Case Study on SME Banking [PRIME BANK]

8/14/2019 Case Study on SME Banking [PRIME BANK]

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(Faculty of Business Studies)

COURSE TITLE- Fundamentals of Computer

ASSIGNMENT ON

SME Banking System ofPRIME BANK LIMITED

Course Instructor: Submitted By:

Mr. Abhijit Pathak Md.Asif mahmood

Lecturer, ID NO. - 0510110661

Faculty of Business Studies Program- BBA

Premier University, Semester-

Chittagong. Batch- 10th

Premier University

Chittagong.

Submission Date- 10th June, 2009


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LETTER OF SUBMISSION

To

Mr. Abhijit Pathak

Lecturer,

Faculty of Business Studies

Premier University

Chittagong.

Subject: Solicitation for the acceptance of the assignment.

Sir,

With due respect and great pleasure I would like to submit our assignment on "SME

Banking".

During this analysis I have enriched and gained experience regarding practical aspects of

Banking System.

I will, however, remain grateful if you would kindly accept my assignment and pardon

me for any shortcoming, which may occur in spite of my utmost endeavor in this regard.

Yours Faithfully,

Md.Asif Mahmood

ID No. - 0510110661

Program- BBA

Semester-

Batch- 10th

Premier university

Chittagong


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Acknowledgement

First of all, I would like to recall Almighty ALLAH, whose kindnesses helped us

to end up with an extensive effort.

My indebtedness and gratitude to the many individuals who have helped shape this

assignment cannot adequately be conveyed in a few sentences. However, I must

record our immense indebtedness to my Course Instructor Mr. Abhijit Pathak, for

sparing his valuable time to give me the direction to compile this assignment. His

help in this regard encouraged us a lot to accomplish this assignment.

It would be unwise on part of us if I dont acknowledge the contribution of

the ban

k officers of PRIME BANK. Without their help our assignment would not be

fruitful.


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Chapter 1

Introduction


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1.1 Origin of the Report:In recent days the Small and Medium Enterprise (SME) Financing has become animportant area for Commercial Banks in Bangladesh. To align its corporate policy withthe regulation of Central Bank, banks have become more concerned about SME andopened windows to conduct business in this particular area. This study has been

conducted to fulfill the requirements of sixth term MBM program and gain an insightabout the present condition of small and medium enterprise in the economy ofBangladesh and their financing scenario in light of Bangladesh Bank regulation.

1.2 Background of the Study:After Liberation of Bangladesh, intensive efforts were undertaken to accelerate the rate ofindustrialization in the country. At the beginning, import substitution and subsequentlyexport-led economic growth strategy was pursued for industrialization. In order to attainthis objective, large amount of industrial credit was funneled to the industrial sector. Butthe whole exercise of industrialization came to a halt with the massive diversion ofresources to other non priority sectors. Policy makers, of late, have come to recognize the

contribution of SME sector towards economic development in the country. Small andmedium enterprises have been recognized as one of the most important means forproviding better economic opportunities for the people of least developing countries likeBangladesh. A developing economy like that of ours suffers from many peculiarproblems such as disproportionate pressure of population on agriculture due to lack ofrural industrialization, unemployment and underemployment of human and materialsresources, unbalanced regional development etc. The contribution of small and mediumenterprises in the solution of these problems is beyond doubt, provided they are organizedand run on scientific basis.Small and medium enterprises are particularly suitable for densely populated countrieslike Bangladesh where SME sector can provide employment with much lower investment

per job provided. Out of 11% employment of the civilian labor force provided by themanufacturing sector, about two thirds are estimated to be provided by the small andcottage industries sector. Again, development of small industries facilitates the effectivemobilization of capital and labor resources. They also help in raising standards of livingof people in rural areas. Contribution of SME sector to GDP remained above 4% duringthe period from 1985-86 to 1999-00. Moreover, the present contribution of SME sector toGDP is approximately 5% and SME sector employs 25% of the total labor forces, thusthis sector is the present available sector for creation of jobs (Saha, Sujit R. 2007).

