ASSESSMENT OF THE EFFECTIVENESS OF COMMERCIAL

BANKS IN FINANCING SMALL AND MEDIUM SIZED

ENTERPRISES:
THE CASE OF CRDB BANK PLC KILOMBERO DISTRICT

Subi Eliakim Subi

A Dissertation submitted for partial fulfillment for the award of Master Degree of
Business Administration (MBA) of the Mzumbe University

2013

i
 1 CERTIFICATION
We, the undersigned certify that we have read and hereby recommend for acceptance by
the Mzumbe University a Dissertation/thesis entitled Assessment of the Effectiveness
of Commercial Banks in Financing Small and Medium Sized Enterprises: A Case
of CRDB Bank PLC Kilombero District in partial/Fulfillment of the Requirements of
the Degree of Master of Business Administration (MBA) of Mzumbe University.

____________________________
Major Supervisor

___________________________
Internal Examiner

Accepted for the Board of School of Business

____________________________
DEAN, SCHOOL OF BUSINESS

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 2 DECLARATION

3 AND

4 COPYRIGHT

I, Subi Eliakim Subi, do hereby declare that this dissertation is my own original work
and that it has not been presented and will not be presented to any other University for a
similar or any other degree award.

Signature ___________________________

Date________________________________

© 2013
This dissertation is a copyright material protected under the Berne Convention, the
Copyright Act 1999 and other international and national enactments, in that behalf, on
intellectual property. It may not be reproduced by any means in full or in part, except for
short extracts in fair dealings, for research or private study, critical scholarly review or
discourse with an acknowledgement, without the written permission of Mzumbe
University, on behalf of the author.

ii
 6 ACKNOWLEDGEMENT
This work could not be the way it is now, without the efforts made by different people to
ensure that I reach this stage. I appreciate every individual and institution that
contributed to this achievement and I wish I could mention by name every one and the
nature of his contribution to this academic work, however, due to limited space and time
I will mention only few of them.

First, I wish to thank my almighty God for his mercy for keeping me on healthy
condition for the entire period of my study and during writing this report. I would have
not achieved if something could have interrupted my study specifically illness and other
obstacles, but due love and kindness of God bestowed upon me gave me an opportunity
to reach this stage. I thank my lord God for his guidance.

Second, my gratitude thanks goes to my parents who kept me safe during my childhood
and taught me to honor education by sending me to school. I real appreciate their
contribution in terms of finance and morals, I am sure without them being education
lover I could end up keeping cattle‟s and excessive alcoholic taker in our home village.
Third, a great respect goes to my academic supervisor Mr. Simon Kitilla of the Mzumbe
University. He has been my academic father through the guidance he provided to me in
writing this research report from the proposal stage. He worked tirelessly by going
through my work and made necessary corrections wherever I was wrong and he did this
faithfully even though he had a tight schedule he spared time to go through my work. I
thank him for his kindness and commitment.

Fourth, I will not be fair if I won‟t thank the entire managements of CRDB Bank PLC
Kilombero Branch and Mzumbe University who have enabled me to accomplish this
work. It is true that both academic and non academic staff played a great role for my
achievement.

iii
Lastly I wish to thank my college mate who encouraged me to continue with this work.
It reached a time when I wanted to dropout because this research work gave me a hard
moment as I had no time to rest, and built a wall with my relatives and friends I used to
be with them, but through encouragement I received from Anorld J. Rwamtoga of
CRDB Bank and Deus Nyoni made me strong and continued with this work until today
when I submit my final draft.

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 7 DEDICATION
I dedicate this work to the lovely family of my brother Mr. and Mrs. Emmanuel M.
Subbi and my child Justice Tambulo Matambalya who missed me for the entire period
of my study.

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 8 LIST OF ABBREVIATIONS

BEF Business Excellence Framework

GNP Gross National Product
HOD Head of Department
KCB Kenya Commercial Bank
LM Line Managers
ME‟s Medium Enterprises

MITM Ministry of Industry Trade and Marketing

NMB National Microfinance Bank

OP Organization Performance
SME‟s Small and Medium Enterprises

SMBs Small and medium-sized business

SSP Statistical Package for Social Sciences

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 9 ABSTRACT
The main objective of the study is to assess the effectiveness of financial institutions in
financing SMEs within Kilombero district in Tanzania, taking cognizance of the role and
contributions of CRDB Bank Tanzania Limited. However, there are number of rigidities
of a macroeconomic, institutional and regulatory nature that may bias the entire banking
system against lending to SMEs. SMEs in Tanzania are entangled with myriad problems
mitigating their growth in Tanzania notably among them are, lack of access to credit,
lack of market for their products, poor technology, poor physical infrastructures, poor
legal and regulatory framework and commercial banks are most often unwilling to
increase loan funding without an increase in the security given thereby leading to
stagnation of growth and certain instances unable to expand to enjoy economies of scale
necessary to serve their potential of being an engine of national growth and are thus
collapsing.
The study selected CRBD bank Kilombero branch as a unit of inquiry where by the
sample were selected from SME owners and bank staff. Researcher applied simple
random sampling, and purposeful sampling method as sampling techniques to ensure
that accurate sample were obtained for the study.
The sources of materials for the study were both primary and secondary. Primary data
were collected by the use of interviews, questionnaires and observation which were
designed and administered to SME customers and employees of the CRDB Bank..
Secondary materials were extracted from relevant textbooks, newspapers,
reports/articles, journals, bulletins and documents presented by corporate financial
analysts and policy planners. The data from the field were analyzed using the following
techniques: editing, tabulation, coding and Statistical Package of social science.
In view of the findings, it was recommended that banks should create a separate
department for the SMEs; the establishment of a common fund by the government for
SMEs; there should be a national policy on SMEs by the government in respect of
funding among others and educate SMEs in the efficient and effective financial
management of their businesses in order to sustain the SMEs to grow into much bigger
industries in the near future.

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 10 TABLE OF CONTENT
11
CERTIFICATION ............................................................................................................. i
DECLARATION ............................................................................................................... ii
AND .................................................................................................................................... ii
COPYRIGHT .................................................................................................................... ii
ACKNOWLEDGEMENT ............................................................................................... iii
DEDICATION ................................................................................................................... v
LIST OF ABBREVIATIONS ......................................................................................... vi
ABSTRACT ..................................................................................................................... vii
TABLE OF CONTENT ................................................................................................. viii
LIST OF TABLES ......................................................................................................... xiii
LIST OF FIGURES ....................................................................................................... xiv
CHAPTER ONE ............................................................................................................... 1
1.0Introduction .................................................................................................................. 1
1.1 Background to the Problem .......................................................................................... 1
1.2 Statement of the problem .............................................................................................. 2
1.3 Objectives of the Study ................................................................................................. 3
1.3.1 General Objective ...................................................................................................... 3
1.3.2 Specific Objectives .................................................................................................... 3
1.4 Research Questions ....................................................................................................... 4
1.5 Significance of the Study .............................................................................................. 4
1.6 Scope of the Study ........................................................................................................ 4
1.7 Organization of the study .............................................................................................. 4
1.8 Limitations of the Study................................................................................................ 5
1.9 Delimitation of the Study .............................................................................................. 6
CHAPTER TWO .............................................................................................................. 7
LITERATURE REVIEW AND CONCEPTUAL FRAMEWORK ............................. 7
2.0 Introduction ................................................................................................................... 7
2.1 Definition of Concepts .................................................................................................. 7
viii
2.1.1 Small and medium sized Enterprises (SMEs) ............................................................ 7
2.2 Theoretical Review ..................................................................................................... 10
2.2.1 Characteristics and Nature of Small Firms .............................................................. 10
2.2.2 Importance of Small and Medium Enterprises ........................................................ 10
2.2.3 The Contribution of SMEs to Economic Development ........................................... 12
2.2.3.1 Employment creation ............................................................................................ 12
2.2.3.2 Regional and Rural Development ......................................................................... 13
2.2.3.3 Provision of Services to Local community ........................................................... 14
2.2.3.4 Supporting the Large Enterprises (LEs)................................................................ 14
2.2.4 General Constraints to SME Development .............................................................. 15
2.3 Empirical Literature Review ....................................................................................... 18
2.3.1 The Tanzanian context ............................................................................................. 18
2.3.1.1 Policy Development .............................................................................................. 18
2.3.1.2 Institutions............................................................................................................. 19
2.3.1.3 Challenges facing SME in Tanzania ..................................................................... 22
2.3.1.3.1 Legal and Regulatory Framework...................................................................... 22
2.3.1.3.2 Physical Infrastructure ....................................................................................... 22
2.3.1.3.3 Business Training............................................................................................... 23
2.3.1.3 4 Technology ........................................................................................................ 23
2.3.1.3.5 Marketing ........................................................................................................... 23
2.3.1.3.6 Access to Finance .............................................................................................. 23
2.3.1.3.7 Institutional Framework for SMEs Development .............................................. 24
2.3.1.3.8 Rural Industrialization: ...................................................................................... 25
2.3.1.3.9 Environmental Considerations: .......................................................................... 25
2.3.1.3.10 Gender and the Disadvantaged Groups ............................................................ 26
2.3.1.3.11 HIV-AIDS ........................................................................................................ 26
2.3.2 The African context ................................................................................................. 26
2.3.3 Global context .......................................................................................................... 28
2.3.3.1 The SME sector in the global economy ................................................................ 28
2.3.3.2 Implications of SME Growth for Domestic Economic Development .................. 28

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2.4 Conceptual framework ................................................................................................ 31
CHAPTER THREE ........................................................................................................ 33
RESEARCH METHODOLOGY .................................................................................. 33
3.0 Introduction ................................................................................................................. 33
3.1 Research Design .......................................................................................................... 33
3.1.1 Area of Study ........................................................................................................... 34
3.1.2 Study population ...................................................................................................... 34
3.1.3 Units of Inquiry ........................................................................................................ 34
3.2 Sample Size and Sampling Techniques .................................................................... 34
3.2.1 Sampling techniques ................................................................................................ 35
3.2.1.1 Purposeful sampling method ................................................................................. 35
3.2.1.2 Simple random sampling method ......................................................................... 36
3.3 Data Collection Methods ............................................................................................ 36
3.3.1 Primary data ............................................................................................................. 36
3.3.1.1 Interview ............................................................................................................... 36
3.3.1.2 Questionnaires ....................................................................................................... 36
3.3.1.3 Observation ........................................................................................................... 37
3.3.2 Secondary Data ........................................................................................................ 37
3.4 Data Analysis and Presentation................................................................................... 37
3.4.1 Data analysis techniques .......................................................................................... 38
3.4.2 Statistical Package of Social Science ....................................................................... 38
3.5 Dissemination of the Results ...................................................................................... 39
CHAPTER FOUR ........................................................................................................... 40
DATA ANALYSIS, PRESENTATION AND DISCUSSION OF THE FINDING ... 40
4.1 Introduction ................................................................................................................. 40
4.2 Demographic features of the respondents. .................................................................. 40
4.2.1 Characteristics of Respondents ................................................................................ 41
4.2.1.1 Education .............................................................................................................. 41
4.2.1.2 Gender ................................................................................................................... 42
4.2.1.3 Respondents Distribution by Age ......................................................................... 43

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4.2.2 Financial Services offered by CRDB bank to SME customers ............................... 43
4.2.3 Relationship Ratings with SME ............................................................................... 44
4.2.4 Conditions for extending credit facilities ................................................................. 45
4.2.5 Major challenges of SME Banking .......................................................................... 46
4.2.6 Main sector of SME activity .................................................................................... 46
4.2.7 Effectiveness of Commercial Bank in SMEs financing .......................................... 47
4.2.7.1 SMEs growth ........................................................................................................ 47
4.2.7.2 Access to finance helps SMEs to grow and prosper ............................................. 48
4.2.7.3 Reduction of SMEs financing gap ........................................................................ 48
4.2.7.4 Improvement of the overall business environment for all firms ........................... 48
4.2.7.5 Enabling Economic Environment ......................................................................... 49
4.2.7.6 Business Training.................................................................................................. 49
4.2.8 Factors influence the financing of SMEs by CRDB Bank Plc ................................ 49
4.2.8.1 The audited financial statement ............................................................................ 50
4.2.8.2 Repayment or first line of defense ........................................................................ 50
4.2.8.3 Competence of management ................................................................................. 50
4.2.8.4 The size of business .............................................................................................. 51
4.2.8.5 Financial Projection or Pro forma financial statement.......................................... 51
4.2.8.6 Purpose of the Loan .............................................................................................. 51
4.2.8.7 The knowledge ...................................................................................................... 51
4.2.8.8 Business risk / Product .......................................................................................... 52
4.2.8.8.1 Capacity ............................................................................................................. 52
4.2.8.9 The third party opinion ......................................................................................... 52
4.2.8.10 Geographical risk ................................................................................................ 53
4.2.8.11 Market involved .................................................................................................. 53
4.2.8.12 Trading experience or track record ..................................................................... 53
4.2.8.13 Planning .............................................................................................................. 53
4.2.9 Barriers Encountered by Financial Institutions in Financing SMEs ........................ 54
4.2.9.1 Banks have difficulty providing tailored foreign exchange products ................... 54
4.2.9.2 SMEs lack collateral ............................................................................................. 55

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4.2.9.3 Banks require SME transparency.......................................................................... 55
4.2.9.4 Lack of effective channels and modalities for communication ............................ 55
4.2.9.5 Banks do not consider SME lending as profitable business ................................. 56
4.2.9.6 Limited Competition for Tailored services Targeting SMEs................................ 56
4.2.9.7 Banks consider SM E lending high risk ................................................................ 56
4.2.9.8 Banks incur higher administrative costs by lending to SMEs .............................. 57
4.2.9.9 Another factor which appears to have a significant impact on SME financing in
the Tanzania is business regulation ................................................................................... 57
4.2.9.10 Obstacles in the legal and contractual environment............................................ 57
4.2.10 Improvement in financing of SMEs ....................................................................... 58
4.2.10.1 Increased access to finance will foster efficient growth in the SME sector ....... 59
4.2.10.2 Improving business conditions ........................................................................... 59
4.2.10.3 Helping SMEs meet the requirements of formal financing ................................ 60
4.2.10.4 Making the financial system more accessible to SMEs ...................................... 60
4.2.10.5 Expanding the supply of finance through the non-financial private sector ........ 62
CHAPTER FIVE ............................................................................................................ 63
CONCLUSIONS, RECOMMENDATIONS AND POLICY IMPLICATIONS ....... 63
5.1 Conclusions ................................................................................................................. 63
5.2 Recommendations ....................................................................................................... 64
5.3 Policy Implications ..................................................................................................... 67
REFERENCES ................................................................................................................ 70
APPENDICES ................................................................................................................. 73

xii
 LIST OF TABLES
Table 2.1 : Categories of SME'S in Tanzania ..................................................................... 8
Table 2.2: Categories of Firms ............................................................................................ 9
Table 3.1: Distribution of respondents .............................................................................. 35
Table 4.1: Distribution of respondents by level of Education .......................................... 42
Table 4.2: Credit Conditions for SMEs ............................................................................ 45
Table 4.3: Major challenges of SME banking .................................................................. 46

xiii
 13 LIST OF FIGURES

Figure 2.1: Conceptual Framework .................................................................................. 32

Figure 4.1: Distribution of CRDB respondents by Sex .................................................... 41
Figure 4.2: Gender of respondents .................................................................................... 42
Figure 4.3: Distribution of Respondents by Age .............................................................. 43
Figure 4.4: Financial services offered to SME customers ................................................ 44
Figure 4.5: Relationship ratings Between CRDB and SME ............................................ 45
Figure 4.6: Main SMEs activities ..................................................................................... 47

xiv
 14 CHAPTER ONE

1.0Introduction
The introductory chapter illuminates the Background information motivating the study
and explains the problem statement, objective, research questions and significance of the
study as well as the limitation, delimitation and scope of the study.

