1. Promoting SMEs though Access to Finance
Presented by:
M. A. Baqui Khalily
Department of Finance
University of Dhaka, Bangladesh.

2. Overwhelming Interest in Access to Finance
Seminal work of McKinnon (1973) and Shaw (1973) led to re-emergence of the issue of “finance matters in development”
The classical work of Patrick (1966) – ‘demand following’ and ‘supply-leading’ finance strategy is re-visited.
Debate on the direction of causality between finance and growth. This is well documented (King and Levin (1993), Levin and Zervos (1998), Arestis et. al. (2001), Gupta (1984).
Several conclusions are derived from the literature: Finance follows growth in developing countries, and growth induces finance in developed countries.

3. Micro Level Research on Access to Finance
Rajan and Zingles (1998): Industries with access to external finance grow at faster rate.
Wurgler (2000) and Aghian et. al. (2007) with similar conclusion: Increase in investment in more growing industries.
BUT small and medium industries find it difficult to raise funds for inherent behavioral characteristics of financial institutions (Hutchinson and Xavier 2007; Berger and Udell 2004).
Research on impact of microfinance reinforces the fact ‘access to finance’ matters (e.g., Hossain 1988; Khandker; Zohir et. al.; Rahman et. al.)

4. SMEs in Development Agenda
Most of the growth theories suggest that industrialization is the engine of economic growth
A balanced growth of both agriculture and industrialization is very important and necessary for the economic development of Bangladesh
For pursuing the industrial development efforts, the main objectives and strategies focused are optimal utilization of resources, creating employment opportunities and catalyzing the growth of production and exports

5. SMEs in Development Agenda
The World Business Council for Sustainable Development (WBCSD) showed that in the developing countries, more than 90% of all firms, outside the agricultural sector, are SMEs and microenterprises and generating a significant portion of GDP
In Bangladesh, enterprises of less than 100 employees account for 99% of firms and 58% of employment

6. SMEs in Development Agenda (cont.)
Well managed and healthy SMEs are a source of employment and wealth as well as poverty alleviation. Moreover, there is a positive relationship between a country’s overall level of income and the number of SMEs per 1,000 people (IFC, 2006)
The World Bank’s Doing Business reports indicate that a healthy SME sector corresponds with a reduced level of informal or “black market” activities
Local SMEs can work as an important source of supply and service provision to the large enterprises of both national and internationals
SME is also good for communities itself, because through employment creation and growth, it will improve the standard of living of the communities.

7. Sources of Finance and Stages of SME Development
The entrepreneurs require mainly three types of finances:
(i) equity capital - to finance assets at the start of a business;
(ii) debts – to refinance assets; and
(iii) working capital – to maintain the day-to-day activities (Jesmin, 2009)
Access to credit/financing is deemed to be one of the greatest hurdles faced by SMEs

8. Financing stages (saublens)

9. INDUSTRIALIZATION AND SME DEVELOPMENT IN BANGLADESH
Bangladesh inherited a weak backbone of industrialization since independence.
According to Bangladesh economic review, the contribution of the broad industry sector to real GDP:
17.31 percent in ,
29.95 percent in
SMEs witnessed very limited growth during 90s, and this was mainly due to negative growth of the small industries (employment size less than 20).

10. State of SMEs in Bangladesh
The importance of SME especially small and cottage industries is always recognized in every development plans of government before and since liberation
Recently the development partners also giving importance to SMEs
The government of Bangladesh is also taking a lot measures for the improvement of the SMEs:
Targeted program for SME
Targeted for women entrepreneurs
SME Foundation
Refinancing of SME loans
The main constraints of financing, even with continuous of effort of government, could not resolved

11. State of SMEs in Bangladesh
There were approximately 6 million micro, small and medium enterprises (MSMEs), which included enterprises with up to 100 workers employing a total of 31 million people, equivalent to 40 per cent of the population of the country of age 15 years and above (MIDAS,2003)
By the end of 2010, it has grown enormously, at least by 50 percent. Approximately around 9 milion MSMEs.
Contribution of MFIs.

12. State of SMEs in Bangladesh
There are more than 600,000 small and cottage enterprises in Bangladesh (Ahmed, 2004) .
Some 3 million micro enterprises are also in operation
90 percent of all industrial units are SMEs (SEDF, 2003)
If we accept the estimates of Ahmed (2004) and the fact reported by SEDF, it can be estimated that there are some 900,000 industrial units in the country. Manufacturing sector contributes only around 10 percent of total employment.

