis of Variance is a way to test the equality of three or more means
at one time by using variances. The null hypothesis of one way ANOVA is all
population means are equal; the alternative hypothesis is that at least one mean is
different. The decision will be to reject the null hypothesis if the test statistic from the
table is greater than the F critical value. Our calculated F value (195.2251) is far
higher than the critical F value (2.0121) rejecting the null hypothesis and the values
are not uniform in the sample units.

Page 5741
APPENDIX-III

Questionnaire for Borrower (Demand side)

1) Which type of SME loan you take from BRAC Bank Limited?

Anonno or Anonno (gold) Apurbo Proshar

Prothoma

Digoon Loan Others_________________

2) Have you ever taken Small scale loan from bank before this?

Yes No

(If yes, from please mention which

organization_______________________________)

3) Is this your first loan from BRAC Bank?

Yes No (If no, how much_________________)

4) Why did you choose this SME loan product?

Flexible interest Lower loan-processing fee Less documentation

Flexible collateral Flexible instalment Less business experience

needed

5) How much amount of loan did you apply for?

_________________________________________

6) How much amount of loan you take?

3-5 lac 6-8 lac 9-11 lac 12 lac or more

7) What type of collateral you have pledge for this loan?

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 Blank Cheque Document of asset Both of these
others______________

8) How many days you have to wait for receiving the loan from (application to
disbursement)?

___________________________________________

9) With how many instalments you repaid this loan.

¬¬¬¬¬¬¬¬¬¬¬¬¬¬¬¬______________________________

10) How much have you repaid of your loan?

___________________________________

11) Which Mode of repayment you like?

Single Instalments Equated Monthly Instalments

12) How much investment do you have in your business now?

___________________

13) How long you doing this business?

___________________

14) How many employees engaged in your business?

_____________________________

15) What is monthly average profit from this business?

_______________________

16) Do you face any problem during taking this loan or the period of loan?

Yes No

(If yes, what type of problem you face ___________________________________)

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17) Do you want to extend this loan with Brac Bank?

Yes NO

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