1.1 Background to the Problem

Small and Medium Enterprises plays a great role to a nation as it contributes to
Economic growth. The development of this business segment is paramount and needs
support of finance and other driving force to strengthen it and achieve its objectives.
Commercial Banks are established to stimulate business growth through provision of
finance (OECD, 2006). However due to most of this business segment being stagnant,
the researcher aims to explore the effectiveness of commercial Banks on its role of credit
provision to Small and Medium Enterprise(SME) in order to reveal the reasons and its
courses.

It is now increasingly recognized that the Small and Medium Enterprises (SMEs) play
an important role in income generation as well as employment creation around the globe
(OECD, 2006). Small and medium-sized enterprises (SMEs) are considered to be one of
the principal driving forces in economic development. They stimulate private ownership
and entrepreneurial skills, they are flexible and can adapt quickly to changing market
demand and supply situations. They also generate employment, help in diversifying
economic activities and make a significant contribution to exports and trade (Szabo,
1996). However, SMEs all over the world and in Tanzania in particular, can be easily
established since their requirements in terms of capital, technology, management and
even utilities are not as demanding as it is the case for large enterprises. (Ministry of
Industry, Trade and Marketing, Tanzania (MITM)), 2002)

1
SME are the core or base for the future development of both developing and developed
countries in creation of jobs and economic competitiveness while financial challenges
seems to be a problem to all level of the business operations. Accessibility of finance
from financial institutions and non-financial Institutions is constantly increasing at a
decreasing rate due to different factors of an economy and marketing opportunities.
Therefore, these challenges occur due to different reasons: First is the level of
entrepreneurship and their characteristics. Second are the roles of SMEs in the business
sector and the contribution roles in the economic activities. However, the nature of
Institutional arrangements in the public and private sector seem to be a continuously
challenges to SMEs growth in Tanzania. Therefore it covers both legal and regulatory
framework which focus on a country business environment as cross-cutting argument in
the creation of a conducive and harmonized structured system in the doing business in
Tanzania. (URT,2002).

In Tanzania, Small and medium enterprises (SMEs) are financed from the Microfinance
Institutions (MFIs) as an array of financial sources; and this is because Microfinance is
acknowledged as one of the prime strategies to achieve the Millennium Development
Goals (MDGs) which are: poverty and hunger reduction, universal primary education,
reduction of child mortality, combating diseases, malaria and environmental
sustainability (Mahjabeen, 2008). The reason is because access to sustainable financial
services enables owners of micro enterprises to finance income, build assets, and reduce
their vulnerability to external shocks (Ehigiamusoe, 2005).

1.2 Statement of the problem

In most jurisdictions, commercial banks as such as CRDB Bank Ltd are the main source
of external finance for SMEs. Therefore, it was essential that the banking system be
prepared to extend credit to the SME sector. However, there are number of rigidities of a
macroeconomic, institutional and regulatory nature that may bias the entire banking
system against lending to SMEs (OECD, 2006).

2
According to Boapeah (1993) Business Behavior and Appropriate Promotion Strategies;
SMEs are entangled with myriad problems mitigating their growth; notable among them
are, lack of access to credit, competition from large-scale industries, the over
liberalization of the economy and difficulty in accessing advisory services and research
findings.
Parker et al (1995) indicates that credit constraints pertaining to working capital and raw
materials are major concern in the industry. Aryeetey et al (1994) reported that 38% of
the SMEs surveyed mention credit as a constraint. This stems from the fact that SMEs
have limited access to capital markets, locally and internationally, because of the
perception of higher risk, informational barriers, and the higher costs of access and
obtaining the assistance.

Despite the constraints facing SMEs in accessing loans, financial institutions (CRDB
bank PLC) in particular claims that they extend greater financial support to SMEs
through loans. On the other hand the sector is complaining on the failure of the financial
institution to support the sector. In view of this dilemma, this study seeks to establish the
effectiveness of commercial banks in financing small and medium size enterprises in
performance improvement.

1.3 Objectives of the Study

1.3.1 General Objective

The general objective of the study is to assess the effectiveness of commercial Banks in
Financing Small and Medium Size Enterprises (SMEs).

1.3.2 Specific Objectives

The specific objectives of the study to attain the above general objective are:-
i) To determine the effectiveness of commercial banks In financing SME,
ii) To determine the factors influencing financial Institutions to finance SMEs (eg
CRDB Bank Plc).

3
 iii) To identify the barriers that commercial banks (CRDB Bank Plc) encounter in
the financing of SMEs.

1.4 Research Questions

In order to attain the above stated objective the study seeks to answer the following
questions:
i) How effective does Commercial bank have in financing SMEs in Tanzania?
ii) What factors influence the financing of SMEs by CRDB Bank Plc?
iii) What barriers do banks (CRDB Bank Plc) encounter in financing SMEs?

1.5 Significance of the Study

The study is expected to assess the effectiveness of commercial banks in financing
SMEs, using a case of CRDB Bank Plc. The results of the study will help the policy
makers to craft policies relating to financing of SMEs and more knowledge will be
acquired by the researcher in relating to this topic. In additional other academic
researchers will use this report as a reference material when they want to pursue a
research on a similar topic.

1.6 Scope of the Study

The study covers the SMEs of Tanzania specifically on agriculture, furniture works,
wood work, metal work and food processing industry. The study conducted within the
framework of evaluating challenges of financial Institutions in financing SMEs in
Tanzania. A case study design was applied to investigate in detail financing of SMEs by
CRDB Bank Plc in Kilombero area.

1.7 Organization of the study

This study comprises five chapters. Chapter one explain the background information to
the problem, Statement of the Problem; research Objective, research questions,
Significance of the study, scope of the study limitation and delimitation to the study.
4
Chapter two presents a broader investigation on literature review specifically on the
financial institutions effectiveness on financing SMEs, SMEs performance,
classification and challenges facing SMEs and financial Institutions in financing SMEs.
Chapter three presents the methodology of the study applied, this includes the study
design, Area for Study, population, Sample size and sampling techniques applies data
collection methods and tools for analysis employed.
Chapter four highlights the presentation, data analysis and discussion of the field results
while chapter five presents the summary of the findings, conclusion and
recommendations of the findings.

1.8 Limitations of the Study

This study was limited by time factor because the researcher had to ensure he completes
the study within the given academic year which is too short to explore in detail the
effectiveness of financial Institutions in financing SMEs and determine its constraints.
The researcher is self sponsored, in considering the extent of poverty prevailing in the
country it is not possible for the researcher to explore extensively and cover wide area
due to lack of enough financial resources.

The study used both secondary and primary data, hence in collecting primary data the
researcher was not able to meet with all the top management of CRDB Bank Plc as most
of the decision is made from the Headquarter in Dar-essalaam while at the Branch level
only operation is done. The provision of information is too beuocratic at the branch level
where by only the branch manager can do but every time whenever I faced him he was
busy with customers. The other limitation was the sometimes difficult situations
whereby the bankers who were governed by the strict banking act which prohibits the
divulging freely or provision of banking information especially with regard to
operational and evaluating criteria used in the business financing applications. However,
through the use of qualitative interview techniques which permitted the use of the
researchers‟ skill and probing techniques, the information required from the bankers
were ably teased out by them

5
1.9 Delimitation of the Study
This study was conducted from March 2013 to June 2013 in Morogoro region at
Kilombero district where CRDB branch was located. In Tanzania, a good number of
banks customers are located in urban areas since the majorities are either employed or
work in Kilombero district. These residents most of them are educated, exposed and
hence understand the use of banks in their day to day life. So getting accurate and first
hand information was an advantage.

6
 15 CHAPTER TWO

16 LITERATURE REVIEW AND CONCEPTUAL FRAMEWORK

2.0 Introduction
This chapter reviews related literature in the area related to the assessment the
effectiveness of commercial banks in financing SMEs. Empirical literature as well as
theoretical framework underpinning the study will be dealt with. The first part deals
with definition of key terms used in this study. The second part is the theoretical
framework as well as policy review of literature in Tanzania and other parts of the
world.

2.1 Definition of Concepts

2.1.1 Small and medium sized Enterprises (SMEs)

The term “SME” encompasses a broad spectrum of definitions. Different organizations
and countries set their own guidelines for defining SMEs, often based on headcount,
sales or assets. While Egypt defines SMEs as having more than 5 and fewer than 50
employees, Vietnam considers SMEs to have between 10 and 300 employees. The
World Bank defines SMEs as those enterprises with a maximum of 300 employees, $15
million in annual revenue, and $15 million in assets. The Inter-American Development
Bank, meanwhile, describes SMEs as having a maximum of 100 employees and less
than $3 million in revenue.

According to SME development policy of Tanzania 2002, The SMEs nomenclature is

used to mean micro, small and medium enterprises. It is sometimes referred to as micro,
small and medium enterprises (MSMEs). The SMEs cover non-farm economic activities
mainly manufacturing, mining, commerce and services. There is no universally accepted
definition of SME. Different countries use various measures of size depending on their
level of development. The commonly used yardsticks are total number of employees,
total investment and sales turnover.

7
In the context of Tanzania, micro enterprises are those engaging up to 4 people, in most
cases family members or employing capital amounting up to Tshs.5.0 million. The
majority of micro
Enterprises fall under the informal sector. Small enterprises are mostly formalized
undertakings engaging between 5 and 49 employees or with capital investment from
Tshs.5 million to Tshs.200 million. Medium enterprises employ between 50 and 99
people or use capital investment from Tshs.200 million to Tshs.800 million. This is
illustrated in the table below:

Table 2.1 : Categories of SME'S in Tanzania

Categories Employees Capital investment in machinery
(Tshs)
Micro enterprise 1-4 Up to 5mil
Small enterprise 5-49 Above 5mil to 200mil
medium enterprise 50-99 Above200mil to 800mil
large enterprise 100+ Above 800mil
Sources: MSEs Development policy 2002-212

N.B. In the event of an enterprise falling under more than one category, then the level of
investment will be the deciding factor.

According to the European Union definition: „ The category of micro, small and
medium-sized enterprises is made up of enterprises which employ fewer than 250
persons and which have an annual turnover not exceeding 50 million euro, and/or an
annual balance sheet total not exceeding 43 million euro.‟ Small and medium enterprises
are thus defined as firms with 10 to 250 employees as and more than 10 million euro
turnover or annual balance sheet total. This definition is more encompassing, and much
larger, especially with regards to turnover, than some others. The precise definition
however, does not impact the overall conclusions and findings of this report.

Department of Trade and Industry (DTI)

The Department of Trade and Industry (DTI) in UK defined the small business by using
the number of employees as one of the determinant of the size of the firm and the

8
turnover. This means that a clear description of the major characteristics of the SME
comes from the Report of the Bolton Committee on Small Firms of 1971. Therefore
according to the DTI statistical definition, they still maintain the statistical definition of
the Bolton Committee on small businesses. (Tonge, 2001)

According to the European Commission (EC), in 1996 they adopted a single definition
for SME that to be applied across all the Community proposals and programs from
December 1997 onwards. This definition is the same as that of the DTI. (Tonge,2001).
However, for statistical purpose, the definition which was used by the DTI is as follows:

Table 2.2: Categories of Firms

Category Employee
Micro Firm 0-9
Small Firm (Including micro) 9-49
Medium Firm 50-249
Large Firm 249+
Sources: MSEs Development policy 2002-212

Wangwe (1999) Wangwe argues that the definition of Micro and Small Enterprises
(MSEs) is slippery and has not been universally agreed upon. He defines micro
enterprises as those engaging 1-5 persons and small enterprises as those which engage 6-
20 persons. MSE therefore are all those enterprises which engage between 1 and 20
persons.
Masawe (2003) defines Small and Micro Enterprises as those employing up to 4
persons; Small Scale Enterprises as those was employing 5-49 persons and Medium Size
Enterprises as those employing 50-99 persons. Generally, therefore, one can take a
working definition of SMEs as those employing between 6 and 99 persons. There have
been various definitions given for small-scale enterprises in Tanzania but the most
commonly used criterion is the number of employees of the enterprise defined by the
(URT, 2002).

9
2.2 Theoretical Review

2.2.1 Characteristics and Nature of Small Firms

The characteristics of the small firms can be said as follows:
i. The small firms mainly focus on a small range of products or services and mainly
sell their product or services on the local domestic market.
ii. In small firms, the owner is the only person in a managerial position, thus no
organized structural management or board of directors.
iii. The small firms operate their business on trust, rather than on contracts and
systems.
iv. In small firms the pressures of day-to-day management and resource constraints
cause their vision and outlook to be bounded by the horizons, skills and experience
of the owner or founder.
v. The small firms likes to operate independently of other businesses and institutions
or work on their own i.e. they prefer more self help rather than seeking advices
vi. The small firms face a fierce competition due to their small range of products and
small market share; therefore they tend to be simply price takers.
vii. Small firms also do not have any preparations for the future plans.
viii. Maximum small firms are not publicly owned companies; they are either
partnership firms or privately owned companies, i.e. most of them are not quoted
on a stock exchange – they are “unquoted”
ix. Small firms have limited resources in terms of assets, manpower, as well as
finance.

2.2.2 Importance of Small and Medium Enterprises

It is estimated that about a third of the GDP originates from the SME sector. According
to the Informal Sector Survey of 1991, micro enterprises operating in the informal sector
alone consisted of more than 1.7 million businesses engaging about 3 million persons
that was, about 20% of the Tanzanian labor force. Though data on the SME sector are
rather sketchy and unreliable, it is reflected already in the above data that SME sector
plays a crucial role in the economy.

