PAKISTAN lacks on almost all fronts in terms of its performance in the small and medium enterprises (SME) sector. The country has a few centres that nurture and groom SMEs. Even at these centres, SMEs are not at par with those in other developing countries.

Finance, which paves the way for the realisation of dreams of young entrepreneurs, has eluded SMEs. Several factors contribute to the reluctance of financial institutions to stand as creditors to small firms.

My experience as a banker dealing with SME credits and data on SME performance over the years indicates that in a given environment, growth in SME finance, whenever achieved by some banks, results from the push and pull strategies of the State Bank of Pakistan.

However, such momentum lasts only for a few months or a year. The default rate increases and risk management prudence halts lending to SMEs. The banks manage with existing clients, and the new-to-bank rate stagnates.

Banks are willing to lend to small businesses integrated with corporations as they tend to have reliable cash flows

Pakistan has experienced no sustained momentum of SME finance growth in its history. These temporary momentums discourage prudent bankers from expanding SME portfolios due to the rise in default rates after these short-lived SME finance growth periods.

Lending to SMEs is a laborious act for banks. It requires a good number of personnel to disburse and manage, for example, Rs1 billion over 50,000 borrowers. The processing and securitisation of SME loans take the same route as the one used in the case of a corporate borrower. Most SMEs do not record business transactions or use modern management tools.

The data of SMEs on accounts receivable provided by them to their respective creditors is just part of formalities and of no practical use. Lending based on credible names, secured by appropriate collateral, is the pivot of SME financing, and all other aspects are just formalities to meet the regulations of the State Bank of Pakistan (SBP).

SME financing is facing many challenges. Some changes in the rules and pushes from SBP have proven to be of no value. We need to innovate to catch up with other nations in developing the SME sector.

Reliable cash flow estimations in new, existing and expanding businesses provide a strong base for lending to SMEs. The processes involved in lending based on cash flow are simple. However, the problem we face at the very outset in the SME sector is the unreliability of estimated cash flows. Assuming externalities remain constant, the internal dynamics of SMEs also lend no support to a reliable cash flow picture.

Cash flow is estimated in an SME credit proposal, but it is not relied upon. Practically, cash flow-based lending is non-existent in Pakistan. We can achieve higher and more sustainable growth of finance to SMEs if we can create an environment that lends support to the reliability of SMEs’ cash flow estimations.

In a given environment, we need to innovate to spur SME finance growth by developing and promoting corporations integrated with SMEs as buyers, assemblers, and marketers of products and services produced by SMEs.

The SMEs which are integrated with corporations tend to have reliable cash flow. The banks agree to lend to such SMEs on a cash flow basis by marking a lien on their receivables. The loan process is simple and fast and promptly serves the cash needs of SMEs. Japanese auto assemblers are prime examples of successful integration models of SMEs with corporations within and without Pakistan.

The relationship between SME finance growth and the level of SME integration with corporations can be ascertained by a review of the literature on SMEs integrated with corporations. Research on integrated SMEs to measure the degree of their financial growth related to being integrated into larger corporations is required to be conducted. Based on the results of this study, a pilot project may be launched to test the model empirically.

Research on SME finance growth from this perspective is expected to open innovative channels for SME finance growth. The governments of Pakistan and other countries may reformulate SME development policy in light of the findings of this research.

The banking sector in Pakistan has been reluctant to finance SMEs. The flow of financial resources to SMEs over the years has been very low. The default ratio of SME Finance is on the higher side. Lending based on cash flow to SMEs is almost non-existent, which points to a low level of integration of SMEs with corporations.

The rate of mortgage-secured lending is very low due to lengthy loan processes and the low availability of suitable collateral on the part of SMEs in Pakistan. The flow of finance to SMEs is resultantly low in this environment.

Once Pakistan adopts a policy that promotes corporations integrated with SMEs as buyers of raw materials, parts and semi-assembled machine parts, agricultural products, and services produced by SMEs, cash flow-based lending to SMEs can be delivered at a low cost using information and communication technologies (ICT).

The dream of SME finance growth may be realised through this innovation and use of ICT. The growth of corporations and SMEs may go hand in hand by adopting this integration model in Pakistan based on proposed research findings.

SME finance growth results in development at the gross root level and prosperity for all. Cash flow-based lending to SMEs can address our low SME finance growth problem as a viable solution.

The writer is the managing partner of DAAMS, a social enterprise for development of SMEs and poverty alleviation

Published in Dawn, The Business and Finance Weekly, February 19th, 2024