NOTE yet the country’s SME Market remains fundamentally under-banked



SME Finance in Pakistan

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The economy
of Pakistan is the 24th largest in the world in terms of purchasing power parity (PPP) and 42nd largest in terms of nominal gross domestic product. Pakistan has a
population of over 207 million1 (the
world’s 5th largest), giving it a nominal GDP per capita of $1,629,2 which
ranks 147th
in the world for 2016.
However, Pakistan’s undocumented economy is estimated to be 36% of its overall
economy, which is not taken into consideration when calculating per capita
income3. Primary
export commodities include textiles, leather goods, sports goods, chemicals,
carpets/rugs and medical instruments. The country’s economy achieved a
GDP Growth rate of 5.28% with a Nominal GDP of $304 billion in 20174.


There are 34 Commercial Banks with
more than 13,0005
branches and 11 Microfinance Banks with 2,4006 branches
operating in Pakistan presently. The Advances to Deposits Ratio (ADR) of
Pakistan’s banking industry stood at 51% as of June 30, 2017.


Pakistan has one of the highest and
most diverse populations of Small & Medium Enterprises (SMEs) in the region
(estimated at more than 3,000,000 businesses) and yet the country’s SME Market
remains fundamentally under-banked and underserved, particularly for the “S”
segment. Fewer than 200,0007 SMEs
currently borrow from banks and less than 40% have any form of banking


Historically, the favourable
macroeconomic and investment conditions in Pakistan began to deteriorate from
2008. Not only the global financial crisis triggered an uncertainty, but the
growing security concerns and widening energy imbalances in the country also
strongly dented domestic business prospects. During this time, overall SME
sector suffered from the spill over impact of sluggishness in the larger
corporate sector. SMEs could not address their cash flow constraints by
borrowing from banks due to high interest rates and banks’ reluctance to lend
to SMEs due to rising bad debts. An additional factor of high fiscal burden
significantly increased government’s appetite for funds from the banking system
leaving little or no liquidity and appetite for the high-risk SME lending.8


This primarily explains the prevailing
risk aversion of banks to SME lending and their preference to stay distanced
from the SME development agenda.


From 2013 and onwards, overall
macroeconomic conditions started improving and with the reduction in the policy
rate from 12% p.a. in 2012 to 6% p.a. in 2017, the situation started favouring
SMEs in conjunction with the support of State Bank of Pakistan (SBP)’s
facilitative role to enhance access to credit including:

Introduction of a separate set of Prudential
Regulations for SME Financing in 2003 with a revision in 2013 wherein Small
Enterprises (SEs) and Medium Enterprises (MEs) were separately defined and more
specific and simpler regulations for SEs and MEs were prescribed.

Facilitation in the approval of “The Financial
Institutions (Secured Transactions) Act, 2016” from the Parliament to
facilitate SMEs and agri borrowers to access credit from banking sector by
using their movable assets as collateral.

Allocation of SME financing targets to banks for the
first time in 2016 in order to enhance the flow of credit to the SME sector.

Introduction of different risk coverage and refinance
schemes for SME Financing aimed at risk-sharing and reducing the cost of
borrowing by SMEs.

Though these efforts have brought
improvement in SME financing portfolio of banks, however, a large number of
SMEs, particularly Micro and Small Enterprises, are still financially excluded.
In order to address this issue and enhance access to credit to SME sector, SBP
has prepared an ambitious policy for promotion of SME finance with the following
key benchmarks to be achieved by 2020:


Increase SME share from existing 8% private sector
credit to 17%

Increase number of borrowers from existing 174,000 to


Despite the policy level work done
so far to create an enabling environment for SME lending, only a handful of
banks (HBL, UBL, Bank AlFalah, and Meezan Bank) have undertaken SME Banking
projects through IFC’s Bank Advisory Services over the past 5 years and have
been successful in increasing their SME Financing portfolios with considerably
low NPLs.


Main reasons behind the reluctance
of banks to lend to SMEs include lack of strategic focus on part of banks, a
high industry-wide NPL ratio for SME loans (21%9), corporate
finance mindset, lengthy and cumbersome foreclosure process, lack of financial
disclosure by SMEs, lack of definition for non-borrowing SMEs, weak technology
platforms including absence of Client Relationship Management (CRM) and Loan
Origination System (LOS) software, absence of SME-specific risk management
function and framework, lack of SME R&D and product programmes, and HR
capacity constraints.