10
Since SMEs tend to be labor-intensive, they create employment at relatively low levels
of investment per job created. At present, unemployment is a significant problem that
Tanzania has to deal with. Estimates show that there are about 700,000 new entrants into
the labor force every year. About 500,000 of these are school leavers with few
marketable skills. The public sector employs only about 40,000 of the new entrants into
the labor market, leaving about 660,000 to join the unemployed or the underemployed
reserve. Most of these persons end up in the SME sector, and especially in the informal
sector. Given that situation and the fact that Tanzania is characterized by low rate of
capital formation, SMEs are the best option to address this problem.

SMEs tend to be more effective in the utilization of local resources using simple and
affordable technology. SMEs play a fundamental role in utilizing and adding value to
local resources. In addition, development of SMEs facilitates distribution of economic
activities within the economy and thus fosters equitable income distribution.
Furthermore, SMEs technologies are easier to acquire, transfer and adopt. Also, SMEs
are better positioned to satisfy limited demands brought about by small and localized
markets due to their lower overheads and fixed costs. Moreover, SME owners tend to
show greater resilience in the face of recessions by holding on to their businesses, as
they are prepared to temporarily accept lower compensation.

Through business linkages, partnerships and subcontracting relationships, SMEs have

great potential to complement large industries requirements. A strong and productive
industrial structure can only be achieved where SMEs and large enterprises not only
coexist but also function in a symbiotic relationship. However, the linkages between
SMEs and large enterprises are very weak in Tanzania. SME development Policy,
therefore, creates the potential for enhancing linkages within the economy. In addition,
SMEs serve as a training ground for entrepreneurship and managerial development and
enable motivated individuals to find new avenues for investment and expanding their
operations.

11
There are also opportunities indicating a bright future for SME sector development in
Tanzania. This includes the various on-going reforms that are oriented towards private
sector development and, thus, lay the ground for SMEs development. In addition, the
recognition of SME sector that it has higher potential for employment generation per
capital invested attracts key actors to support SME development programs. Since SME
development does contribute significantly to poverty alleviation, resources earmarked
for poverty alleviation will also be availed to the SME sector.

Various initiatives towards improving the infrastructures and especially roads do provide
an added opportunity for SME development. Furthermore, there are several ongoing
schemes aimed at strengthening SME service providers such as Small Industries
Development Organization (SIDO), Vocational Education Training Authority (VETA),
Micro Finance Bank (NMB) and various Industrial Support Organizations. These
interventions do provide opportunities for growth of the SME sector. Given the fact that
Tanzania is endowed with abundant natural resources, the creation of enabling business
environment will facilitate exploitation of these resources through SMEs. This is again
an opportunity for SMEs development.

2.2.3 The Contribution of SMEs to Economic Development

2.2.3.1 Employment creation

The contributions of SMEs towards employment creation are undoubtedly manifested
through their reliance on labor-intensive approach in the conduct of their business
activities. This has led to the creation of jobs opportunities for the employment of the
members of the various communities. Bosworth (1986) confirmed by the discoveries
made on SMEs as contributing more to employment generation than the large industries
in Indonesia; as in the fact that, the Large Enterprises are capital intensive industries
require an investment of US $50,000 to employ an additional worker; and that SMEs
require an investment of US$ 500 for an additional worker to be employed in any form
of economic activities, (Soon, 1984).

12
The United Kingdom for example, at one time encouraged small enterprises to employ
more manpower and the Government provided subsidy to the employer for each
additional worker employed. With the relative ease of starting of small enterprises as
compare to that of starting a large enterprise, there is a potential of job creation in the
small business sector. For countries, it is a solution to generate more jobs for
employment (Soon, 2009).

2.2.3.2 Regional and Rural Development

According to Soon (1984), SMEs require relatively little amount of capital and a low
level of technology. They can be easily established in the less developed areas of a
country, and help in spreading economic activities from urban to rural areas. In this way,
small enterprises not only provide the country flakes with employment opportunities, but
also help to reduce the flow of migration from the rural to the already overpopulated
cities. In addition to this, SMEs in the Ashanti Region particularly those in the Kwabre
district have been advised to cultivate the habit of saving with banks to benefit from loan
facilities to improve their businesses, by so doing the SMEs would be in business in
order to effectively carry out this contribution towards the development of Kwabre
(GNA, 2011).

Many researchers conclude that SMEs, being less mobile than large corporations, are
more likely to have ties of dependence and familiarity to their communities, which will
ensure they protect their reputation and relationships among neighbors and customers.
One study of European SMEs notes that on average, 67.5% of them report practicing
some form of external socially responsible activity on a regular basis, such as supporting
a local charity (European Commission, 2002). The main reasons cited for these efforts
were "improvement of the loyalty of customers" and "better relations with the
community" (European Commission, 2002).

13
Recent bodies of research, including a report produced by the United Nations Industrial
Development Organization (UNIDO), support these findings, showing that there is
widespread consensus that SMEs have: Are labor-intensive, providing more
opportunities for low-skilled workers; Are correlated with lower income distribution
inequality; Are an important part of the supply chain for large MNCs (Luetkenhorst,
2004); Are necessary for agriculture-dependent nations transitioning to an industrial-
and service-oriented economy; Are excellent "beta-sites" for innovation and sustainable
initiatives due to their inherent flexibility and risk-taking ability (Raynard and Forstater,
2002)--examples include Verdant Power or Energia Global; and provide all of these
crucial benefits in developing countries despite their relatively smaller presence
(Patricoff and Sunderland, 2005).

2.2.3.3 Provision of Services to Local community

Soon (1984) again suggested that, SMEs play a very important role in many countries in
providing daily services. Indeed SMEs are responsible for the supply of food,
transportation, and daily necessities. Services are all provided batter by small business
than State-large enterprises. Small retailers make it possible for the customers to
purchase many different items in one shop. As a matter of fact, without the services of
SMEs, our life will be hampered and very inconvenient.

2.2.3.4 Supporting the Large Enterprises (LEs)

The concentration of many SMEs sited closely to larger enterprises contributes to each
of the SMEs benefiting from the advantage of economies of scale. Some business
activities require larger amount of capital and a high level of technology, which are
beyond the capability of small businesses. Hence, large enterprises are also important to
the national economy in terms of providing employment and training of skills. Beesley
et al (1994) have argued that, in Japan, large enterprises cannot survive on their owned.
They require the supporting services of small enterprises in terms of supply of material,
parts and components, semi-finished goods and distribution of finished products. Some
foreign investment also looks at the sufficiency and efficiency of locally supporting
services. Some products or components and accessories do not require high precision

14
work and can be outsource to allow companies to concentrate upon more important areas
such as marketing, quality control, product design and research and development.

2.2.4 General Constraints to SME Development

Despite the potential role of SMEs to accelerated growth and job creation in developing
countries, a number of bottlenecks affect their ability to realize their full potential. SME
development is hampered by a number of factors, including finance, lack of managerial
skills, equipment and technology, regulatory issues, and access to international markets
(Anheier and Seibel, 1987; Steel and Webster, 1991; Aryeetey et al, 1994; Gockel and
Akoena, 2002). The lack of managerial know-how places significant constraints on SME
development. Even though SMEs tend to attract motivated managers, they can hardly
compete with larger firms. The scarcity of management talent, prevalent in most
countries in the region, has a magnified impact on SMEs.

The lack of support services or their relatively higher unit cost can hamper SMEs‟
efforts to improve their management, because consulting firms are often not equipped
with appropriate cost-effective management solutions for SMEs. Besides, despite the
numerous institutions providing training and advisory services, there is still a skills gap
in the SME sector as a whole (Kayanula and Quartey, 2000). This is because
entrepreneurs cannot afford the high cost of training and advisory services while others
do not see the need to upgrade their skills due to complacency. In terms of technology,
SMEs often have difficulties in gaining access to appropriate technologies and
information on available techniques (Aryeetey et al., 1994). In most cases, SMEs utilize
foreign technology with a scarce percentage of shared ownership or leasing. They
usually acquire foreign licenses, because local patents are difficult to obtain.

Regulatory constraints also pose serious challenges to SME development and although
wide ranging structural reforms have led to some improvements, prospects for enterprise
development remain to be addressed at the firm-level. The high start-up costs for firms,
including licensing and registration requirements, can impose excessive and unnecessary

15
burdens on SMEs. The high cost of settling legal claims, and excessive delays in court
proceedings adversely affect SME operations. In the case of Ghana, the cumbersome
procedure for registering and commencing business are key issues often cited. The
World Bank Doing Business Report (2006) indicated that it takes 127 days to deal with
licensing issues and there are 16 procedures involved in licensing a business in Ghana.
Meanwhile, the absence of antitrust legislation favors larger firms, while the lack of
protection for property rights limits SMEs‟ access to foreign technologies (Kayanula
and Quartey, 2000).

Previously insulated from international competition, many SMEs are now faced with
greater external competition and the need to expand market share. However, their
limited international marketing experience, poor quality control and product
standardization, and little access to international partners, continue to impede SMEs‟
expansion into international markets (Aryeetey et al., 1994). They also lack the
necessary information about foreign markets. One important problem that SMEs often
face is access to capital (Lader, 1996). Lack of adequate financial resources places
significant constraints on SME development.

Cook and Nixson (2000) observe that, notwithstanding the recognition of the role of
SMEs in the development process in many developing countries, SMEs development is
always constrained by the limited availability of financial resources to meet a variety of
operational and investment needs. A World Bank study found that about 90% of small
enterprises surveyed stated that credit was a major constraint to new investment (Parker
et al., 1995). Levy (1993) also found that there is limited access to financial resources
available to smaller enterprises compared to larger organizations and the consequences
for their growth and development. The role of finance has been viewed as a critical
element for the development of SMEs (Cook and Nixson, 2000). A large portion of the
SME sector does not have access to adequate and appropriate forms of credit and equity,
or indeed to financial services more generally (Parker et al., 1995). In competing for the

16
corporate market, formal financial institutions have structured their products to serve the
needs of large corporate.

A cursory analysis of survey and research results of SMEs in South Africa, for instance,
reveals common reactions from SME owners interviewed. When asked what they
perceive as constraints in their businesses and especially in establishing or expanding
their businesses, they answered that access to funds is a major constraint.

This is reflected in perception questions answered by SME owners in many surveys (see
BEES, 1995; Graham and Quattara, 1996; Rwingema and Karungu, 1999). This
situation is not different in the case of Ghana (see Sowa et al., 1992; Aryeetey, 1998;
Bigsten et al., 2000, Abor and Biekpe 2006, 2007; Quartey, 2002). A priori, it might
seem surprising that finance should be so important. Requirements such as identifying a
product and a market, acquiring any necessary property rights or licenses, and keeping
proper records are all in some sense more fundamental to running a small enterprise than
is finance (Green et al., 2002).

Some studies have consequently shown that a large number of small enterprises fail
because of non-financial reasons. Other constraints SMEs face include: lack of access to
appropriate technology; the existence of laws, regulations and rules that impede the
development of the sector; weak institutional capacity and lack of management skills
and training (see Sowa et al., 1992; Aryeetey et al., 1994; Parker et al., 1995; Kayanula
and Quartey, 2000). However, potential providers of finance, whether formal or
informal, are unlikely to commit funds to a business which they view as not being on a
sound footing, irrespective of the exact nature of the unsoundness. Lack of funds may be
the immediate reason for a business failing to start or to progress, even when the more
fundamental reason lies elsewhere. Finance is said to be the “glue” that holds together
all the diverse aspects involved in small business start-up and development (Green et al.,
2002).

17
2.3 Empirical Literature Review

2.3.1 The Tanzanian context

Government Efforts in recognition of the importance of SME sector, the Government
has continued to design and implement a number of policies and programmes supportive
to the development of the sector.

2.3.1.1 Policy Development

Tanzania Development Vision 2025 seeks to transform from a low productivity
agricultural economy to semi-industrialized one lead by modernized and highly
productive agricultural activities which are buttressed by supportive industrial and
service activities through actively mobilization of people and other resources towards
the achievement of shared goals. In the Poverty Reduction Strategy, the Government has
decided to promote private sector participation including Small and Medium Enterprises.
The Sustainable Industrial Development Policy - SIDP (1996 - 2020) places specific
emphasis on promotion of small and medium industries through the following measures:
supporting existing and new promotion institutions, simplification of taxation, licensing
and registration of SMEs and improve access to financial services. In addition, SIDP
encourages informal sector businesses to grow and be formalized. Furthermore, the
policy identifies measures to enable indigenous entrepreneurs, women, youth and people
with disabilities to take part in economic activities.

The National Micro Finance Policy covers the provision of financial services to small
and micro enterprises in rural areas as well as in the urban sector that are engaged in all
types of legal economic activities. Furthermore the Agricultural and Livestock Policy is
aimed at the development of agricultural and livestock activities that are performed by
both small farmers and livestock keepers. The priority is given to resources-based
enterprises particularly activities that add value to agricultural products. Nevertheless,
agriculture is still the backbone of our economy. It contributes more than 50% of the
country‟s GDP and accounts for about 60% of the country‟s foreign earnings.

18
The Minerals Policy of Tanzania identifies the artisanal and small scale mining
operations as a major target group to be promoted through improved access to finance
and availability of tools, equipment and consumables, supportive extension services,
simplified licensing and enhanced marketing opportunities. The National Employment
Policy recognizes that the private sector including SMEs is the major source of
employment in Tanzania and outlines policies that will contribute to the creation of an
enabling environment for private sector development.

There are also a number of government policies already in place aimed at facilitating
growth of the economy, which have a bearing on the development of the SME sector.
These include: Gender and Women Development Policy, Cooperative Development
Policy, the National Energy Policy and the National Environmental Policy and Rural
Development Strategy. Central to all these policies, is a creation of an enabling
environment, building of a robust private sector and articulation of strategies that will
create a sustainable growth. A number of institutions, both public and private were
established to implement and coordinate various programmes arising from these
policies.

Furthermore, the government has undertaken various measures aimed at creating an

enabling environment to enhance enterprise development. These include, among others,
maintaining macro-economic stability; review of tax regime; simplification of licensing
procedures; implementing a programme on „Business Environment Strengthening for
Tanzania- BEST‟ and implementation of a „Competition Policy‟.

