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Role of Commercial Banks In Financing Small and Medium Enterprises Team 3

Small and Medium Enterprises (SMEs)


and Medium Enterprises (SMEs) constitute the backbone of an economy. They not only provide employment and therefore income opportunities to a large number of people, but are also at the forefront of technological innovation and export diversification.

Finance among the Prerequisites for SMEs Development

Financing is one of the necessary

prerequisites for SMEs development such as legislative, marketing and research requirements. Lack of finance represents a major obstacle to SMEs growth and development. It is undeniable that in both developed and developing countries, SMEs traditionally lacked access to formal credit, particularly long-term finance

This is because SMEs are considered of high risk

due to insufficient assets, low capitalization, and lack of collateral as well as high vulnerability to market conditions.

Role of the Banking Sector in Financing SMEs:

Commercial banks play an important and active role in the economic development of a country. If the banking system in a country is effective, efficient and disciplined it brings about a rapid growth in the various sectors of the economy. The following is the significance of commercial banks in the SME development in a country.

Role of Commercial Banks in the SME Development

1. Banks promote capital formation 2. Investment in new enterprises 3. Promotion of trade and industry 4. Development of agriculture business 5. Balanced development of different regions 6. Influencing economy activity 7. Export promotion cells

1. Banks promote capital formation:

Commercial banks accept deposits from

individuals and businesses, these deposits are then made available to the businesses which make use of them for productive purposes in the country. The banks are, therefore, not only the store houses of the countrys wealth, but also provide financial resources necessary for economic development.

2. Investment in new enterprises:

Businessmen normally hesitate to invest their

money in risky enterprises. The commercial banks generally provide short and medium term loans to entrepreneurs to invest in new enterprises and adopt new methods of production. The provision of timely credit increases the productive capacity of the economy.

3. Promotion of trade and industry:

With the growth of commercial banking, there is vast

expansion in trade and industry. The use of bank draft, bill of exchange, credit cards and letters of credit etc has revolutionized both national and international trade.

4. Development of agriculture business:

The commercial banks particularly in developing

countries are now providing credit for development of agriculture and small scale industries in rural areas. The provision of credit to agriculture sector has greatly helped in raising agriculture productivity and income of the farmers.

5. Balanced development of different regions:

The commercial banks play an important role in

achieving balanced development in different regions of the country. They help in transferring surplus capital from developed regions to the less developed regions. The traders, industrialist etc of less developed regions are able to get adequate capital for meeting their business needs. This in turn increases investment, trade and production in the economy.

6. Influencing economic activity:

The banks can also influence the economic activity of the

country through its influence on a. Availability of credit b. The rate of interest If the commercial banks are able to increase the amount of money in circulation through credit creation or by lowering the rate of interest, it directly affects economic development. A low rate of interest can encourage investment. The credit creation activity can raise aggregate demand which leads to more production in the economy.

7. Export promotion cells:

In order to increase the exports of the country,

the commercial banks have established export promotion cells. They provide information about general trade and economic conditions both inside and outside the country to its customers. The banks are therefore, making positive contribution in the process of economic development.

Banking Sector services provided to SMEs, take various forms

(1) short term loans, compatible with SMEs business and income patterns (2) repeated loans, where full repayment of one loan brings access to another, and where the size of the loan depends on the client's cash flow

(3) very small loans, or bank overdraft facilities are also appropriate for meeting the day to-day financial requirements of small businesses (4) factoring and invoice discounting, asset finance (including commercial mortgages), and equity finance, all being within the framework of a customer-friendly approach

Factors recommended that banks take into consideration

(1) that outlets are located close to entrepreneurs, (2) to use extremely simple loan applications, (3) to limit the time between application and disbursement to a few days (4) as well as to develop a public image of being approachable to low-income people. These are all among the characteristics that should be available in banking units serving the SMEs sector.

Advantages of Commercial Banks in Financing SMEs

(1) Clear Regulations illustrating the conditions

of ownership, financial disclosure, and capital adequacy that help them ensure prudent risk management. (2) Physical Infrastructure, including a large network of branches, which enables them to reach a substantial number of small and medium sized clients

(3) Well-Established Internal Controls, Administrative and Accounting Systems which facilitate keeping track of a large number of transactions (4) Ownership Structures Increasingly Dominated by Private Sector which tends to encourage sound governance practices, seeking costeffectiveness and profitability.

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