Research papers developed by Bakht, Zaid (1998) and Ahmad, Salahuddin et al. (1998)described that the policy environment within which SMEs in Bangladesh operate

accompanies legal, regulatory and administrative constraints to employment creation bySMEs. The robustness of SME contributions to employment generation is a commonphenomenon in most developing countries in that the magnitude varies between 70% to95% in Africa and 40% to 70% in the countries of the Asia-Pacific region (Ahmed, M.U.1999).Liberalization of industrial and trade regimes along with globalization are likely to havehad significant effects on Bangladeshs SMEs (Ahmed, 2002; Bhattacharya et. al., 2000).


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Various recent studies (Ahmed, M.U. 2001, ADB 2001, USAID 2001) show that SMEshave undergone significant structural changes in terms of product composition, degree ofcapitalization and market penetration in order to adjust to changes in technology, marketdemand and market access brought by globalization and market liberalization. Theofficial data show that the share of private investment in Bangladeshs GDP in the late

1990s, which may be considered as the post-reform era, has remained more of lessconstant at around 15% (Bhattacharya, 2002). This may be interpreted as an evidence ofstagnant private sector activities in the country.

The recent private sector survey estimates the contribution of the micro, small, andmedium enterprises (MSMEs) is 20-25% of GDP (Daniels, 2003). While SMEs arecharacteristically highly diverse and heterogeneous, their traditional dominance is in afew industrial sub-sectors such as food, textiles and light engineering and wood, cane andbamboo products. According to SEDF sources quoted from ADB (2003), food and textileunits including garments account for over 60% of the registered SMEs.

Despite these contributions in the economy of the country, Banking sectors are notinterested in financing the small and medium enterprises; rather there is a decline in theamount of advances by the Banking sector. There are approximately 52 Banks operatingin our country and all are serving large enterprises rather than SMEs though only thesmall enterprises contribution is 5% in GDP of Bangladesh in 2007. But why?

What are the causes for which Banks are not interested in financing this sector? Fromrecent statistical data of Sonali Bank of Bangladesh, we see that the credit recovery rate is51.44% in this sector. Why this recovery rate is not large enough? Why the SMEs arefailing to payback their credit to the lenders? We have tried to find out the answer ofthese questions in this research paper.

1.3 Objectives of the Study:Based on the above discussion the following objectives are set for the study :

To review the role of SMEs in the economy as well as current status of SMEsand their financing by Banks in Bangladesh.

To find out the reason why the Banks are not interested (problems) to financethe SMEs.

To review the present role of Regulatory Authorities in SME financing anddevelopment.

1.4 Methodology of the Study:The study was conducted mainly based on secondary information although someinformation relating to entrepreneurs have been collected primarily. The sources of datainclude Office Records, BIBM - Library, Different Research Paper regarding SMEs,Different Publications on SMEs of different banks and some websites.

Sample banks of DNCBs, PCBs, and FCBs from the sample frame, was selectedpurposively considering the amount of loan size, interest rate, loan processing fees,


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period of loans, mode of finance and management.

Policies relating to SME financing such as fiscal policy, monetary policy and internalpolicies of commercial banks was examined thoroughly with a view to find out theinfluence of existing policies on SME financing. Trend and pattern of bank financing to

SME was analyzed by classifying the financing in terms of areas, rate of interest, types,category, and banks.

The collected information was qualitatively analyzed according to the objectives of the

study.

1.5 Limitations of the Study:Since this research is only for academic purpose, there were some limitations in thisstudy. These are mentioned below:

1. Discussion about the Small and Medium Enterprises is a vast subject, but onlysome selected areas are covered in the research paper.

2. The study is basically based on secondary data.3. Time was enough but it was not possible to give full concentration in this regard

due to continuous pressure from other courses.