2.3.1.2 Institutions
The Institutions and programmes established to support the SME sector in Tanzania
Include:-
i) Small Industries Development Organization-SIDO
The first major attempt to promote the small industries sector in Tanzania was
undertaken in 1966 when the National Small Industries Corporation (NSIC) was formed

19
under the National Development Corporation (NDC). The NSIC set up small industrial
clusters, which were basically training cum production workshops. Thereafter, the Small
Industries Development Organization (SIDO) was established in 1973 by Act of
Parliament to plan, coordinate, promote and offer every form of service to small
industries.

SIDO remains the main government arm for promoting SMEs in the country. Some of
the measures employed in the process included:- the construction of 16 industrial estates
with more than 140 sheds at regional headquarters; the establishment of 10 training-
cum-production centers that offered simple rural based technologies; introduction of hire
purchase programs through which more than 2000 entrepreneurs were assisted with
machines and working tools; and setting up of regional extension services offices that
rendered advice on setting up of new industries, choice of technology, preparation of
feasibility studies, preparation of economic surveys, installation, operation of machinery,
maintenance and marketing of products.

SIDO in collaboration with other stakeholders supported establishment of SME

association to empower the private sector. Some of those associations include Tanzania
Food Processors Association (TAFOPA), Tanzania Small Industries Organization
(TASISO) and „Vikundi vya Biashara Ndogo‟ (VIBINDO). These associations have
been useful in involving the members in all issues related to advocacy as well as
accessibility to market, information, raw material, packaging and micro credit services.
Other Initiatives/Programmes:

Apart from SIDO, various institutions were established to support enterprise

development in Tanzania. These institutions cater for the whole enterprise sector
including SMEs. They include the Tanzania Industrial Research Development
Organization (TIRDO) which supports local raw materials utilization; Centre for
Agricultural Mechanization Rural Technology (CAMARTEC) which is involved in
promotion of appropriate technology for rural development; Tanzania Engineering and

20
Manufacturing Design Organization (TEMDO) responsible for machine design;
Tanzania Bureau of Standards (TBS) mandated to promote standards; Board of External
Trade (BET) which is instrumental in promotion of exports mainly through trade fairs;
and the Institute of Production Innovation (IPI) now known as Technology Transfer
Centre which is active in proto-type development and promoting their
commercialization. The Vocational Education and Training Act of 1994 provide the
framework for the vocational training system in Tanzania. This Act led to the formation
of Vocational Education Training Authority which has over 630 centers in the country
offering training in more 34 different trades. In 1999, the University of Dar-es-Salaam
established Entrepreneurship Development Centre within the Faculty of Commerce and
Management. The Centre provides consultancy and training in SME related issues.
Furthermore the College of Business Education offers business training including
entrepreneurship development.

A number of initiatives have been designed by the Government to set up funding

mechanisms and schemes to address poverty and employment related problems through
promoting SMEs. Such funds include National Entrepreneurship Development Fund
(NEDF), Youth Development Fund (YDF) which is managed by the Ministry of Labor,
Youth Development and Sports and the Women Development Fund (WDF) that is
managed by the Ministry of Community Development and Women Affairs and
Children. Apart from these, there are other related programmes that were established
through Government/donor joint efforts including the Small Entrepreneurs Loan Facility
(SELF), National Income Generating Programme (NIGP), Presidential Trust Fund and
Community Development Trust Fund. Another initiative towards this direction has been
the establishment of the National Micro-finance Bank (NMB), meant to cater
specifically for micro enterprises.

In recent years, the country has witnessed the mushrooming of Non-Government

Organizations that are doing a commendable job in promoting SMEs. Most of the NGOs
are mainly involved in credit delivery, business training, providing general consultancy,

21
supporting market linkages and addressing gender and environmental issues. However,
most of the institutions supporting SMEs are rather weak, fragmented, concentrated in
urban areas and uncoordinated. This calls for the need to strengthen the institutions
supporting small and medium enterprises. Therefore the SME Development Policy
intends to support and strengthen these institutions.

2.3.1.3 Challenges facing SME in Tanzania

Generally, SMEs are confronted with unique problems including heavy costs of
compliance resulting from their size. (According to SME development policy of
Tanzania 2002 these constraints includes)

2.3.1.3.1 Legal and Regulatory Framework

Despite of various interventions aimed at improving the business environment in
Tanzania, the legal and regulatory framework is bureaucratic, costly and centralized.
These characteristics of the legal and regulatory environment affect all sizes of
businesses adversely. However, SMEs are further constrained in this environment in
comparison to larger businesses due to the disproportionately heavy costs of compliance
arising from their size. As a result most of informal enterprises have failed to formalize
and micro enterprises have been unable to grow and graduate into Small and Medium
Enterprises.

The tax regime in Tanzania is also unfavorable for SMEs development. Taxes are many,
rather high and collected by various authorities including Tanzania Revenue Authority
and the Local Government Authorities. Furthermore, entrepreneurs are ignorant of tax
matters and the cost of complying with tax regulations is considered high. Whereas
taxation of businesses is a necessity for national economic development, the present tax
regime imposes a major burden on SMEs.

2.3.1.3.2 Physical Infrastructure

The poor infrastructure in Tanzania including working premises, roads, cold rooms,
warehouses, power, water and communication adversely the development of the SMEs.
Even where these services are available, the supply is unreliable and costly. Serviced

22
land or business premises are in short supply in most of the cities and towns, especially
for industrial use. The very poor state of infrastructure makes it difficult to attract even
local investors to the rural areas where almost 80% of Tanzanians live. This has been an
obstacle in promotion of SMEs especially in rural areas.

2.3.1.3.3 Business Training

SME operators in Tanzania have rather low business skills and seem not to appreciate
the importance of business education. On the other hand, the quality of training provided
by existing business training institutions and costs involved has tended to be unattractive
and unaffordable to the potential beneficiaries.

2.3.1.3 4 Technology
Technology advancement and transfer are important aspects for SMEs development.
SMEs have limited access to technology development partly because they lack the
relevant information. The problem is further compounded by the existence of industrial
support institutions which are weak and do operate in isolation without focusing on the
actual requirements of the SME sector. Furthermore, technologies available are not
disseminated to the potential clients. In addition, SMEs cannot afford the services
provided by the relevant institutions. As a result of the above, SMEs continue to hold on
poor and obsolete technologies.

2.3.1.3.5 Marketing
Sustainability of a firm depends largely on its performance in the marketing.
Unfortunately, many enterprises are facing problems of marketing due to poor quality of
products, poor packaging, inadequate marketing skills and stiff competition.
Inadequate marketing services have been prohibiting SMEs to become competitive in
local and international markets.

2.3.1.3.6 Access to Finance

The SME sector in Tanzania has limited access to finance due to the following factors:
the sector is perceived as a high risk one; inability of the SME operators to fulfill the

23
collateral requirements; most banks do not operate an SMEs financing window; some of
the banks operate in limited geographical areas; inexperience of Bank Staff in issues
related to Micro-finance; lack of a guarantee scheme to back up banks financing SMEs;
high cost of screening and administering small loans spread over big areas and inabilities
of borrowers to prepare and present applications that meet bank's requirements.

The current reforms have resulted in liberalization of the financial sector to a great
extent. This has led to establishment of a number of banks including the Micro Finance
Bank, liberalization of financial rates and establishment of a stock exchange market. In
spite of all these, the SME sector is facing a major constraint in accessing finance. This
limits their capacity to survive, increase capacity, upgrade its technologies and even in
many cases, expand their markets and improve management or raise productivity and
eventually increase incomes.

2.3.1.3.7 Institutional Framework for SMEs Development

The institutions supporting the SME sector are weak, fragmented, uncoordinated and
concentrated in urban areas. Currently, numerous stakeholders made up of Government
ministries and agencies, private sector associations, NGOs and development partners are
involved in the development of programmes aimed at supporting the SME sector in
Tanzania. Most of their programmes are ineffective and their efforts are uncoordinated.
Although the government has put in place a number of Industrial Support Organizations,
including the Small Industries Development Organization (SIDO), these institutions are
ill equipped in terms of equipment, personnel and operational funds, and therefore,
unable to discharge their mandated responsibilities. Furthermore, it has been established
that government officials responsible for development of the sector do not have adequate
knowledge, skills and SME orientation to create the desired enabling environment for
the sector.

24
2.3.1.3.8 Rural Industrialization:
Agriculture accounts for about 50% of the national income, 60% of merchandise exports
and is a source of livelihoods of about 80% of Tanzanians. Despite this importance, its
performance over years has not been impressive. This has been caused by the following
major factors: inadequate access to extension services; lack of improved farm inputs;
poor infrastructure; lack of comprehensive market information; lack of credit; multiple
taxes and levies; dominance of low technologies; inadequate processing capacities in the
rural areas; poor or inadequate research and weak link between extension services and
research.

The Tanzania Development Vision 2025 emphasizes the need to transform the economy
from a predominately agricultural one to a diversified semi-industrial economy with a
modern agricultural sector. Small and medium industries have a critical role to play in
attaining this goal due to the following factors: SME technologies tend to be simple,
affordable and manageable and thus appropriate for rural areas; SMEs can process
effectively locally available raw materials and thus add value. In addition, SMEs provide
backward and forward linkages, which maximize the multiplier effect to the rural
economy.

2.3.1.3.9 Environmental Considerations:

Latest developments in environmental issues have tended to create limitations to the
development of SMEs in terms of legal requirements and complexities in compliance to
changing regulations. They demand environmentally friendly technologies that are
expensive, clear waste disposal techniques and systematized waste management.
Furthermore, environmental law and regulations require environmental impact
assessment and do impose penalties for non-compliancy to laid down regulations. All
these require resources, which are not within the reach of SMEs. This is more
compounded by the limited awareness of SME operators on the environmental issues.

25
2.3.1.3.10 Gender and the Disadvantaged Groups
Women are a significant part of the Tanzanian labor force and as such any meaningful
development effort must mainstream women. Unfortunately, they have less access to
productive resources such as land, credit and education due to cultural barriers. As such,
it is clear that men and women stand on uneven ground and thus the need for specific
measures for promoting women entrepreneurship. The same applies to youth and people
with disabilities. Due to these facts there is a need to rectify the situation by facilitating
their involvement in the economic activities through participation in the

2.3.1.3.11 HIV-AIDS
The HIV-AIDS pandemic is a threat to the whole world including Tanzania. It affects
the labor force in terms of supply, skills and productivity. It is estimated that an
increasing number of Tanzania‟s population is infected with the deadly HIV-AIDS
disease. Consequently, all sectors including SMEs are affected negatively.

2.3.2 The African context

In Africa One of the major factors hindering the growth of economies and organizations
is the lack of capacity to carry out tasks that are necessary for such growth. It is
therefore essential to engage in capacity building as a component of development. This
suggests the importance of training and development. Given this importance, many
African countries have launched initiatives to training employees in public sector
organizations. These initiatives have been supported by the donor community which has
similar views to those expressed in a World Bank Long-Term Perspective Study of
Africa that identified capacity building as vital to the continent's growth and
development. Thus, various policies on training and development have been developed
and large amounts of money spent on them. An important issue, given such importance
and expenditure, is to assess the effectiveness of training and development. Dominic, T
(2010) et al.

26
Ndihazuka M, (October 2010) states that training and development lead to increase in
employee‟s performance and output, it was gathered that majority of the respondents
were of the opinion that training and development will lead to high efficiency of the
organization, profitability and expansion of the Organization. Despite the short run
initial challenges associated with training and development, it brings about long term
benefits to the organization.

Several theories provide theoretical basis for understanding the impact of employee
training on organizational performance. These theories (for example, resource-based
view, transaction costs, institutional theory etc.) explain the reasons behind, and the
benefits of training employees in organizations. Specifically, this study is theoretically
underpinned by the resource based view. Resource-based view (RBV) of the firm as a
theoretical basis was propounded by Penrose (1959) and developed into a more robust
theory by Barney (1991).The basic assumption of this theory is that, organizations can
gain competitive advantage by concentrating on their internal resources (Abilities, skills,
knowledge, capabilities, competencies etc.). While transaction cost theory argues from
the cost side, RBV emphasizes dynamic value and capabilities. The RBV suggests that
firms should develop and maintain those resources that are core to the firm (Barney
2001). Besides, HRM activities, the human resources themselves constitute huge
resources that can be fully developed in order to create the needed value and capabilities
for achieving organizational performance.

Barney (2001) argues that organizations must obtain sustained competitive advantage by
implementing strategies that exploit their internal strengths, through responding to
environmental opportunities, while neutralizing external threats and avoiding internal
weaknesses. Similarly, it is strategically poor for organizations not to develop their
human resources as a way of exploiting their internal strengths; the HR. The dynamic
capabilities view is useful in making the resource-based view operational in any industry
by identifying specific organizational processes that build valuable resources. However,
training is that organizational process that helps builds capabilities for organizations;

27
therefore, building HR value and capabilities appear to be the suitable rationale behind
employee training and organizational performance analysis.

2.3.3 Global context

2.3.3.1 The SME sector in the global economy

The SME sector is the backbone of the economy in high-income countries, but is less
developed in low-income countries. The Organization for Economic Co-operation and
Development (OECD) reports that more than 95% of enterprises in the OECD area are
SMEs. These enterprises account for almost 60% of private sector employment, make a
large contribution to innovation, and support regional development and social cohesion.
Also in low-income countries, the SME sector makes a critical contribution to GDP and
employment.

SMEs include a wide range of businesses, which differ in their dynamism, technical
advancement and risk attitude. Many are relatively stable in their technology, market
and scale, while others are more technically advanced, filling crucial product or service
niches. Others can be dynamic but high-risk, high-tech “start-ups”. Researchers and
practitioners agree that SMEs are crucial contributors to job creation and economic
growth in both high and low-income countries.

2.3.3.2 Implications of SME Growth for Domestic Economic Development

Increased SME growth has a direct effect on GDP growth due to increased output, value
add and profits. The GDP contribution per SME is the difference between the return on
capital and the cost of capital. Returns on capital are often high, with different datasets
showing ranges up to 20-30% a month (for the most capital-strained firms), which is
considerably higher than typical interest rates. The GDP contribution can be illustrated
on a micro-level by looking at the additional economic activity generated by a
hypothetical loan, as shown in figure 9 below. This example gives a simplified view on
how a SME owner who invested his loan into the purchase of imported goods increases
consumption and GDP.

28
This example does not cover the significant multiplier effect in the wider economy,
through the increased economic activity of employees and suppliers.36 The relationship
between increased SME and GDP growth is touched upon in the World Bank‟s report,
Finance for All: “If entry, growth, innovation, equilibrium size, and risk reduction are all
helped by access to and use of finance, it is almost inescapable that aggregate economic
performance will also be improved”.

