Financial Problems Faced by Small & Medium Enterprises (SMEs) in Pakistan

Abstract

This study attempts to research the issues faced by the SMEs in accessing finances in order to grow and develop and play their role in development of the economy. This study concludes that SMEs are not maintaining good deal of financial information that can be used by the banking institutions in order to assess the credit worthiness and other factors associated with the loan or financing applications. This shows that there is sheer lack of information handling and presentation on the part of SMEs due to which the banking institutions become skeptical and restrict issue of financing to SMEs. For some banks financing SMEs may be very difficult due to lack of precise reliable information on the financial condition and performance; not credible and weak business plans; weakness in SMEs management, market links, Governance and Information technology. There can be a lack of training for banks’ staff, who might not be sufficiently informed about lending to growing, high-risk companies. Banks’ weaknesses in identifying the characteristics of SMEs often lead to unsatisfactory lending arrangements. The banks often resist due to the higher overhead cost resulting from a high number of customers with smaller loan size. There is a perception that government is not in favor of SMEs and the policies are not the growth and development oriented. This might be due to the fact that the previous governments did not develop any polices that were in favor of the SMEs and SMEs were toatally ignored in the previous regimes. Due to this, people think that the government policies are not in facor of SMEs and they are right in their perception since there are no concrete steps taken towards devising policies to support the growth and development of SMEs. Banking policies are one of the major detterents in the path of SMEs to ask for loans and secure financing. Banks have adopted strict financing policies are are most of the time skeptical in releasing financing to the SMEs. Even if financing is issued, the policy is so strict that the SMEs are not comfortable in asking for financing from banks. Banks are also discriminating SMEs by imposing higher rates of financing. This negatively impacts SMEs as they have to cope up with the higher production costs along with meeting up the financing costs. This in turn negatively influences the bottom line and net incomes of the banks. Besides, the growth and development of the SMEs are also being showed down. In view of all the above analysis it was found that SMEs are reported to face a number of impediments to their growth and survival including limited access to financing. Access to equity and formal debt financing has repeatedly been identified as a recurring constraint to SME growth and development. Commercial banks apply conservative policies in lending to SME. More, importantly the existing structure of financial sector was developed to serve medium to large enterprises which are organized as a formal business. Most banks prefer to hold risk free-income generating assets and lending to SME is unattractive due to a range of objective and subjective factors. These include high transaction costs, regulatory rigidities or gaps in the legal framework, inability to do away with tangible collateral requirement, no linkage of financial products with sector needs and the inability to structure/ offer and manage risk-prone SME specific medium to long term financing options. It has been observed that 57% of new investment for Small and Medium Enterprises and 67% of working capital finance come from internal finance or retained earnings; only about 7% of funds for investment or working capital come from banks or other financial institutions. Even suppliers’ credit rivals the contribution of the banks as a source of working capital (4.5%). Another survey concludes that SME are indeed being rationed out of the credit market, rather than merely exhibiting a lower demand for credit.