SME development

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

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.  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 1980-81,
 29.95 percent in 2009-10
 SMEs witnessed very limited growth during 90s, and
this was mainly due to negative growth of the small
industries (employment size less than 20).
INDUSTRIALIZATION AND SME
DEVELOPMENT IN BANGLADESH

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

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

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 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. 1979).
• SEDF (2006) reports that even 16 percent of loans
sanctioned did not take loan for lack of sufficient

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

22. Total number of borrowers by year (in
thousands)
2007 2008 2009 2010
52.12
77.49
65.42
59.39
1.26
2.84
1.92
1.03
53.38
80.33
67.34
60.42
Male Female Total

23. Industry mix of SME customers
2007 2008 2009 2010
49,791
52,285
44,007
40,687
2161
13389
8881
9351
1,063
12,439
12,554
8,960
356
2,225
1,891
1,418
Trade Agriculture Manufacturing Service

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

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
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)
[134]
12.13
(7.12)
[134]
11.00
(13.22)
[7]
Repeat
40.01
(8.60)
[286]
9.54
(3.31)
[286]
15.01
(8.30)
[286]
8.05
(10.48)
[19]
Total
39.41
(8.60)
[420]
9.53
(3.20)
[420]
14.09
(8.04)
[420]
8.85
(11.08)
[26]
Table: General characteristics of the
borrowers

27. 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
Total Capital (USD) 4.1 33.44
Table: PSM estimates of financial
indicators

28. Table: Matrix of Economic Indicators
Economic
indicators
Specific
measuremen
t indicators
Repeat
Borrower
s
New
Borrower
s
Differenc
e
t-stat
% of
chang
e over
contro
l
(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. Table : Matrix of Economic Indicators:
reflection of Perceptions (percent)
Economic
indicators
Repeat
Borrowe
rs
New
Borrower
s
Differenc
e
t-stat
Percentag
e 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
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
Market development indicators Growth rate
Backward linkage 167 percent
Forward linkage 127.8 percent
Expansion of similar business 98.67

32. Effectiveness
indicators
Specific
measurement
indicators
First time
borrower
Repeated
borrower
Di
P>|z|
DiD
P>|z|
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
(25)
1.69
0.421
Accessibility
to BRAC loan
Borrower-friendly
flexible lending
system
50.00
(127)
45.20
(254)
-0.048
0.376
Table: Matrix of effectiveness indicators

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.