SME growth also impacts GDP indirectly, through increased innovation and macro-
economic resilience of the overall economy. Every year new SMEs enter the market,
representing 5 to 20% of the existing number of firms. Smaller firms are often the most
dynamic and innovative, and can be a test ground for new business ideas. 38 Although
nearly half of all start-ups will fail within 5 years, a few of them will grow to become
large firms, and replace incumbents. This process yields positive structural changes to
the economy, can lead to large productivity gains, and is shown to be linked to GDP
growth.
Finally, a stronger SME sector can bolster a country‟s resilience by broadening and
diversifying the domestic economy, thereby reducing the vulnerability to sector-specific
shocks and fluctuations in international private capital flows.

Barriers to finance for SMEs

The following section will first look at debt financing, and the reasons why regular
banks provide insufficient debt to SMEs. It will demonstrate that the access to finance
gap is a complex problem driven by several factors including lower returns, higher risk
perceptions, an uninspiring regulatory environment and lack of intermediary skills,
experience and capacity.

Debt financing
Banks are not adequately providing SMEs with capital in developing countries. As
described in previous sections, there is large financing gap for SMEs in developing
countries. The top five banks serving SMEs in non- OECD countries reach only ~20%

29
of formal micro enterprises and SMEs. As shown in figure 10, in Sub-Saharan Africa,
this number is even lower, at 5%. Nearly 25% of SMEs in emerging markets have a loan
but are financially constrained, and almost 60% do not have a loan overdraft, but need
one, as shown in Figure 11. This deteriorated further during the 2008-2010 financial
crisis. 53 IFC,

Banks can often earn high returns in their core markets, giving them little reason to take
on additional risk in the SME market. Banks in countries with immature financial
systems often face little competition and a low threat of entry and can therefore earn
handsome returns by lending to large public and private players. Banks in Africa are
among the most profitable, earning often returns in equity in the 15-25% range, as
shown in Figure 12.56 They might realize the potential of the SME market, but they
have little incentive to move outside of their comfort zone and develop SME products.
As Paul Collier observed: “African banks were operating profitably via the easier and
safer role of lending to large firms, and holding high-yielding government debt.” As a
result, in the words of a manager of one leading African bank “we have only scratched
the surface of the SME market.”

Impact on taxation
SME growth increases government income from taxation. Revenues and profits of
SMEs contribute to governments‟ corporate tax income. Moreover, they stimulate
increased indirect taxes (such as value-added taxes). There might also be additional tax
income through the taxation of the profits of the investment funds and banks, depending
on the local capital gains taxation laws.

The location decision by funds is based on more factors than taxation. Funds make their
location decision by combining the need for appropriate financial regulation (e.g. anti-
money laundering legislation), political stability and rule of law, a developed financial
system, and a financial service industry (e.g. accounting, auditing, legal), with the ability
to facilitate cross-border capital transfers. Many African financial systems do not meet

30
these criteria, as the systems are yet underdeveloped; with many systems smaller in size
than a mid-sized bank in Continental Europe.47 Only a limited set of global financial
hubs offer the required services at a competitive price. For example, Mauritius has by far
the most developed financial, legal and administrative ecosystem for financial cross-
border transactions in Africa. A large number of Africa-focused funds, with both
African or international fund managers have therefore chosen to locate their funds in
Mauritius.

Tax revenues would, in some cases, be relatively higher if capital for SMEs was
provided by a local rather than a foreign lender / investor. Some NGOs have criticized
private equity funds that are not domiciled in mainland Sub-Saharan Africa. In order to
understand this argument, it is helpful to split the tax burden in the three main
components:
1) Corporate taxes by the SME,
2) Taxes paid by the limited partners, and
3) Taxes paid by the general partners.

As described above, regardless of the location of the investment fund financing them,
SMEs pay corporate taxes in their countries of residence. The taxation of general and
limited partners is influenced by their country of residence, the location of the SMEs,
cross-border taxation legislation and overall capital gains tax rates. In some cases, the
tax revenues from the limited and general partners to the government of the investment
country would be higher if they were to be based in this same country. In other cases,
there would be little to no difference, as there are many African countries that have low
to no capital gain taxation laws.

2.4 Conceptual framework

The study assess the effectiveness of financial institutions in financing SMEs within
Kilombero district in Tanzania, taking cognizance of the role and contributions of
CRDB Bank Tanzania Limited. However, there are number of rigidities of a

31
macroeconomic, institutional framework, environment consideration, technology,
business training, legal and regulatory nature that may bias the entire banking system
against lending to SMEs as summarized in the figure 2.1.

Figure2.1: Conceptual Framework

Institutional
framwork

Business training

Technology

Commercial
Banks Legal and regulatory Effective
financing SMEs

Environment
consideration

Physical
infrastructure

Source: Researcher, 2013

32
 17 CHAPTER THREE

18 RESEARCH METHODOLOGY

3.0 Introduction
This chapter addresses how the whole study was carried. It highlights the scope, mode of
operation, as well as techniques that was used in data analysis. It describes the sampling
technique/procedure and states the main methods used in data collection from the field.
Research methodology was a way to systematically solve the research problem. It may
be understood as a science of studying how research is done scientifically. In it, we
study the various steps that were generally adopted by a researcher in studying his
research problem along with the logic behind them (Kothari, 2002:10)

3.1 Research Design

Research design is a logical and systematic plan prepared for directing the collection,
measurement and analysis of data in objective and economical procedures
(Krishnaswami, 2002). The research employed a mixed research design, a cross-
sectional design which involves collecting data at one point in time, utilizing a
combination of activities, including an extensive literature review, consultations with
experts and local communities to provide socio-economic oriented findings (Bryman,
2008) and a Case study of CRDB Bank Plc Kilombero branch drawn to enable
description of features in detail (Bryman, 2006). It involved the methods of inquiry
which focus on collecting, analyzing and mixing both quantitative and qualitative data in
a single study (Creswell and Plano-Clark 2007). Thus, both qualitative and quantitative
approaches used in data collection and analysis procedures, and/or inferences. The
primary focus of this approach was the use of multiple approaches in answering research
questions, rather than restricting or constraining researchers‟ choices.

33
3.1.1 Area of Study
The study was conducted at CRDB bank Kilombero branch Morogoro Region which is
second largest region in Tanzania with population of 2,218,492 located on the eastern
side of Tanzania Mainland. The Region lies between latitudes 50 to58‟ and 1000‟ South
of the Equator and between longitudes 35 to 25‟ and 38to30‟ East of Greenwich. It is
bordered by seven regions. In the north are Tanga and Manyara while in the eastern
sides are the Coast Region and Lindi regions. On the western there are Dodoma and
Iringa Regions while Ruvuma is located in the southern side of the Region.
Administratively, Morogoro Region is divided into five (5) districts, namely Kilosa,
Mvomero, Kilombero,Gairo and Ulanga. The researcher concentrated at CRDB branch
Kilombero district due to time and financial constraints and the interest is due to the
performance of the operator on the business.
In the context of the proposed research problem, the study intends to find out
effectiveness of commercial banks in financing SMEs.

3.1.2 Study population

The targeted population of the study consisted of CRDB Bank staff in Kilombero
Branch and Owners/managers of SMEs in Kilombero Districts. The estimated
population is 4392 made up of 1,892 staffs from CRDB Bank Tanzania and 2,500 SMEs
in Kilombero.

3.1.3 Units of Inquiry

In order to achieve the overall objectives of the study, CRDB Bank Plc was the units of
analysis, sample of respondents were selected. For the purpose of this research and
basing on their influence and knowledge of the bank‟s strategy and operations activities,
the following was the units of inquiry;- SMEs Owners/managers in Kilombero district
and bank staff.

3.2 Sample Size and Sampling Techniques

Sample size refers to the number of items to be selected from the universe to constitute a
sample. It should neither be too large nor too small (Kothari, 2008). A sample is a

34
portion of a population (Ndunguru, 2007). A sample size is representative and
generalization of whole population (Haralambos and Holborn, 1990). For a sample to be
representative enough for statistical analysis, it is recommended that at least a total of 10%
of the entire population to be taken for study

The total sample size for the study involved 82 respondents which included 22 CRDB
staff and 60 SMEs owner and managers in Kilombero District as shown in table 3.1

Both probability (simple random sampling) and non probability sampling (purposive
sampling) were used.

Table 3.1: Distribution of respondents

Targeted group Estimated no. Sample selected
CRDB Bank staff 1,892 22
Consumers and owners of SMEs Kilombero District 2,500 60
Total 4,392 82

Source: CRDB Report, 2012 and Census, 2012

3.2.1 Sampling techniques

3.2.1.1 Purposeful sampling method

The researcher chose the sample based on who they thought was appropriate for the
study. This is used primarily when there is a limited number of people that have
expertise in the area being researched.
In this research purposive method was employed to determine the sample to present
SMEs and bank‟s officials basing on the position, experience and knowledge of the
respondents. This was because not all bank‟s officials are actively involved in the
strategy setting exercise.

35
3.2.1.2 Simple random sampling method
Simple random sampling was applied in this study provided equal chance of
respondents‟ to be involved in the study. The obtained results were generalized. Thus,
the random sampling was adequate and representative (Kothari, 1990). This technique
was also appropriate for quantitative data analysis that was used in the research.
This technique was employed to determine the sample to represent the staff and SMEs
owner managers.

3.3 Data Collection Methods

The study involved both primary and secondary data source because it important and
allows for dissemination of accurate information and development of meaningful
finding.

3.3.1 Primary data

These are information gathered directly from respondents. This is through interview,
questionnaires and observation.

3.3.1.1 Interview
Interview involved both structured and unstructured questions for the purpose of
collecting information from managers who have social information and who can not
have adequate time for filling in the questionnaires. The interviews were designated for
bank and SME managers

3.3.1.2 Questionnaires
It is the tool for data collection which involves respondents filling forms with questions
regarding the problems facing the research. In this study, the researcher used
questionnaires to collect data from staff members of CRDB bank at Kilombero district.
The totals of 22 questionnaires were distributed and all were completed and returned
successfully.

36
3.3.1.3 Observation
The method was the most convenience instrument of collecting information since it was
used by following what was happening in the real situation. Through participation and
non participation observation, the researcher was observing different activities
conducted by bank officials and SMEs in order to observe the whole financial activities
rendered by bank to SMEs. Also Researcher was observing activities, approaches and
facilities employed during the exercise and the respond of customers and attitudes
towards the SMEs as activities were conducted within a place of study.
This method helped the researcher to provide first hand information, which was free
from the respondent biasness. The information was gathered by observing day to day
activities.

3.3.2 Secondary Data

Data were extracted from different source in order to come up with relevant conclusion
and recommendations. In order to get previous and present information that helped the
researcher in drawing meaningfully conclusions and recommendations, the researcher
spent some time in office trying to explore statistical data from different sources/records
such as files, research reports, SMEs policy of Tanzania and other documents available.
Invaluable assistance in terms of papers and reports was rendered by various officials at
CRDB bank plc Kilombero branch, News papers, internet facilities, and the Mzumbe
University main library.

3.4 Data Analysis and Presentation

Analysis involved computation of certain indices along with searching for patterns of
relationship that exists among the data groups. The collected data was analyzed by using
descriptive techniques and then interpreted to logical meaning and information.

37
3.4.1 Data analysis techniques
Data collected from the research were analyzed on item to item basis. It was hoped that
data were gathered and re- arranged into much workable framework. The analysis of
data involved the following techniques so that they were remarkable to analysis.

Editing the information collected were edited to ensure that consistency is maintained
by removing redundant data, filling of missing data completeness of data, substance
and reliability data, also correct the entries present wrong position.

Coding the information collected was coded by marking with some alphabets and
numerals so that while sorting should be taken out by single search command.

Classification the data collected were sorted so that to make the data analysis easy,
also helps in making comparison and achieve the desired results as per specifications.

Tabulation the classified data collected presented in the form of chart, tables and
graph so that to present clearly and to the point whereby the table named to identify
what the table presents, therefore it present simple, accurate and clear picture of the
finding.

3.4.2 Statistical Package of Social Science

The information collected were coded in order to allow easy analysis in the Statistical
Package for Social Sciences (SPSS) and hence its presentation leading to valid
inferences/conclusions with respect to the problem under investigation. After coding, the
data were subjected for analysis into the SPSS version 12.

SPSS was among the most widely used programs for statistical analysis in social
science. It was used by market researchers, health researchers, survey companies,
government, education researchers, marketing organizations and others. The original
SPSS manual (Nie, Bent & Hull, 1970) has been described as one of "sociology's most

38
influential books". In addition to statistical analysis, data management (case selection,
file reshaping, creating derived data) and data documentation (a metadata dictionary is
stored in the data file) are features of the base software.

3.5 Dissemination of the Results

Results expected to first be presented to Mzumbe University and upon approval widely
dissemination to the CRDB Bank PLC Kilombero branch and maybe other stake holders
for the betterment of the organization performance methods.

Therefore the study selected CRBD bank Kilombero branch as a unit of inquiry where
by the sample were selected from SME owners and bank staff. Simple random sampling
and purposeful sampling method used as sampling techniques to ensure that accurate
sample were obtained for the study. The sources of materials for the study were both
primary and secondary. Primary data were collected by the use of interviews,
questionnaires and observation which were designed and administered to SME
customers and employees of the CRDB Bank. Secondary materials were extracted from
relevant textbooks, newspapers, reports/articles, journals, bulletins and documents
presented by corporate financial analysts and policy planners. The data from the field
were analyzed using editing, tabulation, coding and Statistical Package of social science.

39
 19 CHAPTER FOUR

20 DATA ANALYSIS, PRESENTATION AND DISCUSSION OF THE

FINDING

4.1 Introduction
The Study carried out in Kilombero district. Myriad information sources were used to
collect data for the study, these included interviews, questionnaires and observation.
Respondents were classified into two groups namely CRDB staffs and SMEs owner or
managers. The data were presented by graphs, bar charts and tables. The following is the
field results:-

4.2 Demographic features of the respondents.

The research revealed an overall ratio of 1:1.3 with regard to male and female
distribution in terms of gender representation as demonstrated in Figure 4.1. The ratio is
an indication of the dominance of females in CRDB bank staff showing significant
interest in working, most of them involved in the customer service dept, sales, and
marketing. The female dominance could also be attributed to the fact that until recently,
whereby most of the male population was employed in bank using the non-probability
sampling method of random sampling, specifically the purposive sampling technique the
researcher selected the sample based on targeted units This method ensured that
representative samples of all the known elements of the population were:

40
Figure 4.1: Distribution of CRDB respondents by Sex

Source: Field data, 2013

4.2.1 Characteristics of Respondents

In order to put the results of the study in perspective, the profile of the respondents and
their enterprises were presented. It provides brief description of some demographic
characteristics of the sampled respondents, specifically age and education. Examinations
of these characteristics of individuals not only helps the accuracy of the data but also
provided the outlook of the trends in these characteristics over time, most importantly it
provided the basis for the analysis of the way these characteristics are related to most of
the other issue investigated in the study

4.2.1.1 Education
A key determinant of performance is education. Education provides necessary skills and
knowledge to employees which enable them to increase labor productivity. Thus in this
study education level is an important factor. Table 4.1 below shows the distribution of
the respondent‟s by level of education.