1.6 Organization of the Report:This paper is divided into ten chapters. The first chapter is the introduction of the report.The second chapter focuses on the current status of SMEs in the economy. The thirdchapter explains the current status of SME financing by banks in Bangladesh. The fourthchapter explains why banks are not interested in financing the SMEs. The fifth chaptershows minimum requirements for SME financing according to Bangladesh Bank. Thesixth chapter contains prudential regulations for SME financing by Bangladesh Bank.The seventh chapter shows guidelines by Bangladesh Bank for SME financing. The

eighth chapter describes other developmental activities for SME financing. The ninthchapter explains constraints of SME financing. The last chapter contains the concludingremarks of the report.


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2.1 Brief Macro-economic Review:

Bangladesh, mainly backed by the growth of manufacturing, construction and servicesector has achieved a year-upon-year GDP growth of 6.51% in 2006-07, as comparedwith the 6.63% in FY 2005-06, and 5.38% in 2004-05. Per capita GDP recently surpassed

$500. From 1% during the 1970s, growth rate of GDP per capita has ramped up to over3% since the early 1990s and, since 2003-04, even higher, to 4 off percent. Growth hasbeen more stable too; Bangladesh among the handful of countries that sustained positiveper capita growth in each year since the early 1990s. This performance has beenunderpinned by rising agricultural and non-farm rural output and a rapid expansion inexport of readymade garments (RMG).

Faster economic growth has helped Bangladesh to reduce the poverty rate by about 1(one) percentage point per year since 1990. Poverty fell from 60% in 1990 to 50% in2000. Although the latest poverty data are still being collected, proxy indicators suggestthat good progress on poverty reduction and social development has continued in recent

years. Many MDGs are also on track for being met. (World Bank 2005)

The rate of gross investment in GDP in 2007-07 is 24.33%. The relative share of privatesector in gross investment, which has been growing secularly, is 18.73% in 2006-07.Between 2005-06 and 2006-07, credit to the private sector grew by 11.2%. Thepopulation growth rate averaged 1.5% or so; the literacy rate has averaged at 62% duringthis decade.Growth rate of manufacturing output of Bangladesh is on an increasing trend.Manufacturing growth during 1992-96 averaged 8.21%. In the next four years, thecorresponding growth averaged more than nine percent annually. Service sector grew atan average rate of 4.9%, which is lower than that of industries (manufacturing) sector.

The quantum index of SMEs has grown by 5.4%. The export of readymade garments(RMG) both woven and knitwear has picked up a commendable mode of growth, whichearns over 76% export earnings.

2.2 Current Status of Small and Medium Enterprises in

Bangladesh :The Small and Medium Enterprises worldwide are recognized as engines of economicgrowth. The commonly perceived merits often emphasized for their promotion especiallyin the developing countries like Bangladesh include their relatively high labor intensity,dependence on indigenous skills and technology, contributions to entrepreneurshipdevelopment and innovativeness and growth of industrial linkages.

2.2.1 Definition :According to the latest circular of BANGLADESH BANK (Date 26/05/2008), thedefinition of Small & Medium Enterprise sector is given below:

Small Enterprises Small enterprises refer to those enterprises which are not anyPublic Limited Companies and which fulfill the following criteria-


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Service Concern - Having an investment of Tk. 50,000 to Tk. 50, 00,000 excludingland & building and / or employing up to 25 workers. Business Concern - Having an investment of Tk. 50,000 to Tk. 50, 00,000excluding land & building and / or employing up to 25 workers. Manufacturing Concern- Having an investment of Tk. 50,000 to Tk. 1,50,00,000

excluding land & building and / or employing up to 50 workers.

Medium Enterprises Medium enterprises refer to those enterprises which are notany Public Limited Companies and which fulfill the following criteria- Service Concern - Having an investment of Tk. 50,00,000 to Tk. 10,00,00,000excluding land & building and / or employing up to 50 workers. Business Concern- Having an investment of Tk. 50,00,000 to Tk. 10,00,00,000excluding land & building and / or employing up to 50 workers. Manufacturing Concern - Having an investment of Tk. 1,50,00,000 to Tk.20,00,00,000 excluding land & building and / or employing up to 150 workers.

