A sustainable approach to supporting CMSMEs

Cottage, micro, small, and medium sized enterprises (CMSMEs) play a vital role in the economy of Bangladesh. Therefore, it is no surprise that they continue to receive special attention from the government. To support the policy objectives of the government, Bangladesh Bank (BB) has taken various measures to facilitate the growth of CMSMEs, the latest of which is the Credit Guarantee Scheme (CGS). In my previous article titled, "New credit guarantee scheme approved by Bangladesh Bank—Necessary, but not sufficient" which was published by The Daily Star on August 23, 2020, I discussed at length several CGS design issues that require further improvement. In addition, I briefly touched upon the necessity of a vigorous effort to encourage business formalisation as well as the establishment of a Collateral Registry. Now I will seek to weave an organic web of policy recommendations that can help create an enabling environment for CMSMEs to thrive in Bangladesh both amid and after the pandemic.  

While CMSMEs have always grappled with limited access to finance, Covid-19 has exacerbated their situation with financial institutions having become more risk-averse. As already mentioned, Bangladesh Bank (BB) has implemented several policies to provide financial support to the CMSME sector that has been hit hard by Covid-19. However, there is a need for a sustainable approach to supporting the CMSMEs such that the wheels of the market are sufficiently greased leading to them requiring minimal intervention from the government in the long run. After all, the plights of the CMSMEs are not new and without a sustainable approach, it will not be long before the effects of short-term government interventions dissipate. Therefore, it is imperative that a holistic approach is adopted that combines both short-term direct interventions from the government as well as sufficient motivation for the private sector to extend support to the CMSMEs as part of a sustainable business model.

While it is true that CMSMEs are inherently risky even when they are formalised because of the scope and nature of their businesses, financial institutions are also not trying enough to cater to their needs. Most of the commercial banks have not shown a sincere interest in adjusting or updating their lending methodologies when it comes to lending to CMSMEs. It is high time that the financial institutions, in particular, commercial banks, had developed bespoke loan products that were suitable for SMEs. For example, after months of shutdown caused by the coronavirus, now that businesses are reopening, many CMSMEs, in particular, the ones in retail businesses are in need of money to replenish their inventories. This is an opportune time for financial institutions (FIs) to develop loan products such as inventory finance for CMSMEs.

Also, CMSMEs in other sectors, such as those in manufacturing, which provide supplies to larger enterprises, can benefit from invoice discounting or factoring. These types of loan products do not necessarily require additional collaterals since inventories and invoices (i.e. accounts receivables) themselves act as collaterals. Classic examples of floating charges that relate to inventory and invoice discounting minimise the lending risk that the FIs have to bear. Nevertheless, the commercial banks in Bangladesh are yet to exhibit adequate interest in providing CMSMEs with these kinds of products which have already found traction in many countries seeking to support the SMEs. To this end, the Bangladesh government may consider providing technical assistance to the financial institutions to help them develop and roll out these loan products for CMSMEs, at least as a dry run.

Section 159 of the Company Act 1994 already provides for the registration of the floating charges as far as private limited companies in Bangladesh are concerned. If required, the laws governing floating charges (as in the case of inventory financing) should be revised, or further clarified and communicated clearly to the FIs to ensure their rights as they lend to CMSMEs. In addition, as mentioned previously, the government may consider establishing a Collateral Registry where FIs can register their security interests in CMSMEs' inventories or invoices which will deter the borrowing enterprises from using them as collaterals while seeking additional loans from other FIs.

While devising policies, it needs be understood that "one-size-fits-all" approach will yield only limited benefits. Instead targeted policies should be designed and implemented. This is because the needs and challenges of cottage and micro enterprises are different than those of small enterprises. Medium sized enterprises are even more different. While commercial banks are relatively better positioned to cater to the needs of the medium sized enterprises, microfinance institutions, due to their business model based on KYC (know-your-customer) are more effective in terms of lending to the cottage and micro enterprises. These nuances should be kept in mind when policy measures such as CGS are designed.

In Bangladesh, there is a sizable proportion of individual livestock farmers who raise cattle for dairy production or resale of animals for Eid-ul-Azha. These farmers, particularly the latter ones, reportedly, made losses due to lost sale opportunities during the last Eid mainly caused by information asymmetry. In order to ensure that these losses do not have a long-term adverse impact on the livestock farmers, micro finance institutions have to play a very critical role.

One of the major issues that FIs cite for a lack of interest in lending to cattle raising farmers is that it is virtually impossible (or very costly) for the FIs to monitor the cattle bought with financing. This concern is not unfounded since there have been many instances where farmers sold off their cattle to smooth their consumptions (or for other reasons) without repaying the debt in full. In order to address this particular issue, the government may consider following the example of Zimbabwe where the Ministry of Agriculture, Mechanisation and Irrigation Development has decided to launch a national cattle identification programme. The programme will entail having all cattle in Zimbabwe tagged with an electronic RFID enabling reliable traceability. This will also enable the FIs to grant loans to smallholder farmers using cattle as security and register a lien of the animals.

Finally, small and medium sized enterprises in Bangladesh can benefit from a Junior Stock Exchange Market as has been implemented by China and more recently, Jamaica. The idea behind the Junior Stock Exchange is to allow small and medium sized enterprises with high growth potential to register themselves on a separate stock market to raise capital through equity. Typically, this kind of market has less stringent rules for listing and provides some form of tax benefits to the listed companies. While the benefits of this kind of junior market vary with jurisdictions, it certainly has the potential to provide the much-needed support to emerging companies in Bangladesh in the medium and long run, if not in the short run.

Dr Tasneem Raihan is a Financial Economist at the Public Company Accounting Oversight Board (PCAOB).

The views expressed here are only those of the author.