41
Table 4.1: Distribution of respondents by level of Education
Level of education frequency percent
Primary education level 22 26.8%
Secondary education level 10 12.5%
Tertiary education level 10 12.5%
Ordinary diploma level 15 18.2%
Advance diploma level 10 12.5%
University college level 15 18.2%
Total 82 100%

Source: Researcher, 2013

In summary, 99% percent of the respondents were educated and could therefore make
the requisite in-depth contributions on the subject matter. Even in the case of the
illiterates, they had their questionnaire explained in the Swahili language and their
respective answers were appropriately incorporated.

4.2.1.2 Gender
The respondents were interviewed considering their gender. The idea behind was to
ensure men and women were equally involved as respondents. Men and women
sometimes have different opinions which were important to capture in the study. The
sample of respondents had a good gender balance. Figure 4.2 shows the gender
distribution of the respondents.

Figure 4.2: Gender of respondents

Source: Researcher, 2013

42
4.2.1.3 Respondents Distribution by Age
Age is an important factor in this study, partly because it reflects the maturity of the
respondent and also his or her experience. The largest proportion of the respondents is
the medium age groups Respondent‟s age range from 25 years to 35 years this, age
group comprises the majority of the labor force in the bank industry which is 60.9
percent, where 15 percent were between 36-46 years. Figure 4.3 below shows the age of
respondent

Figure 4.3: Distribution of Respondents by Age

Source: Researcher, 2013

4.2.2 Financial Services offered by CRDB bank to SME customers

The study identified five main financial services rendered to SMEs; include Overdraft,
Trade Credit, SME Banking, Cash Management, and Business Advice. It was discovered
that the financial services mostly offered to SME managers and owners by Crdb Bank,
Kilombero Branch, were Business Advice is 27 percent and SME Banking evidenced
by 20 percent representation recorded in the afore mentioned services, as illustrated

43
graphically by Figure 4.4. Cash Management also featured strongly as next most
patronized services offered by the bank, as shown by the 10 percent representation;
while overdraft 5 and trade credit was rendered by the 20 percent representation.

Figure 4.4: Financial services offered to SME customers

Source: Researcher, 2013

4.2.3 Relationship Ratings with SME

The study wanted to know the relationship existing between Bank officers and the SMEs
owner managers. The rating showed that 50 percent indicated a good relationship, 15
percent very good, 10 percent excellent and only 7 percent poor. In average the
respondents showed that there is a good relationship between bank and customers. Even
though only few respondents had a negative opinion we should not ignore them,
therefore something is needed to be done to improve the relationship so that business
owners can benefit from the banking services. Details are shown in Figure 4.5 below.

44
Figure 4.5: Relationship ratings Between CRDB and SME

Source: Researcher, 2013

4.2.4 Conditions for extending credit facilities

The study identified six major conditions or criteria considered when the CRDB bank is
extending credit to SME customers. These conditions are years of existence, past and
projected cash flow, credit history, lines of business, collateral and business location.
Although all conditions had equal weight, collateral was considered more than others
because it acted as a loan security. This condition has lead to the disqualification of the
most of SMEs owner to get loan from the bank. Table 4.2 illustrates the conditions or
criteria which shows the qualification of SMEs credit.

Table 4.2: Credit Conditions for SMEs

Criteria Frequency Percentage%
Years of existence 10 16.6%
Cash flow 10 16.6%
Credit history 17 20.7%
Line of business 15 20%
Collateral 20 33.3%
Business location 10 16.6%
Total 82 100%
Source: Researcher, 2013

45
4.2.5 Major challenges of SME Banking
The study identified three major challenges faced by Bankers in the area. Among these
were loan management, default rate and business monitoring. Loan management
referred the whole process of the institution to plan, organize, coordinate and control the
loan disbursement process while the default rate and monitoring indicate how the loan
beneficiaries breach the loan repayment agreement and the failure to track the customers
at early sign of default. High default rate on the part of SMEs has been that bane for the
SME Banking Unit of the Kilombero branch.

Table 4.3: Major challenges of SME banking

Challenges Frequency Percentage
Management 20 24.3%
High default 42 51.2%
Monitoring 20 24.3%
Total 82 100%
Source: Researcher, 2013

Analysis of Responses of SME owners

4.2.6 Main sector of SME activity

SMEs in Kilombero area are involved in five major business categories. These were
classified as Food processing, agriculture, wood products, furniture works and metal
works. The study indicated that 33.3 percent of respondents engaged in agriculture; 25
percent in food processing, 16.6 percent in furniture works or wood products while only
8.3 percent engaged in metal works figure 4.6 illustrate below.

46
Figure 4.6: Main SMEs activities

Source: Researcher, 2013

21

4.2.7 Effectiveness of Commercial Bank in SMEs financing

Credit institutions exposure to SMEs has grown significantly in recent years and
currently comprises an important part of their commercial loan portfolio. The size of the
SME credit market (both loans and leases) based on the legal definition of SMEs shows
a rapid increase from a low to high. The following are the contribution of Commercial
bank in financing SMEs

4.2.7.1 SMEs growth

Recent research revealed that financial development helps small firms to grow. Both
firm-level and industry-level studies suggest that small firms do relatively better
compared to large firms in countries with better-developed financial institutions. Access
to finance is necessary to create an economic environment that enables firms to grow
and prosper. SMEs in developing countries specifically Tanzania, however SMEs face
significant barriers to finance. Financial constraints are higher in developing countries in

47
general, but SMEs are particularly constrained by gaps in the financial system such as
high administrative costs, high collateral requirements and lack of experience within
financial intermediaries. Increased access to finance for SMEs can improve economic
conditions in developing countries by fostering innovation, macro-economic resilience,
and GDP growth.

4.2.7.2 Access to finance helps SMEs to grow and prosper

The Investment Climate Surveys of the World Bank show that access to finance
improves firm performance. It does not only facilitate market entry, growth of
companies and risk reduction, but also promotes innovation and entrepreneurial activity.
Furthermore, firms with greater access to capital are more able to exploit growth and
investment opportunities. In other words, aggregate economic performance will be
improved by increasing the access to capital.

4.2.7.3 Reduction of SMEs financing gap

Financing for SMEs is limited, particularly when compared to commercial debt for large
firms and microfinance. When asked to name the most severe obstacles to growth, SMEs
worldwide listed financing constraints as the second most-severe obstacle, while large
firms placed it only fourth. Often, the costs and risks of serving SMEs are perceived to
be too high by commercial finance. Microfinance loans, on the other hand, are too small
to meet SME capital needs. For example, if a rural coffee producer needs a loan of
$300,000, the request may be too large for the local microfinance institution, but too
small, risky and remote for commercial banks. This financing gap is referred to as the
“missing middle”,

4.2.7.4 Improvement of the overall business environment for all firms

The Bank‟s latest research emphasizes the importance of strengthening the overall
business environment for all firms, instead of focusing on and subsidizing SMEs. In fact,

48
there is no robust evidence that SMEs by themselves matter for growth or poverty
alleviation.

4.2.7.5 Enabling Economic Environment

The World Bank and the International Finance Cooperation (IFC) rank economies
according to their ease of doing business; in this framework, the ability for business to
get credit is an important criterion. The Global Entrepreneurship Monitor (GEM)
Entrepreneurship Framework Condition also highlights entrepreneurial finance, defined
as the availability of financial resources for SMEs in the form of debt and equity, as one
of the key factors for stimulating and supporting entrepreneurial activity.

4.2.7.6 Business Training

One of the contributions done by commercial banks in Tanzania is provision of business
training to SMEs. Before SME operators in Tanzania have rather low business skills and
seem not to appreciate the importance of business education. On the other hand, the
quality of training provided by existing business training institutions and costs involved
has tended to be unattractive and unaffordable to the potential beneficiaries.

4.2.8 Factors influence the financing of SMEs by CRDB Bank Plc

A necessary condition for the sustainable growth of the SME lending market in Tanzania
is the presence of a stable macroeconomic environment and a predictable policy regime.
The findings of the paper suggest that banks and other financial institutions in the
country are pursuing the SME segment because of its attractiveness, despite important
constraints. In order to ensure that this trend continues uninterrupted, strong
macroeconomic performance and a stable and consistent fiscal and monetary framework
have been identified as important considerations. It is also important that Tanzanian
should continue its efforts to modernize their financial systems, including the prudential

49
regulatory framework, enhancing competition and innovation so as to give rise to
alternative financing providers and financial solutions to better serve the SME segment.

4.2.8.1 The audited financial statement

The financial statement used is the audited financial statement for the corporate
company because this financial statement contain both qualitative information (e.g. the
auditors‟ report and chairman‟s statement), and quantitative information (e.g. balance
sheet) of the business (Berry et al, (1993). For sole proprietor and Partnership Company
3 years

‟ Unaudited accounts are required .Analysis of financial statement typically includes

four key ratios: liquidity, profitability, gearing and operational performance and usually
banks use the last three, four, or five years audited financial statement (Rose, 1999).
Information from balance sheets and income statements is typically supplemented by
financial ratio analysis. The ratios commonly used by the bankers are; operating
efficiency, coverage ratio, liquidity ratio, profitability ratio, and leverage ratio. The cash
flow is referred to as the sources and uses of income.

4.2.8.2 Repayment or first line of defense

This factor allows the banker to know the source of income for the repayment. This
factor is important in order to evaluate the ability of owners to earn a sufficient amount
to repay the loan.

4.2.8.3 Competence of management

It usually refers to the management skills of the SME to manage the business. In reality
the success or failure of business depends upon the skills of the management team.
Hence, banks must have the confidence that the SME firm has good management skills
before a loan is granted.

50
4.2.8.4 The size of business
The size of the applicant‟s business will be extremely influential in a lending decision
because it will effect on the banker‟s perception of risk. In terms of liquidations small
firms go into liquidation than larger counterparts.

4.2.8.5 Financial Projection or Pro forma financial statement

Pro forma financial statement is a projected statement based on the forecast. The
forecast is important to develop internal budgets for the functional department of the
business. The lenders seek this financial statement because they want to make sure that
the applicant‟s business will generate enough profit to pay back both the principal and
interest on the loan.

22

4.2.8.6 Purpose of the Loan

The purpose of the loan is a significant variable in the lending decision because the loan
raised will be influential in assessing the potential risk involved in the lending decision
(Berry et al, 1993). An understanding of the loan‟s intended use helps the analyst to
understand whether the loan request is reasonable and acceptable.

4.2.8.7 The knowledge

Knowledge refers to the information gathered by the bankers in the applicant‟s business.
This knowledge will greatly help a banker in assessing the risk associated with a lending
proposal. This knowledge can be derived through past records and bank‟s own internal
records

51
4.2.8.8 Business risk / Product
For some businesses, by their nature, are likely to be riskier than others. In finance
theory this type of risk is normally referred to as business risk. Business risk is reflected
through the volatility of profits (Berry et al, 1993). The business risk also can relate with
the product produced by the business, because once the business produce a product
which cannot enter into the market or the business produce a product which cannot
expand it will course the business to be more risky. The business ability also is referring
to the ability of applicant to generate enough cash, in the form of cash flow, to repay the
loan. Generally, the borrowers have only three sources to draw upon to repay their loan:
cash flow generated from sales or income, the sale or liquidity of assets or fund raised by
issuing debt or equity securities.

4.2.8.8.1 Capacity
It is defined as the legal status of the borrower to enter into contract (Reed & Gill, 1989),
whether a borrower has the authority to borrow on behalf of his firm or business because
if the borrower lacks such authority, banks may find difficult to collect their loans.
Capacity may also refer to the repayment ability of the borrower (Shamsudin et al,
1988), which is measured by the expected cash flow of the borrower‟s business

4.2.8.9 The third party opinion

Third party opinion is the information acquired by asking the other parties involved with
the applicant‟s business such as supplier, customers, others bankers, and etc. In
particular, if the third party has previously been a source of good introductions
presumably the banker will have greater confidence in this third party‟s opinion and
introductions.

52
4.2.8.10 Geographical risk
Geographical risk is the geographical location of SMEs. CRDB bank limit their
exposure to residential property in certain areas because there no branches opened hence
it is difficult to monitor the SME as well as the value and marketability of residential
property differs substantially between urban centers and small rural areas.

4.2.8.11 Market involved

The market involved means how far the products that produced by the borrower can
establish and also can compete with others product in the markets. This can be explained
in connection with the industry risk which is an uncertainty of future outcomes. Banks
place great emphasis on conditions in the industry and the applicant‟s competitive
position and relative stability. Industry risk also look at the trends of industry including
technological changes, new process, and changes in customer demands.

4.2.8.12 Trading experience or track record

Track record is the past experience of the borrower‟s business and it is concerned with
relevant past experience such as the number of years spent in the industry, other
commercial experience, training etc. The past track records have been used by the
bankers to assist them in doing the judgment on the forecast information. The past track
record could include the assessment of the management‟s ability to meet their
objectives, to manage staff and to manage their finance.

4.2.8.13 Planning
This factor is a systematic process that takes from some current state to some future
desire state. Business planning usually relates and takes into account the perspectives of
strategic planning. Strategic planning is a long-term plan for a business and involves
establishing an overall plan for the business. Strategic planning concern with
establishing firms priorities and also allocates resources and takes the steps necessary to
meet the strategic goals.

53
4.2.9 Barriers Encountered by Financial Institutions in Financing SMEs
Banks have limited information, skills and regulatory support to engage in SME lending.
There are different forms of SME lending, most of it are difficult to implement in
developing countries. The countries often have weak accounting standards, and the
SMEs have no accurate financial statements on their revenues, profits and ability to pay
Furthermore, there is often lack of general market data on the SMEs market and specific
sub-sectors (e.g. default rates).This limits the potential for lending based on financial
statements or small business credit scores. Therefore, banks primarily engage in
relationship-based or other forms of collateral-based lending, rather than cash-flow
based lending. Banks tend not to provide financing for working capital to SMEs, which
is cited by SMEs as one of the areas of greatest need. The lack of collateral for some
borrowers and/or clear recourse legislation (e.g. ability to claim collateral) however, can
complicate the possibilities to do collateral based lending (e.g. asset-based, real-estate or
equipment lending). Finally, banks need specific skills to engage in the different forms
of SME lending. Lack of these skills can lead banks to shun the SME market in its
entirety, and invest only in high-yielding sovereign government debt, or it can translate
into inadequate risk management, leading to lower repayment rates and returns. Some
recent initiatives, such as the CRDB bank training to SMEs, are aimed at decreasing this
skill gap.