SMEs in Bangladesh are also defined for purposes of industrial policies by Ministry ofIndustries (MOI). Historically, this definition has been in terms of fixed investment brackets, and a dual mode definition is in place, separate for manufacturingestablishments, and service establishments.

According to the Industrial policy 2005, small and medium enterprises shall becategorized using the following definitions:

a. Manufacturing enterprise:

Small enterprise an enterprise should be treated as small if, in current market prices,the replacement cost of plant, machinery and other parts / components, fixtures, supportutility, and associated technical services by way of capitalized costs (of turn keyconsultancy services, for example), etc, excluding land and building, were to be up to tk.15 million;

Medium enterprise - an enterprise would be treated as medium if, in current marketprices, the replacement cost of plant, machinery and other parts / components, fixtures,support utility, and associated technical services by way of capitalized costs (such as turnkey consultancy services), etc, excluding land and building, were to be up to tk. 100million;

b. Non-manufacturing enterprise:

Small enterprise an enterprise should be treated as small if it has less than 25workers, in full time equivalents;

Medium enterprise - an enterprise would be treated as medium if it has between 25and 100 employees.

2.2.2 Overview of the SMEs in the economy of our country:


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There is a great interest in small and medium enterprises (SME) as a major plank ofpoverty reduction in Bangladesh. The government has formulated a comprehensiveindustrial policy 2005 by putting special emphasis for developing SMEs as a thrust sectorfor balanced and sustainable industrial development in the country to help deal with thechallenges of free Market economy and globalization.

Some data with a national scope that are pertinent to characterizing SMEs in Bangladeshas of 2001-2003 are presented in Table 1. The highlight of this table is the following:There are some 78,440 private sector establishments of various sizes in Bangladesh withsome 3.5 million workers employed in them. The urban Bangladesh accounts for some60% of units and 76% of employment in the private-sector enterprises. Rural Bangladeshaccounts for the rest. 93% of all units in Bangladesh belong in the SME category, i.e.have between 20 and 99 employees. However, SMEs account for only 44% of the totalemployment of the enterprise sector.Private companies limited by liability account for strictly a very small proportion of thetotal number of SMEs in Bangladesh.

Table 1: Number of units and levels of employment in small and medium enterprises,

2001-03 (All numbers are in thousands)

Description Urban Rural TotalSmall Medium Large Small Medium Large Small Medium Large

No of units 39.9 3.17 4.036 29.0 1.29 .88 68.96 4.46 5.01

% Of totalnumber of

units

50.9 4.0 5.1 38.1 1.6 1.11 87.9 5.7 6.4

Employment 740.4 211.5 1712.67

516.8 85.85 234.669

1257.2

297.4 1947.3

% Of totalemployment

21.14 6.0 48.9 14.8 2.4 6.7 35.9 8.5 55.6

Source: BBS Census of Enterprises, 2001/2003.

Table 2 shows the average employment per establishment within each of the small andmedium classes for urban and rural Bangladesh in 2001/2003. The following results areworth highlighting. Let it be noted that these are weighted averages.

First, the average employments per establishment for small establishments have values ofbetween 17 and 20 workers across all industries. We find a similar a narrow range ofbetween 65-69 employees for average employment size for medium enterprise.

Table 2: Average head-count per establishment across Bangladeshs industries,

2001-03

(All numbers are inthousands)

Small Medium SME Large All

Food and Tobacco 18.6 65.1 21.0 470.5 38.9

Textile manufacturing 19.1 66.2 21.9 490.9 56.6


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Ready to wear apparels 17.8 70.3 22.9 512.7 249.6

Wood, leather & paper printing 17.0 66.8 19.7 373.9 38.0

Chemicals and plastics 19.1 67.0 22.7 367.2 58.0

Non-metallic mineral products 26.0 70.3 41.5 196.8 83.4

Fabricated goods, electrical & means of

transport

17.0 65.7 20.3 282.5 35.1

Mining and manufacture 24.6 65.5 32.7 227.7 58.9

Various personal services 17.5 66.0 19.9 293.3 28.2

Education/healthcare 18.1 65.5 20.3 292.4 26.7

All industries 18.2 66.7 21.2 288.5 44.6Source: BBS Census of Enterprises, 2001/2003.

