In December 2017, the State Bank of Pakistan (SBP) launched its policy to encourage financing for small and medium enterprises (SMEs). The policy seeks to enhance the sector’s share in private-sector credit from 8.7 per cent to 17pc and increase the number of borrowers from less than 164,500 to half a million by 2020.

A year later, the situation remains more or less unchanged: The sector, particularly the small enterprises that are also known as the Missing Middle of Pakistan’s economy, continues to be excluded from the formal financial sector.

Clearly, commercial banks remain uninterested in lending cash to small entrepreneurs because such borrowers don’t own liquid assets or past credit history. They are poorly documented as a large majority of them operates in the informal sector. Apart from considering SME finance a risky business, banks haven’t made any attempt to develop skill and expertise for clean lending to small enterprises. This is in spite of several policy interventions by the central bank to boost SME finance over the last decade and a half. Lack of access to banking credit remains a major factor hampering the sector’s growth.

Commercial banks remain uninterested in lending cash to small entrepreneurs because such borrowers don’t own liquid assets

The number of SMEs across Pakistan is estimated to be 3.2 million. They employ 78pc of the country’s labour force and account for 30pc of GDP and 25pc of the total manufactured goods exports.

Given their impact on exports, jobs and growth, successive governments made the promotion of SMEs a major plank of their economic plans. But no effort has succeeded primarily because of the reluctance of banks to support small enterprises for fear of losing money as well as their tendency to focus on corporate finance.

The present government has repeatedly underscored the importance of SMEs in its economic revival plan. But it is unlikely to succeed in pushing SME growth without increasing small entrepreneurs’ access to formal credit. One way of doing so is to allow microfinance banks (MFBs) with skills and experience of clean lending on the basis of a business’s cash-flow analysis.

“Commercial banks neither have the expertise to assess repayment capacity of small businesses (not backed by liquid assets) nor have they tried to develop any such model. And they’re mostly hesitant to give smaller than Rs10m loans because of the cost and effort involved, thus creating a huge financing gap for the Missing Middle,” says Mudassar Aqil, the CEO of Finca Microfinance Bank.

“MFBs have demonstrated how to work with a small business. They have the insight and experience to assess a small business and are naturally positioned to fill this gap if the central bank provides them with the regulatory space by initially allowing them to finance a business in need of cash up to Rs10m and then gradually increasing the financing limit,” he argues.

At present, MFBs are allowed to lend a micro or small business up to Rs1m. “Finca and other MFBs have experience and expertise of assessing the repayment capacity of a business and clean lending on the basis of the cash-flow analysis. We’re naturally aligned to work with small enterprises, especially in areas like restaurant business where commercial bankers dare not go at all owing to the high risk involved. With our maximum loan limit of Rs1m, we can serve a micro enterprise but not a small business.”

According to Mr Aqil, whose bank has a 10pc share in the existing Rs250 billion microfinance market, with a loan portfolio comprising 97pc clean and 3pc gold-backed advances, says MFBs have a network of 3,500 branches across the country that allows the industry to reach out to and serve a large majority of small enterprises.

“Besides, Finca and other MFBs are fast moving into digital space or branchless banking that allows them to disburse loans at a rapid pace. Our bank takes three days to process a loan application, assess the repayment capacity, do a cash-flow analysis and digitally transfer loans to its borrowers. We are reducing this application-to-disbursement period to 24 hours.”

The Finca chief contends that the enhanced regulatory space allowing MFBs to tap the market of small businesses will help them reduce their transaction costs and consequently interest rates. “The bigger the loan size, the smaller the administrative and distribution cost and interest rate.”

He is of the view that the government should positively incentivise the microfinance industry to financially support the small sector through tax incentives. At present, MFBs are paying 39pc tax that includes 35pc corporate tax and 4pc super tax. “We serve people in areas where even government services are missing. The removal of super tax will help us increase our retained earnings that MFBs have been reinvesting in their expansion and enhancement of their lending capacity through rapid digitisation of their business processes. We are the most efficient engine (of growth) in the country’s financial sector.”

For starters, he argues, the government should allow MFBs to enter the SME finance, set financing targets and allow tax rebates to the banks that meet their targets on their income from lending to the marginalised sectors — micro and small enterprises.

If the government and the regulator are interested in helping the country’s Missing Middle, they’ll have to make innovative policy interventions and allow regulatory space and tax incentives to MFBs. Expecting commercial banks to get out of their comfort zones and start financing “risky businesses lacking liquid assets” hasn’t worked in the last 70 years and is unlikely to work in the future.

Published in Dawn, The Business and Finance Weekly, January 14th, 2019