4.2.9.1 Banks have difficulty providing tailored foreign exchange products

SMEs seek financing in currencies that match their income streams, to prevent foreign
exchange mishaps. SMEs that have income in foreign currencies (e.g. USD for a coffee
trader) want debt in the same currency. Alternatively, an SME with only local currency
income wants to avoid dollar-denominated debt. Banks in developing countries
sometimes face restrictive local regulation and limited forex availability that make
tailored foreign exchange solutions more difficult.

54
4.2.9.2 SMEs lack collateral
When CRDB bank grants loans or credit; their decisions are mostly based on the
availability of fixed assets as collateral. Many SMEs cannot provide collateral as they
cannot dispose of equipment, machinery, or land. Frequently, banks do not accept a
personal guarantor like many micro-financing institutions do. SMEs in Tanzania suffer
from Environmental Accountability, Responsibility and Transparency (often suffer from
bank demands for collateral. They might ask for high amounts of collateral, 150% or
more of the loan value. SMEs in Tanzania consider such demands too stringent.
Therefore, these banks with such physical collateral requirements will not accept the
SMEs as clients, and the SMEs cannot access finance from the banks.

4.2.9.3 Banks require SME transparency

Most financial institutions and banks lack information on SMEs and their likely cash
flows or credit histories. The banks then doubt the SME‟s capacity to repay a loan. They
also require financial statements and records but such documentation is also frequently
lacking. The majority of small and micro-enterprises targeted by CRDB bank and other
financial institutions reviewed in this report, lack corporate governance, and this are a
major hurdle for the banks.

4.2.9.4 Lack of effective channels and modalities for communication

With credit providers for funding purposes, SMEs are often not aware of financial
solutions provided by the banks, especially in the area of finance, nor of the procedures
to follow to gain access to finance. This could be the case of a non-transparent banking
system – as the CRDB bank Mainstreaming Energy Efficiency through Business
Innovation Support reports. CRDB bank Sustainable and Cleaner Production in the
agriculture found that banks do not have the capacity to engage and inform SMEs on
accessible financial solutions, nor do they have the knowledge for assessing agriculture
production investments.

55
23

4.2.9.5 Banks do not consider SME lending as profitable business

Due to their size SMEs are often only looking for a small investment but banks do not
find such small transactions profitable. High operating costs for SME lending and
contract enforcement remain an obstacle even at low default rates. The researcher
through CRDB bank found that banks are often not interested in serving SME clients
needing small loans. Smaller SMEs in Kilombero district that want to invest in various
economic activities have more difficulties finding a bank that finances such investment.
By targeting the financial needs of larger enterprises, banks tend to do better business
than by addressing SMEs. Many financial institutions across Tanzania do not make
enough profit with SMEs as their sole, or major, debt clientele, despite charging a
premium on the interest because of the high risk and transaction cost.

4.2.9.6 Limited Competition for Tailored services Targeting SMEs

As larger companies and their needs for investment offer better business, most financial
institutions in Tanzania do not offer tailor-made services for SMEs. Due to the low
degree of competition among banks for SME clients, there is a shortage of innovative
financial products addressing the needs of SMEs.

4.2.9.7 Banks consider SM E lending high risk

Loans responding to financial requests from SMEs are often considered high risk by the
banks. The weak capacity inherent in SMEs for drawing up business plans and
developing business projections mean that banks find it difficult to assess profitability
and, at the same time, could face an increased financial risk as a lender in case of
default. The CRDB bank Kilombero branch believes that banks do not fully understand
the environment surrounding SME lending. They also do not appear to have appropriate
tools to help them assess the risk of lending to SMEs for particular investments, such as
cleaner production measures. Researcher saw a problem with the capacity of banks.
Bankers are not familiar with the SMEs market compared with mature market products
such as mortgage loans. Where credit evaluators do not understand the SMEs lending
business, they are likely to consider lending as high risk.

56
4.2.9.8 Banks incur higher administrative costs by lending to SMEs
The costs of lending to SMEs are relatively high, as loan sizes are small, and the
transaction costs per loan are relatively constant. This reduces incentives for regular
banks to lend to them. The difference in fees,interest rates and relative share of loans to
SMEs for African and non-African banks.

4.2.9.9 Another factor which appears to have a significant impact on SME

financing in the Tanzania is business regulation
The majority of banks in Tanzania regard this area of regulation as exerting a significant
impediment to SME lending. The most common complaint was that the business aspects
of “know your client” (KYC) process imposed by most of the central bank in the
Tanzania was too stringent for SMEs. The documentation required in most instances was
to a large extent akin to that required for large corporations and therefore considered
excessive for SMEs. Most of the banks in the Tanzania do not have a separate simplified
business company registration process for SMEs, which is any different from the process
for larger corporations, with the result that documentation requirements prove to be
excessively burdensome for SMEs. Overall, 50 percent of the banks stated that the
documentation requirements were a significant obstacle to SME lending.

4.2.9.10 Obstacles in the legal and contractual environment

The researcher found that Obstacles in the legal and contractual environment were also
seen as negatively impacting SME lending in the Tanzania, though the overall
investment climate can be considered an obstacle to private sector development in
general and not only to SME financing. Judicial inefficiencies, in particular, were
perceived as a very significant obstacle to SME lending, with half of the banks surveyed
mentioning them. Three quarters of the banks Tanzania mentioned this aspect,. Specific
aspects of judicial inefficiencies and other legal obstacles which were mentioned
included (i) general efficiency of the court systems; (ii) political influence; and (iii) the
fact that SMEs can easily get injunctions stopping enforcement of contracts. A quarter of
the banks in the Tanzania also mentioned the lack of contractual enforcement as an
obstacle to their involvement in the SME finance market.

57
4.2.10 Improvement in financing of SMEs
Africa‟s SMEs have little access to finance, which thus hampers their emergence and
eventual growth. Their main sources of capital are their retained earnings and informal
savings and loan associations (tontines), which are unpredictable, not very secure and
have little scope for risk sharing because of their regional or sectoral focus. Access to
formal finance is poor because of the high risk of default among SMEs and due to
inadequate financial facilities. Small business in Tanzania can rarely meet the conditions
set by financial institutions, which see SMEs as a risk because of poor guarantees and
lack of information about their ability to repay loans. The financial system in most of
Africans under-developed countries however and so provides few financial instruments.
Capital markets are in their infancy, shareholding is rare and no long-term financing is
available for SMEs. Access to finance is necessary to create an economic environment
that enables firms to grow and prosper. SMEs in developing countries, however, face
significant barriers to finance. Financial constraints are higher in developing countries in
general, but SMEs are particularly constrained by gaps in the financial system such as
high administrative costs, high collateral requirements and lack of experience within
financial intermediaries. Increased access to finance for SMEs can improve economic
conditions in developing countries by fostering innovation, macro-economic resilience,
and GDP growth.

Reforming the legal and regulatory environment might contribute to increase banks‟
involvement with SMEs. A first area of intervention might be the legal framework for
creditor rights and for secured lending. Efficiency of the courts and issues surrounding
the definition of collateral has been listed as important constraints to the development of
the SME lending market. Targeted interventions on the relevant legislation might
contribute to speed up enforcement procedures and improve the efficiency of the
judiciary. For SMEs, what constitutes acceptable collateral is also an important issue.
Reforming the legal framework for secured lending and reviewing the regulatory
treatment of collateral would facilitate SMEs to pledge a wider share of their assets as a
guarantee for their borrowings. Finally, governments might explore the possibility of

58
introducing a simplified company registration process, which takes into consideration
the peculiarities of SMEs compared to larger companies.

Access to finance helps all firms to grow and prosper. The Investment Climate Surveys
of the World Bank show that access to finance improves firm performance. It not only
facilitates market entry, growth of companies and risk reduction, but also promotes
innovation and entrepreneurial activity. Furthermore, firms with greater access to capital
are more able to exploit growth and investment opportunities. In other words, aggregate
economic performance will be improved by increasing the access to capital.

4.2.10.1 Increased access to finance will foster efficient growth in the SME sector
Small firms are disproportionately handicapped by a lack of finance, but they receive a
stronger boost in growth than large firms if financing is provided. Financing obstacles
affect small firm‟s more than large firms. Small firms not only report higher financing
obstacles, but they are also more adversely affected by these obstacles. This might be
due partly to a lack of other financing sources, and partly because it hinders SMEs from
taking advantage of economies of scale. Esther Duflo and Abhijit Banerjee have argued
that production technologies follow a step-function and that credit might be needed for
SMEs to make the jump to the next step (e.g. move from manual to automatic
production).

4.2.10.2 Improving business conditions

Proper information, a key to deciding whether to make a loan, would be helped by
adopting clear accounting standards, setting up independent, competent and reputable
accounting firms and creating more credit bureau supplying data on the solvency of
firms. An impartial legal system that can help settle contract disputes, commercial law
reform and drafting and clarifying land titles, as well as effective bankruptcy procedures,
are vital for growth of the business sector.
A country‟s tax laws can either coax small businesses into the formal sector of the
economy or keep them out of it. Governments should also make sure that they pay
SMEs promptly, since public contracts are vital to the financial security of these firms.

59
4.2.10.3 Helping SMEs meet the requirements of formal financing
Apart from the need to boost SME capacities, some financial instruments can help
provide missing information or reduce the risk stemming from some SMEs‟ lack of
transparency. Franchising, which is very popular in Tanzania and East Africa in general
with the encouragement to allow use of a brand name or know-how that reduces the risk
of failure?

Other financial instruments, such as leasing and factoring, can reduce risk effectively for
credit institutions but are still little used in African countries.
Credit associations that reduce risk by sharing it are more common. They help financial
institutions choose to whom to lend, by guaranteeing the technical viability of projects,
and sometimes providing guarantees. But growth of these bodies is limited by the lack of
organization among SMEs in Tanzania and by their focus on certain sectors and
geographical areas.

Governments and donor sources have thus preferred creation of guarantee funds to
ensure repayment in case of default. In several countries, especially in Central Africa,
this has not worked since provision of a guarantee has meant less rigorous choice of
investment projects and a lower rate of debt recovery. Elsewhere, notably in
Mozambique, borrowers and financial institutions have worked together to maintain a
good rate of recovery and to reduce interest rates.

4.2.10.4 Making the financial system more accessible to SMEs

Most Tanzania financial systems are fragmented. The “missing middle” in the pattern of
size of firm is matched by one in the range of financing available. Lack of funding for
SMEs has partly been made up for by micro-credit institutions, whose growth is due to
the flexible loans they offer small businesses. In Angola, Novobanco provides loans free
of bank charges, without a minimum deposit and with informal guarantees (property
assets and a guarantor), as well as permanent contact with loan managers. Though
adapted to local needs, however, micro-credit institutions remain fragile and modest-
sized. As well as lacking trained staff, micro-credit institutions face limited expansion

60
because of their limited funds. Their mainly short-term finance means they cannot easily
turn the savings they collect into medium or long-term loans. They are also up against
the cost of refinancing through the formal banking sector and have no access to
refinancing either by the central bank or by venture capital.

Microcredit institutions could be put on a firmer financial footing by developing and

adapting long-term savings products that exist elsewhere, such as life insurance and
home-saving plans, and encouraging the setting up of specialized refinance banks such
as Mali‟s “solidarity bank” (Banque malienne de solidarité), or working more closely
with the formal banking sector (Benin‟s SME support organization PAPME and the
local Bank of Africa).Some countries (such as Kenya) have dealt with the lack of
funding by supporting growth of smaller commercial banks so as to bring traditional
banks and SMEs closer geographically and business-wise.

South Africa passed two laws in early 2005 to expand the banking system to include
savings and loan institutions (second-tier banks) and co-operative banks (third-tier
banks) while easing banking regulations so the newcomers could still be flexible in
providing loans. In many countries, commercial banks are also setting up their own
micro-credit services. Removing the obstacles to access for SMEs‟ to finance requires
that commercial banks, micro-credit institutions, community groups and business
development services (BDS) work closely together. Pushing for agreements between
financial bodies and BDS suppliers will help make up for lack of capacity and reduce
costs by more efficient division of labor.

The BDS supplier makes the initial choice of projects on a purely technical basis and the
credit institution looks at financial viability. Making loans to intermediaries (NGOs and
federations of SMEs) with the job of allotting funds to members can also help cut
administration costs. Solidarity between banks, especially setting up inter-bank
financing to (as in Nigeria) pool money to be invested in SMEs, reduces the extra risk of
lending to SMEs, as well. Working with banks boosts the financial viability of micro-

61
credit institutions and can also help informal financial bodies to move towards the
formal sector.

4.2.10.5 Expanding the supply of finance through the non-financial private sector
Financial institutions are not the only source of money for SMEs. Apart from
remittances by nationals working abroad, which are key boosts to private-sector growth,
the interdependence between SMEs, large firms and sectoral “clusters” is a major
potential source of finance, as shown in Asia and Latin America. Big firms can do a lot
to help SMEs get finance more easily by transferring resources (money and factors of
production) and guaranteeing SME solvency with financial institutions. Links with
major companies can also help SMEs get export credits, which are especially important
in countries with weak institutions, since commercial partners are better informed than
other creditors (especially financial institutions) about the ability of their customers to
repay debts. Export credits have been proved useful in Zambia‟s agro-food industry.
Subcontracting is still uncommon in Africa, but has grown rapidly in South Africa since
1998, though there is increasing scepticism about it because it may confine SMEs to
low-skill informal activities. Clusters of SMEs, which are very active in Asia, enable
member firms to seek finance together, provide collective guarantees or even set up their
own financial body. The threat of expulsion from the cluster ensures that promises are
kept, which allows the network to overcome shortcomings in the legal system. Frequent
interaction with financial authorities, as well as the role that reputation plays in the
cluster, can greatly increase confidence between firms and financial institutions and thus
make it easier to get loans and lower rates of interest. Working together also means
firms can get supplier credits and can borrow from each other when necessary, which
reduces general costs. Such clusters, however, are very little developed in Africa and are
concentrated in South Africa, Kenya, Nigeria, Tanzania and Zimbabwe.

