A commonly held belief in banking is that small and medium enterprises (SMEs) are the most vulnerable and risky ventures for financing.
However, IDLC Finance, a non-bank financial institution, has proven the concept a myth by showing how access to finance for small enterprises can create robust employment, keeping default loans at the lowest level.
IDLC, which turned its business focus on the SME sector 15 years back with the slogan "Small is Beautiful", saw an impressive annual growth in terms of employment generation, which reached 50% in the last five-year average period till 2019.
The SMEs which got access to finance saw robust growth in employment generation at the time when overall employment of the country grew at 1.5-2% in the pre-Covid-19 period.
Despite lending at a high rate to SMEs, IDLC managed to keep non-performing loans (NPL) at 3% in the last 15 years while the overall bad loan rate in the banking sector was above 10%.
The success story of IDLC was revealed in a survey titled "Access to Finance for SME & Impact on Job Creation: Empirical Evidence based on IDLC Finance". It was conducted jointly by IDLC and Policy Research Institute (PRI) of Bangladesh.
The survey result was disclosed at a virtual conference held on Tuesday. Dr Bazlul Haque Khondker, director of PRI, presented the survey paper while the institute's Executive Director Dr Ahsan H Mansur and IDLC Finance Managing Director Arif Khan were present.
Despite such a success story, banks still appeared reluctant to finance SMEs, which is evident in slow implementation of the Tk20,000 crore stimulus package announced for the cottage, micro, small, and medium enterprises (CMSMEs) by the government to support pandemic-affected businesses.
Banks disbursed only 40% of the package till last week and the Bangladesh Bank is planning to extend the disbursement target for the third time till December, which earlier was November.
On the other hand, almost 90% of loan disbursement under the stimulus package of Tk30,000 crore announced for large industries is already complete and most banks have completed their target already, according to the Bangladesh Bank data.
The reason for the banks' reluctance to disburse loans under the CMSME package is because SMEs are most affected by the pandemic and this poses a risk for banks when it comes to recovering loans, said a senior executive of the Bangladesh Bank.
To relieve the banks from this unease, the Bangladesh Bank in July introduced a credit guarantee scheme of Tk2,000 crore to share credit risk with banks to encourage them to lend to SMEs.
While the banks are reluctant to finance SMEs, the IDLC survey came up with a different picture of such enterprises.
Though the SMEs find it challenging to get financing, employment growth in the IDLC-financed enterprises increased by 75% between 2016 and 2019, indicating that the recently established firms have been expanding more in terms of employment generation.
To assess employment impacts created by IDLC-financed SMEs, the survey was conducted among 782 sample enterprises. IDLC has 46% of SME financing out of its total portfolio and the number of SMEs was around 14,000 in 2019.
There is a belief among banks that SME financing is highly risky due to the vulnerable nature of the businesses but IDLC proved them wrong as it kept bad loans at the lowest level of 3% in the SME sector in the last 15 years, said IDLC's Arif.
Despite the high default rate in corporate loans, above 10%, in the banking sector, banks are more inclined to invest in large businesses, ignoring small ones which are leading in employment generation, he said.
Due diligence and a proper transparent loan process gave good results to IDLC as growth in employment generation in IDLC-assisted SMEs was large – over 100% – when the time frame considered was from their inception to 2019, Arif explained.
He said IDLC-financed SMEs were successful even after taking out loans at a higher interest rate. "So, interest rate is not the issue. The issue is ensuring access to finance."
However, Covid-19 put the brakes on fast employment generation, putting SMEs in deep trouble which will ultimately hit overall employment generation in the country, the IDLC Finance managing director said.
With the ongoing ravage of the pandemic, the rosy picture completely changed as 30%-40% of SME borrowers could not pay back their loans, said Arif.
Low-cost stimulus will help them recover early, he hoped.
Employment growth in sample enterprises from their inception to 2019 has been large, according to the survey, while that in all sample enterprises from inception in 1989 to 2019 was 105.7%.
Employment growth in sample enterprises incorporated between 2011 and 2015 was 91.8% and the annual average employment growth over a 6.5-year period was 14.1%.
The largest employment growth was recorded in the service sector, 174.2%, while it was 131% in manufacturing over the entire period from inception to 2019.
The most impressive part of employment generation in the SME sector was that the largest growth was observed in salaried jobs. This reflects that small enterprises are shifting from informal to formal sectors.
The largest share was for salaried jobs at 62%, followed by day labourers, 22%.
The annual turnover of single-ownership enterprises doubled from 2015 to 2019.
Joint-ownership enterprises experienced a five-fold increase in annual turnover, reaching Tk20.75 crore in the last five years, while it more than doubled for single ownership ventures, amounting to Tk8 crore, according to the survey.
A research report titled "Development of SMEs in Bangladesh: Lessons from German Experiences" recently said 99% of ventures in the Organisation for Economic Co-operation and Development (OECD) countries were SMEs.
About 70% of the labour force in these countries are employed in the SME sector and they contribute 50%-60% to their national economies, according to the report prepared by the SME Foundation of Bangladesh and Friedrich-Ebert-Stiftung (FES), a German non-profit organisation.
IDLC's survey data shows that despite having robust growth in employment generation and good performance in loan repayment, SMEs are still suffering from a lack of access to finance.
Most of the single-ownership and small firms tended to start their operations with very limited access to formal sources of financing. Almost 92% of the firms started their operations solely with their own funding, and 3.1% sourced loans from informal sources like friends and relatives.
Though job creation is higher in the SME sector, technology penetration is lower, which will cause a drop in SMEs, said Ahsan H Mansur.
Moreover, SMEs are mostly focused on the local market, which is another challenge for their sustainability, he said.
According to the survey, the majority of the sample enterprises catered to local, regional and national markets. Sales of their products and services were mostly in local markets, about 95%. Only 1.3% of the sample enterprises were catering to the export market.
The share of sample enterprises catering to both local and export markets was even smaller, around 0.8%.
Mansur said capital intensity has increased which is a global trend. "So, investment will have to increase. Now the main concern is to increase investment which remains stagnant."
The survey data shows that it cost about Tk10 lakh for IDLC borrowers to create jobs for 37 people in 2015, which came down to eight jobs in 2019.
Mansur said large borrowers try to use muscle power for not returning money to banks.
"They even influence the legal system by taking a stay order against their status as defaulters while SMEs are paying regularly. So, the government should provide support to SMEs instead of injecting capital into state banks."
He said the credit guarantee scheme can play a good role in encouraging banks to finance SMEs by sharing risks with the government.
The stimulus package of Tk20,000 crore is inadequate to support SMEs, said Mansur.
He suggested that the government increase the credit guarantee scheme fund to incorporate new entrepreneurs under it.