Table 3 shows the percentage importance (in terms of both number of units and the

employment level) of SMEs in the overall world of enterprises. The numbers of SMEunits predominate the numbers of large enterprises: typically more than 90% of allenterprises are in the SME class-class. However, the percentages share of SMEs in totalemployment controlling for the location is almost always less than for the number ofunits.

Table 3: The structure of industries in Bangladesh with respect to size of firms,

2001-03(All numbers are in thousands)

% Of establishments % Of total persons employed

Small Medium Large Small Medium Large

Food and Tobacco 6.7 0.4 .03 2.8 0.5 3.1

Textile manufacturing 14.2 0.9 1.2 6.0 1.3 13.2

Ready to wear apparels 1.8 0.2 1.7 0.7 0.3 20.1

Wood, leather & paper printing 2.9 0.2 0.2 1.1 0.2 1.4

Chemicals and plastics 1.7 0.1 0.2 0.7 0.2 1.7

Non-metallic mineral products 1.6 0.9 0.9 0.9 1.3 4.0

Fabricated goods, electrical &means of transport

4.6 0.3 0.3 1.6 0.5 1.7

Mining and manufacture 0.2 - - 0.1 0.1 0.2

Various personal services 13.6 1.2 0.8 9.3 1.8 5.1

Education/healthcare 31.1 1.5 0.8 12.6 2.2 5.2

All industries 87.9 5.7 6.4 35.9 8.5 55.6Source: SME Cell, using data from BBS Census of Enterprises, 2001/2003.

Table 4 show that the relative importance of SMEs, both in terms of numericalimportance of establishments or employment, in the context of all enterprises withemployment size of exceeding 9 workers remains roughly similar across an urban-ruraldivide. The role of SMEs in production is therefore not affected by geography.


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Table 4: Proportion of SMEs in enterprise population, and in employment, by

administrative Divisions of Bangladesh, 2001-03

(All numbers are in thousands)

Divisions Urban (% Of SMEs in thenumber of

urban units)

Urban (% OfSMEs

employment inurban areas)

Rural ((% OfSMEs in the

number of ruralunits)

Rural (% OfSMEs

employment inrural areas)

Dhaka 93.8 61.2 95.6 65.3

Chittagong 93.7 54.2 62.4 69.1

Rajshahi 95.3 65.9 97.9 81.3

Khulna 93.8 59.1 95.8 70.5

Sylhet 96.6 68.6 91.9 41.5

Barisal 95.7 69.4 97.8 82.7

All divisions 94.8 63.1 95.2 68.4


Table 5 shows the percentage structure of small and medium enterprises, takenseparately, across a large number of industries. Like in the discussion of Table 3, weagain see the quantitative importance of food, beverage, textile manufacturing, non-metallic mineral products among manufacturing sub-sectors as providing the basis forsmall and medium enterprises in Bangladesh. Once again, the importance of services ishighlighted.

Table 5: Industrial structure of small and medium enterprises in urban and rural

Bangladesh, 2001-03

(All numbers are in thousands)Sectors Proportion of small

enterprises in the totalProportion of mediumenterprises in the total

Ruralenterprises

Urbanenterprises

Ruralenterprises

Urbanenterprises

Mining 0.4 0.2 1.2 1.0

Food and Tobacco 16.6 9.3 7.4 9.0

Textile MFG 58.7 8.4 29.2 17.5

Wearing apparels 0.3 4.6 1.0 3.3

Wood products 0.2 2.6 0.4 1.8

Tanning etc 1.1 0.8 0.1 0.2Paper and printing 0.1 3.3 0.4 3.4

Chemicals and plastics 0.4 4.2 0.7 4.6

Non-metallic mineral products 6.1 1.1 47.9 3.1

Fabricate products 0.7 3.9 0.6 5.8

Electrical equipment 0.0 0.7 0.2 0.7

Mfg. Transport equipment 1.6 0.5 0.9 0.7

Utility service 0.2 5.0 1.9 3.0


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Construction 0.1 0.5 0.6 1.8