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 24 CHAPTER FIVE

25 CONCLUSIONS, RECOMMENDATIONS AND POLICY IMPLICATIONS

5.1 Conclusions
This paper presents the findings of a survey of SME lending with CRDB bank,
Tanzania. Although the bank staff interviewed was sometimes selective in the answers
and information they divulged, we believe the general findings of this paper offer a
reliable overview of the banks‟ attitudes and perceptions towards SME financing in
Tanzania.
Contrary to the general view that financial institutions are averse to SME finance,
CRDB bank as the sample is on the whole very keen to have SMEs as clients and is
adapting their internal systems to better serve this market segment. The results of the
survey indicate that a bank consider the SME segment strategically important and is
actively pursuing SMEs. The average SME loan portfolio in the sample amounts to 37
percent of total loans to the private sector.

Most banks in Tanzania re aware of the importance of SMEs in their respective

economies and see the SME segment as an important pillar of their growth strategy in
view of its profitability and the cross-selling opportunities it offers. SMEs are pursued
because of their perceived attractiveness as a business proposition. The SME market is
considered large, very competitive and yet not saturated, with a positive outlook for
further growth. Several constraints are, however, holding back the further involvement
of crdb bank with SMEs in the region: inherent SME characteristics (availability and
reliability of information, informality, family-owned structures, inability to post
adequate collateral); recent interest rate and exchange rate instability; the business
regulatory framework, especially the KYC requirements; the legal and contractual
environment, particularly judicial inefficiencies; a rather inorganic government approach
towards this crucial segment of the economy; prudential regulation, in particular the
requirements in the area of collateral; and some bank-specific factors.
Banks in the Tanzania have developed coping mechanisms to overcome the obstacles
which discourage them from entering the SME segment. Most banks have established
63
separate units to be more responsive to the needs of their SME clients, in recognition of
the inherent differences between SMEs and consumer and corporate clients. Some of
them are allocating resources to provide training to their SME clients to improve their
management skills and financial reporting. Though loan products remain largely
standardized, there is an observable trend towards increasing tailoring, and banks are
pursuing innovation and differentiation as a part of their SME strategy. Lending remains
overall based on collateral. Risk management is increasingly automated though banks,
with the exception of foreign-owned institutions, have not yet embraced on a large scale
the use of scoring and risk-rating technologies.

All this suggests those banks in Tanzania to have embraced the SME segment
enthusiastically and are making substantial investments to develop their relationship
with SME clients. This holds good promise to contributing to close the “SME financing
gap” which characterizes East Africa including Tanzania, compared to other developing
regions. It is, therefore, important that this trend is supported and encouraged by
removing those institutional and policy obstacles that constrain SME lending.
A necessary condition for the sustainable growth of the SME lending market in Tanzania
is the presence of a stable macroeconomic environment and a predictable policy regime.

5.2 Recommendations
On the basis of the study findings, it has been recommended that CRDB bank should
foster a culture of continuously financing SMEs and help to improving their business
knowledge, experience, competencies, skills and attitudes of their customers to meet the
ever-changing demands of their business. Towards meeting this objective, SME
financing should be viewed as pivotal to the sustainability and efficient operations of
their business and overall economy, hence the need for Continuous investment by
Tanzanian banks in SMEs financing.

This study may have important implications for practice. The findings may point to
negative reactions toward SME opportunities being insufficient, and infrequent in terms

64
of obtaining high levels of outcomes. Therefore, the findings would help banks
management and government to address this issue of effectiveness of commercial banks
in financing SMEs in Tanzania for which may lead to higher levels of SMEs outcomes
in the in future.

This study also established that enhancing the SMEs competencies in their business
place strongly depends upon environment of a given firm. This implies that banks and
other financial management should be committed towards supporting SMEs training
categories with equitable provision being made within the spirit the equal opportunity
for all SMEs.

The findings of the paper suggest that banks in Tanzania are pursuing the SME segment
because of its attractiveness, despite important constraints. In order to ensure that this
trend continues uninterrupted, strong macroeconomic performance and a stable and
consistent fiscal and monetary framework have been identified as important
considerations. It is also important that banks in Tanzania should continue their efforts
to modernize their financial systems, including the prudential regulatory framework,
enhancing competition and innovation so as to give rise to alternative financing
providers and financial solutions to better serve the SME segment.
Reforming the legal and regulatory environment might contribute to increase banks‟
involvement with SMEs.

The first area of intervention might be the legal framework for creditor rights and for
secured lending. Efficiency of the courts and issues surrounding the definition of
collateral has been listed as important constraints to the development of the SME
lending market. Targeted interventions on the relevant legislation might contribute to
speed up enforcement procedures and improve the efficiency of the judiciary. For SMEs,
what constitutes acceptable collateral is also an important issue. Reforming the legal
framework for secured lending and reviewing the regulatory treatment of collateral

65
would facilitate SMEs to pledge a wider share of their assets as a guarantee for their
borrowings.

Finally, government might explore the possibility of introducing a simplified company

registration process, which takes into consideration the peculiarities of SMEs compared
to larger companies. There is also room for optimizing the role of the governments in
the. Tanzania Current government programs in the SME space are perceived as
generally insufficient in supporting the growth of the market. This might be due to the
lack of consistency. Government might therefore consider introducing a dedicated and
organic SME policy to boost this segment. A first start should be the adoption of a
uniform definition of SME. Most of the banks in Tanzania use loan size and turnover as
criteria to define SMEs. The adoption of such criteria and their formalization into
relevant legislation might ease the attainment of policy objectives in this area.

A second area of intervention might include the optimization of current financing

support mechanisms, including national and regional development finance institutions,
by focusing on additionality and on developing new instruments. In this respect, an
assessment of their mandate and their development effectiveness would help fine tune a
policy review in this area.

Finally, a better understanding of the SME segment and the implementation of measures
aimed at addressing some of their intrinsic weaknesses should be a further policy
priority. Given the crucial importance attributed by banks to SME-specific constraints,
priority might be given for example to the collection of statistics and data on their
characteristics in order to better understand the demand-side perspective, which is
equally important in the development of the SME lending market. Measures in this
domain might include the scaling up of capacity building programs and the introduction
of incentives for SMEs to formalize

66
5.3 Policy Implications
Since there has neither been a comprehensive policy to guide an appropriate
implementation of SMEs programme nor adequate efforts to make them aware of its
function then the HR department should strive to design an effective policy and involve
all respective employees in its implementation. This will help to reduce the growing
negative attitude towards the function.

An assessment of the SME sector has shown that it is facing constraints which need to
be addressed adequately through this policy. Given the importance of the sector and the
need to transform it to a vibrant and dynamic one, it is crucial to put in place strategies
that will facilitate the removal of those constraints so that it can attain the desired vision
and identified objectives. In the SME Development Policy strategies have been
identified focusing on areas which have maximum impact on the sector. The major areas
of focus include: creation of the enabling business environment, developing the
infrastructure, strengthening financial and non-financial services and establishing and
strengthening institutions supportive to SME development. In this policy, problems are
identified, Government statements are articulated and appropriate strategies are
specified.

a. The Government should enhance implementation of programmes aimed

simplification and rationalization of procedures and regulations so as to
encourage compliance and minimize transaction cost
Government Support Programs for SMEs:
Evaluate government support program, to determine their additionality and to
fine-tune them in order to better attain their intended objectives
Assess how such programs could support capacity-building activities for SMEs
(i.e. financial literacy, business skill training etc.) and promote the development
of new SME financing instruments (i.e. factoring, risk capital etc.)

67
 Design incentives for SMEs to formalize (e.g. simplification of tax
policy/administration, relevant labor and social security regulations,
procedures/cost of inscription in commercial registries etc.)
b. Analyze and further streamline existing inter-institutional coordination of
policies geared towards the SME market
c. Legal &Contractual Framework
Review and reform the legal framework for secured lending by consolidating
diverse and overlapping legislation to enhance the ability of SMEs to pledge
moveable property as collateral
Continue to improve the general framework for creditor rights and insolvency
proceedings by strengthening enforcement procedures and registry systems

d. The Government should continue to improve the physical infrastructures and

provision of utilities in collaboration with Local Authorities, private sector and
development partners.
e. The Government should promote entrepreneurship development through
facilitating improved access of SMEs to financial and non-financial services.

f. Financial Sector Regulations: Government should assess the effects of the

interest rate ceiling on access to credit by SMEs and as a source of legal and
regulatory Uncertainty for credit institutions

g. The Government should facilitate and support programmes aimed at increased

access of information pertinent to the development of SMEs.
h. The Government should facilitate acquisition and adaptation of technologies as
well as enhance networking between R&D Institutions and SMEs in a bid to
upgrade technologies so as to raise the productivity and competitiveness of the
sector.

68
i. The Government must be committed to facilitating support programmes aimed at
Improving SMEs‟ access to market.
j. The Government should enhance financial reforms aimed at further liberalization
of the financial sector and the creation of financial intermediaries to cater for
SMEs Strategies:
k. The Government will facilitate strengthening of institutions and associations
supporting the SME sector.
l. Statistics & Data Collection on SMEs
Unbundle SMEs from micro enterprises in official statistics
Improve periodic data collection on SMEs in order to identify their
characteristics (size, economic sector, region, financial performance, contribution
to employment and GDP, informalities.) and to better understand the demand-
side perspective
Expand SME definition to include annual turnover as a criterion

m. Analyze and further streamline existing inter-institutional coordination of

policies geared towards the SME market.

69
 26 REFERENCES
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with SMEs: Beyond Relationship Lending”, Journal of Banking and
Finance 34, 2280–2293
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 27 APPENDICES
APPENDIX I

QUESTIONNAIRE FOR STAFF

ASSESSING THE EFFECTIVENESS OF COMMERCIAL BANKS TOWARDS
FINANCING SMALL AND MEDIUM SIZE ENTERPRISES (SMEs): THE CASE
OF CRDB BANK PLC KILOMBERO DISTRICT TANZANIA.
This is a research being conducted in partial fulfillment of the requirement for the award
of masters in business administration (MBA). Respondents are assured of confidentiality
and anonymity of the information they provide. They are further assured that any
information they provide is purely for academic purposes.
1 .How long have you been in SME banking?
a) Less than 2 years []

b) 3 years []

c) 4 years []

d) 5 years []

e) Over 5 years. []

2. Which financial services do you offer your SME customers?

a) Overdraft []

b) Trade credit []

c) SME banking []

d) Cash management [ ]

e) Business advice []

f) Others (specify)……………………………………

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3. How is your relationship with your SMEs?
a) Good []
b) Poor []

c) Very good []

d) Excellent []

4. What conditions do you consider when extending credit to customers who are SMEs?
a) Years in existence []
b) Past and projected cash flows [ ]
c) Credit history []
d) Line of business []
e) Collateral []
f) Business location []

5. What has been the major challenge for your SMEs banking unit?
a) Management []

b) High default rate [ ]

c) Monitoring []

d) Other (specify) []

6. Provide the names of at least five major SMEs that your bank has single-handedly
extended assistance from its start-up stage to its current state.
a) ………………………………………….
b) ………………………………………….
c) ………………………………………….
d) ………………………………………….
e) ………………………………………….

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 7. Do you have a client SME in CRDB Bank Plc - If yes please name
them......................................

8. Apart from the provision of financial assistance to the SMEs, what other service do
you render to them?
……………………………………………………………………………………………
……………………………………………………………………………………………
……………………………………………………………………………………………
……………………………………………………………………………………………
………………………………
9. What recommendations would you like give which you believe would be a panacea to
surmount the financing challenges facing SMEs.
……………………………………………………………………………………………
……………………………………………………………………………………………
………………
Thank you for your time

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 APPENDIX II

BUSINESS OWNERS QUESTIONNAIRE

ASSESSING THE EFFECTIVENESS OF COMMERCIAL BANKS TOWARDS
FINANCING SMALL AAND MEDIUM SIZE ENTERPRISES (SMEs): THE
CASE OF CRDB BANK PLC AT KILOMBERO DISTRICT TANZANIA.
This is a research being conducted in partial fulfillment of the requirement for the award
of masters in business administration (MBA). Respondents are assured of confidentiality
and anonymity of the information they provide. They are further assured that any
information they provide is purely for academic purposes.

Instructions: Please kindly tick in the boxes provided or write in the spaces provided
your responses
1. Identify the sector that represents the main activity of your business
a) Food processing industry [ ]
b) Bakery industry [ ]
c) Wood products industry [ ]
d) Furniture works industry [ ]
e) Metal works industry [ ]
f) Machinery works industry [ ]

2. Have you registered your business?

a) Yes [ ]
b) No [ ]

3. If your answer to question 2 is “yes,” what is the legal status of your business? (Check
one only)
a) Private limited liability companies [ ]
b) Sole proprietorship [ ]
c) Private Partnership [ ]

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4. How old is your firm?
a) 2 years or less [ ]
b) 3 and 5 years [ ]
c) 6 and 10 years [ ]
d) 11 years and above [ ]

5. For how long have your firm transacted business with CRDB Bank?
a) 3 years or less [ ]
b) 4 - 6 years [ ] 7 - 9 years [ ]
c) 10 -12 years [ ]
d) 13 years and above [ ]

6. Do you have a designated account manager assigned to manage your firm‟s banking
relationship?
a) Yes [ ]
b) No [ ]

7. How did the firm first request a financing from CRDB Bank Plc?
a) [ ] Application filled in at branch
b) [ ] Application made by phone
c) [ ] Application over the internet (include electronic mail and website)
d) [ ] Others (please specify)………………………………………..

8. Have you ever had your application rejected before?

a) Yes [ ]
b) No [ ]

9. Were you satisfied with the explanation above?

a) Yes [ ]
b) No [ ]

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 c) Don‟t know [ ]

10. Are you required to provide personal assets as collateral by CRDB Bank Plc to
guarantee the granting of loans?
a) Yes [ ]
b) No [ ]
c) Don‟t know [ ]

11. Are business owners required to provide their personal assets as collateral by CRDB
Bank Plc to guarantee the granting of loans?
a) Yes [ ]
b) No [ ]
c) I refuse to answer [ ]
d) Don‟t know [ ]

………………………………………………………….
Thank you for your time

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 APPENDIX III
Focus group discussion Interview
Place………Date……..Time started…………finished…………………
1. Are you aware of financing Small and medium size enterprises?
2. Can you mention any services provided by your local bank in relation to SMEs?
3. Did you participate in Financing/receive fund for SMEs development purpose?
4. What is the contribution of commercial Bank in growth and development of SMEs?
5. What is the barrier in financing SME?
6. Is there any legal or regulatory framework supporting financing SMEs?
7. What is do you think are initiative to be taken by the government and commercial
bank to make effective financing of SMEs?

79