13. State of SMEs in Bangladesh
Return to capital investment is higher for micro and small enterprises (above 30 percent) compared to 13 percent for the medium enterprises
SMEs in Bangladesh have higher profitability than some European countries. Operating profit of SMEs as reported in SEDF (2006):
Bangladesh: 12 percent
Greece: 7 percent
Franc 5.1 percent, and Canada: 9.2 percent
SMEs in Bangladesh have higher potentials and can play very significant role in growth and development, as it is Japan.

14. State of SMEs in Bangladesh
There is no precise estimate of the contribution of SMEs to GDP. Serder (2000) reported around 20 percent contribution of small-scale enterprises to GDP.
Daniels (2003): Contribution of MSMEs - around 25 percent to GDP. The contribution is expected to increase with the inclusion of public sector enterprises.
Rabbani and Sulaiman (2005) show that SMEs with relaxed liquidity constraint because of bank finance tend to create more employment than the SMEs with lesser or no access to credit
Despite lack of adequate data, empirical evidences suggest that SMEs perhaps contribute around 25 percent to GDP

15. SME Financing in Bangladesh
Dismal pictures of SME financing:
Khan, Imam and Khatun (1998)
Khan, Imam, Khatun and Ahmed (2003)
Daniels (2003)
SEDF (2006)
All these studies report same findings: Around forty percent of the SMEs do not approach banks for loans. Around fifteen percent of the loan applications are rejected on the ground of guarantee or collateral, asymmetric information and high transaction cost
In Bangladesh, SMEs are largely financed by own funds.
Equity fund through capital market is not a widely used source for small and medium entrepreneurs.

16. SME Financing in Bangladesh
The recent study of SEDF (2006) reinforces the earlier findings that SMEs have limited access to bank financing
It shows that about two-third of the SMEs did not approach banks for loans
Most of them approached banks for working capital loans. Not all of them were granted loans
It takes about two months on an average to get loan sanctioned. The findings are similar to the earlier studies.

17. Finance is a constraint
Access of the small enterprises to credit has not improved over the past 30 year – access to finance is still a dominating constraint.
All previous studies reported the same:
SEDF (2006)
Task Force report 2004
Ahmed 2004
Khan et.al. (2003)
Daniels (2003)
Serder (2000)
Khan et. al. (1998)
Rahman et. al. (1979)

18. What is the Present Trend? Small have little access
Trend in Industrial Finance by Size
Year
Industrial Term Credit
Working Capital
As % of Total credit
LME SE
Industrial Credit
Working capital
2009
89.08
4.04
95.47
2.33
21.30
17.59
2005
93.06
3.04
93.75
5.46
17.87
20.43
2004
93.35
3.52
92.88
6.34
18.59
19.49
2003
94.26
2.95
93.56
5.72
19.51
16.97
Source: Bangladesh Bank Publications

19. What restricts banks to finance SMEs?
Literature on industrial finance and entrepreneurship development amply document two factors that restrict banks to extend sufficient credit facilities to the SME sector.:
Collateral,
High transaction cost
Empirical evidences suggest that banks do not sanction credit to the SMEs for lack of collateral and high transaction cost (SEDF 2006; Khan et. al., 2003; Khalily et. al. 1994, Rahman et. al ).
SEDF (2006) reports that even 16 percent of loans sanctioned did not take loan for lack of sufficient collateral.

20. What Do We learn?
Small enterprises are largely excluded. They are the “Missing Middle’. This group has nether access to formal credit market nor do they have access to micro credit market.
Collateral is a constraint for promoting SMEs, in particular small enterprises.

21. BRAC Bank and “Missing Middle”
BRAC bank initiated SMEs lending in 2001
BRAC Bank emerged through a process of learning. BRAC
They probably perceived that while the ‘big push’ was required for taking micro enterprises to the next phase of development, it was important that small enterprises are promoted as they are the ‘missing middle’ in the path of development
In the private banks, the SMEs did not get sufficient access to get loan as the large corporation did.
BRAC bank came to break that tradition, and started providing different types of SME loans, particularly small business, since inception

22. Total number of borrowers by year (in thousands)

23. Industry mix of SME customers

24. BRAC Bank, as a Development Bank, follows Triple Bottom Line
Although BRAC Bank finances SMEs, its focus has been on the small enterprises with average loan size around TK 5 lacs. WHY?
They are largely left out in the credit market
Small entrepreneurs are essentially the people within lower 50th percentile of income distribution
These entrepreneurs learn through doing, and/or learning from the experience of others in the same profitable business
They have potentials to grow with backward and forward linkages
These enterprises are generally family enterprises with participation of qualified family members and hired laborers
They will be effective agents of change at the community level
promoting small enterprises will in fact help others with homogeneous characteristics to learn from the experiences of these arguably successful entrepreneurs.
BRA Bank not only provides credit to small business, they promote social and environmental dimensions of credit as well.