Trade 2.4 4.9 0.5 4.4

Eaterties 1.4 7.1 0.3 5.2

Transport and Communication 1.2 22.0 2.8 7.6

Finance and Banking 8.4 16.9 3.8 13.5

Real Estate 0.2 3.9 0.3 7.5



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2.2.3 Contribution of SMEs in the Economy:In view of present economic development effort in Bangladesh the SME sector plays an

important role. These are reflected in the following performance /activities of this sector:

During the Fourth Five year plan, a total of 0.35 million jobs were created againstthe target of 0.4 million.

Contribution of SME sector to GDP remained above 4.5% during the period from2000-01 to 2004-2005 despite decline in the amount of advances by the bankingsector to this sector.

SME sector employs 25% of the total labour force. As a result, this sector is thepresent available sector for creation jobs.

SME sector help alleviate poverty, increase income level of rural people andpromote agro-industrial linkage in Bangladesh.

SME sector requires lower energy supply, lower infrastructure facilities and thissector imposes less environmental risk. They contribute towards better utilization of local resources and skills that might

otherwise remain unutilized. Small industries being labour oriented are capable of generating more

employment. They are necessary to maintain and retain traditional skills and handicrafts. They are the only medium for diversification of rural economy and for peaceful

and concurrent socio-economic development of all classes of people.

From the above discussion, we can say that SMEs are playing an important role in oureconomy in various ways.


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Chapter 3

Current Status of SME Financing

by Banks in Bangladesh


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3.1. Current Status of SME Financing by Banks in Bangladesh

The NCBs are disbursing significant amount of credit under various programs like SmallEnterprise Development Project, Self-help Credit Program, Projects for SmallEntrepreneurs, Special Investment Program and Agro-based Supervisory Industrial Creditetc. for the promotion and development of SMEs. The investment of private sector banksin financing SMEs remains insignificant in Bangladesh. Of all the private sector banks,BRAC Bank, Eastern Bank Ltd. (EBL), Prime Bank Ltd, Dhaka Bank Ltd, MercantileBank Ltd, Dutch-Bangla Bank Ltd, Islami Bank Bangladesh Ltd, IFIC Bank Ltd. havethe leading role in SME financing. Bank of Small Industries and Commerce BangladeshLtd. (BASIC) is entrusted with the responsibility of providing medium and long-termloans for promotion and development of small-scale industries. The memorandum andArticles of Association of the bank stipulates that 50% of loanable funds shall be used forfinancing small scale and cottage industries. The outstanding credit of BASIC stood atTk158.9 crore at the end of December 2001 for small and cottage industries sector that

rose to Tk178.7 crore by 12.46% at the end of December 2002.

Table-6 gives an idea of the role of small and medium enterprises as destinations for bankcredit in 2004 and 2005. Bangladeshs classification of bank advances lumps mediumenterprises with the large enterprises, while small units are lumped with cottage-basedunits. As such, unfortunately, it is not possible to speak of the access to finance issues forSMEs per se. We know however separately that SCIs corresponds to more than 99% ofall productive establishments in Bangladesh.Out of 3.8 million establishments of all kinds in Bangladesh, only 10,798, or just about0.3% happen to fall in either medium or large establishment size class based on