By and large, banks in Pakistan
still do not see SME Banking as a unique and profitable business function in
addition to and separate from the Corporate and Consumer banking shops. Despite
the various policy level initiatives taken by SBP including the Credit
Guarantee Scheme and Refinance Facilities, off-take under these has remained
low. On the one hand, banks feel that the Credit Guarantee Schemes introduced
by SBP have a cumbersome process coupled with an uncertain favourable outcome
for banks in case of defaults by borrowers, and on the other, the Refinance
Facilities that are aimed at providing low-cost liquidity to banks for SME
lending, have little or no demand due to reduction in policy rate coupled with
surplus liquidity available across the banking industry. Furthermore, all these
schemes except one, are targeted at SMEs engaged in the manufacturing business
and given that only 22% of all SMEs fall into this category, utilization
remains low.




Challenges faced by SMEs and
potential solutions


Main challenges and constraints to
business growth faced by SMEs, particularly Micro and Small Enterprises,
include historically high interest rates, requirement of collateral for
securing loans (access to financing), long turn-around-time of banks for SME
loans (avg. 90 days), scarcity of financial solutions and conservatism of
banks, uncertain economic policy, macro-economic instability, tax
administration, and tax rates.


In terms of way forward,
considerable work needs to be done by banks in the country including the
following to enable them to undertake SME lending in a profitable and scalable

Investment in Technology (Application Scorecards,
Collections, Loan Origination System, and Client  Relationship Management software)

Definition of non-borrowing SMEs

Simplification and automation of Credit Process to
reduce Turn-Around-Time

Target Market Identification and Cluster-based
Approach for Programs supported by segment-specific Risk Acceptance Criteria

Development of Supply Chain Financing programs and
other cash flow based products

Re-alignment of the existing Delivery Channel
including the use of Alternate Delivery Channels (Internet Banking, ATMs, and
Branchless Banking platforms) for SME lending


Opportunities for other
stakeholders consist of:

SME Lending and SME Banking Advisory for banks

Development of customized training programs for SME
loan officers and SME credit and risk staff

Introduction of Credit Guarantee / Risk Sharing
facilities directly with partnering banks and financial institutions

Introduction of Venture Capital funds for SMEs


and mitigating measures for Credit Guarantee Funds

The biggest challenge for a
private credit guarantee fund would be the regulatory approval by SBP to allow
treatment of a private credit guarantee at par with guarantees issued by
financial institutions and multilateral agencies in case the fund partners
directly with banks, particularly, if the fund is not set up as a Non-Banking
Finance Company (NBFC). Other challenges including optimal utilisation and
minimizing unnecessary loan losses, could addressed through a combination of
the following:


Partnering with banks that already have sizable SME
portfolios or are desirous of increasing their market share (would strongly
suggest the first round with private sector conventional and Islamic banks,
microfinance banks, and leasing companies only).

Partnering “directly” with banks either for across the
board new SME lending or for launching or increasing outreach under product /
program lending. Any credit guarantee that is launched through SBP dilutes the
interest immediately as the decision to reimburse the bank in case of default
rests solely with SBP and banks are paid after SBP’s audit. No claims are paid
if SBP decides that the loan was not granted according to its guidelines and
banks cannot argue with the regulator!

Providing on-ground and hands-on support in client
selection and credit decisions at least for the first 3 years. This period
could be very effectively used for knowledge transfer and capacity building
within the partner banks. One way of doing this could be to control the credit
autonomy during the first year with a higher loss coverage (say 75%); allow
joint credit decisions with a reduced coverage of say 50% during the second
year, and limit yourself to an oversight of decisions made by the bank’s staff
with say 25% coverage.

Encouraging and helping banks to introduce cash-flow
based and preferably collateral-free lending for Micro and Small Enterprises
with a comparatively higher coverage that collateralised loans.


Despite all the challenges, the attractiveness
of Pakistan’s SME market is high with ample opportunities for growth
particularly with the anticipated economic upturn associated with the China
Pakistan Economic Corridor (CPEC) initiative.

CENSUS – 2017 PAKISTAN (PDF). Pakistan Bureau of Statistics.
August 2017.

Ministry of Finance, Government of

Secret Strength of Pakistan’s Economy”. Bloomberg.

ECONOMIC INDICATORS” (PDF). Pakistan Bureau of Statistics.

Sector Statistics June 2017. State Bank of Pakistan.

Pakistan Microfinance Review 2016. Pakistan Microfinance Network.

Finance Annual Review 2016. State Bank of Pakistan.

for Promotion of SME Finance 2017. State Bank of Pakistan.

9 SME Finance Quarterly Review June 2017.
State Bank of Pakistan.