25. How Effective is BRAC Bank?
A recent study shows that BRAC Bank has made impact at the enterprise and household level of the borrowers.
The study was conducted over randomly selected 525 enterprises of 21 SME unit offices of BRAC bank
Of the enterprise borrowers, 35 percent were repeat borrowers. The other samples included enterprises who did not apply for repeat loan or rejected for the repeat loan.
The basic characteristics prior to accessing Brac Bank credit were homogenous in terms of number of employees, assets size, initial capital size.

26. Results Table: General characteristics of the borrowers
Types of Borrowers
Age of the entrepreneur
Educational qualification of the entrepreneurs
Experience in Current business
Experience in Family business
New
38.11
(8.48)
[134]
9.49
(2.97)
12.13
(7.12)
11.00
(13.22)
[7]
Repeat
40.01
(8.60)
[286]
9.54
(3.31)
15.01
(8.30)
8.05
(10.48)
[19]
Total
39.41
[420]
9.53
(3.20)
14.09
(8.04)
8.85
(11.08)
[26]

27. Table: PSM estimates of financial indicators
Variable
t-test
Difference as % of Control
Accumulation of Assets
Total Assets at cost (USD)
4.34
62.08
Total Assets at Market Price (USD)
4.77
50.12
Growth rate of Total Assets (USD)
3.69
111.85
Utilization of resources
Growth rate of Fixed Assets at cost
3.04
98.95
Growth rate of Fixed Assets at market price
6.37
157.75
Ratio of Fixed assets to Total Assets
-2.49
-12.75
Sales-fixed Assets
2.16
66.3
Long Run profitability
Growth Sales
Sales (US Dollar)
3.19
4.43
98.24
76.3
Profitability
Profit (USD)
1.81
2.82
Growth rate of Profit
2.68
75.02
ROA
-4.69
-22.97
Rate of Return
-6.38
-27.43
Financial Structure
Total Capital (USD)
4.1
33.44
Total Debt (USD)
3.68
31.89
Equity Capital (USD)
3.45
33.82

28. Table: Matrix of Economic Indicators
Specific measurement indicators
Repeat Borrowers
New Borrowers
Difference
t-stat
% of change over control
(N=134)
(N=286)
Employment creation
Number of full time male employees
2.26
1.62
0.64
3.27
39.64
Number of full time female employees
0.31
0.29
0.02
0.23

29. Creation of competitive environment or business
Table : Matrix of Economic Indicators: reflection of Perceptions (percent)
Economic indicators
Repeat Borrowers
New Borrowers
Difference
t-stat
Percentage change
Generation of savings
75.95
72.24
3.70
0.37 -
Income enhancement
52.21
30.88
21.34
6.60
69.12
Business expansion
71.71
35.03
36.68
8.84
104.70
Creation of competitive environment or business
74.68
71.51
3.17
0.49

30. Table : Matrix of Social indicators
Repeat Borrowers
Repeat borrowers
Difference
t-value
Percentage of change
(N=134)
(N=286)
Use of child labor (Number)
0.09
0.04
0.05
1.57
14.20
Education of children
(Percentage increase in expenditure)
51.88
28.52
23.35
4.30
81.89
Health (Percentage increase in expenditure)
45.99
26.33
19.66
6.81
74.69
Television (percentage increase in expenditure)
15.64
6.53
9.11
4.04
139.46

31. Table : Matrix of Market Development Indicators
Growth rate
Backward linkage
167 percent
Forward linkage
127.8 percent
Expansion of similar business
98.67

32. Table: Matrix of effectiveness indicators
Specific measurement indicators
First time borrower
Repeated borrower Di
P>|z|
DiD
Creating awareness
Communication by bank staff
47.27
(121)
47.95
(281)
0.68
0.9004
Bank advertisement
3.91
(10)
2.73
(16)
-1.18
0.530
Proximity to the unit office of BRAC Bank
9.77
(25)
14.68
(86)
4.91
0.528
Cost of fund
Low interest rate
2.76
(7)
4.45
1.69
0.421
Accessibility to BRAC loan
Borrower-friendly flexible lending system
50.00
(127)
45.20
(254)
-0.048
0.376

33. BRAC BANK is effective
BRAC Bank is effective in reaching the long ignored “missing middle” with average loan size of around Taka350,000.
They do provide collateral free loans.
Their loan programs have positive impacts at the enterprise and household level. Most interestingly, it has contributed to backward and forward linkages.
The bank operates largely in rural areas, and therefore playing a critical role in rural financial market

34. Can MFIs play a role in reaching out ‘missing middle’?
MFIs are largely financing micro enterprises in Bangladesh.
Missing middle can be financed by MFIs if lateral entry is permitted. Microcredit Regulatory Agency should think about it.
This will also create competition in rural credit market.