employment size. The percentage is even much lower in manufacturing or trade---thetwo sub-sectors from which the case studies in this paper are drawn. And yet, suchstaggering smallness of the proportion of medium and large establishments is coupledwith a preponderance of large and medium enterprises in total credit disbursements fromthe banking system. It is quite safe to assume that of total credit disbursed to large-and-medium class, an overwhelming majority ---perhaps, 80% or so---is arrogated by largeestablishments. It becomes quickly clear that SMEs, for all their numerical superiorityamong establishments, receiving bank credit is the exception and not the rule.Why is the access to finance for the SMEs in Bangladesh not even based on neutralground, not to speak of rosy or good? This is because the issue of bank credit is based onthe ownership of collateral: bankers insist on immoveable property for collateral. Only

about 15-20% of the owners of SMEs own any immoveable property at all in which the bankers are interested. This automatically excludes about 80% of SMEs from beingamong the privileged client of a bank loan.


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Table 6: Percentage distribution of advances made by PCBs, FCBs and DNCBs in

2005 and 2004: By receiving sectors(Numbers are percentages; last row shows the disbursements in Tk. crores)

NAME OF

SECTORS AND TYPEOF FINANCING

PRIVATE

COMME-RCIALBanks,2005

PRIVATE

COMM-ERCIALBanks,2004

FOREIGN


FOREIGN


DENATIO-NALISED


DENATIO-NALISED

COMM-ERCIALBanks, 2005

Agriculture 0.8 0.6 0.1 0.1 56.7 10.8

Large & Medium industry 14.0 11.4 10.9 11.1 17.9 21.1

SCI 0.7 .6 .6 .6 .9 1.1

WC large/medium industry 17.2 14.4 27.2 26.3 7.1 17.9

WC for SCI .9 .7 1.4 1.3 .4 .9

Construction 8.7 15.7 0.9 0.8 1.6 6.7

Transportation 1.8 7.8 2.2 1.0 0.2 0.8

Storage 0.2 1.6 0.0 0.0 3.0 1.3

Trade financing 46.6 39.0 24.9 21.2 7.7 30.2

Miscellaneous 9.1 8.2 31.7 37.6 4.6 9.3

Total 100.0 100.0 100.0 100.0 100.0 100.0

Total advances 53029 40298 7819.8 6629 10637 37662

Note: SCI stands for small and cottage industry; WC stands for working capitalSource: All estimates are based on trade estimates, and not based on detailed survey(s).

In Banglaesh, some banks have come forward to finance SMEs for their development,but many of them do not have good experience regarding loan servicing in this sector. In

the next page, small and cottage industry credit position in overall industrial credit ofSonali Bank has been shown.Table 7: Small and Cottage Industry Credit Position in overall industrial credit of

Sonali Bank as on 2003 (Taka in crore)

INDUSTRY SMALL & COTTAGEINDUSTRY

SCI CREDIT AS % OFIC

Sanctioning 1858.56 523.08 28.14

Disbursement 1258.57 456.68 36.28

Recoverable 1121.85 556.68 49.62

Recovered 427.84 220.12 51.44

Overdue 694.01 336.56 48.49Outstanding 2260.00 685.39 30.32Source: Bari, M. A. & Jamal, Sabera A.Reading materials of the course on Financing of SME, BIBM

From the above table, we found that the recovered amount of credit is very low i.e. therecovery rate of disbursement is very poor. Small and Cottage Industry sector is facing ahuge overdue of credit that are disbursed to this sector.


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Scheduled banks in Bangladesh continued to provide credit to the small-scale industrialsector. But it is evident that deployment of resources in large and SME sector in therecent years is disproportionate compared to their relative contribution to GDP. Table 8shows the disproportionate picture.

It shows from the table, that deployment of bank credit to large industries increasedgradually from 32.40% of total advances in 2000-01 to 39.60% of total advances in 2004-05. But advances to Small industries rose very slightly from 1.70% to 2.00% althoughcontribution of Small industry sector to GDP remained well above 4.5% during the sameperiod.Table 8: Contribution of industries in GDP and their relative financing by banks (In percent)Year Contribution

of industryto GDP

Contributionof large

scaleindustry to

GDP

Contributionof small

scaleindustry to

GDP

Scheduledbanks

advances toindustry

Scheduledbanks

advances tolarge scaleindustry

Scheduledbanks

advances tosmall scale

industry

2000-2001 15.40 11.06 4.54 34.10 32.40 1.702001-2002 15.90 11.41 4.51 34.90 33.20 1.70

2002-2003 16.60 12.04 4.56 36.10 34.30 1.80

2003-2004 17.10 12.51 4.59 38.40 36.50 1.90

2004-2005 17.80 13.19 4.61 41.60 39.60 2.00Source: i) Scheduled Bank Statistics, Bangladesh Bank different issues. ii) Economic Survey, Ministry ofFinance, Govt. of the Peoples Republic of Bangladesh, different issues. iii) SME Foundation (Chowdhuryand Miah,2006)

Outstanding advances by Denationalized Commercial Banks (DNCBs) depicted a risingtrend. The following table shows the amount of outstanding advances of DNCBs duringthe last few years.

Table 9: Amount of outstanding advances of DNCBs during the last few years(Tk in million)

Sonali Bank Janata Bank Agrani Bank Rupali Bank

2006 2007 2008* 2006 2007 2008* 2006 2007 2008* 2006 2007 2008*

Industrial sector

4053 3321 1801 2341 2954 1308 2042 2137 1151 582 5251 3518

Large &mediumindustry

3150 2531 1288 2327 2912 1300 1531 1298 620 564 5219 3507

Small &cottage

industry

903 790 513 14 42 8 511 839 531 18 32 11

Source: Resume of Activities of Banks and Financial Institutions, Ministry of Finance, Govt. of the PeoplesRepublic of Bangladesh, different issues.


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3.2 Comparative analysis of SME Credit Scheme of Six

Different Banks currently available in Bangladesh

3.2.1 Loan documents needed for SME financing by banks

Criteria for loan selection are similar among financial institutions. Most frequentlyrequested documents by financial institutions as a part of the loan application processinclude:

Personal guarantee Business plan Appraisal of assets to be financed Purchase agreement Cash flow projection Personal financial statement Formal application for financing Business financial statement

Tin certificate Citizenship certificate Bank solvency certificate Vat certificate Export license

3.2.2 About the Sample Banks

3.2.2.1 Dhaka Bank Ltd.The Bank started branch operations at Belkuchi Sirajgonj in April 2003. Prior to theBanks intervention, the weaving community did not have the financial strength to stock

their products till Eid ul Fitr when the annual sale takes place. Traders were takingadvantage to the situation by buying up entire productions at low prices and liquidatingstocks just before Eid. With financial services from Dhaka Bank Limited, the weavershave converted to power looms, significantly increased profitability and reduced theinvolvement of middlemen. Already they have identified several clusters and are workingon improving access to finance within these clusters.

3.2.2.2 Dutch-Bangla Bank Ltd.Dutch-Bangla Bank Limited (the Bank) is a scheduled commercial bank. The Bank wasestablished under the Bank Companies Act 1991 and incorporated as a public limitedcompany under the Companies Act 1994 in Bangladesh with the primary objective to

carry on all kinds of banking business in Bangladesh. The Bank is listed with DhakaStock Exchange Limited and Chittagong Stock Exchange Limited.DBBL a Bangladesh European private joint venture scheduled commercial bankcommenced formal operation from June 3, 1996. The Bank commenced its bankingbusiness with one branch on 4 July 1996. The bank opened SME windows in 2001


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3.2.2.3 Prime Bank Ltd.As per decision of the Board of Directors of Prime Bank Ltd. in its 78th meeting held on17.11.1999, Small & Medium Enterprise (SME) Cell has already been established atHead Office under the Credit Division.

Now the bank can replicate quality anywhere in the world. So, the competitivedifferentiation comes from swiftness to market and innovation. And in this regard, smallcompanies right down to the individual can beat big bureaucratic companies ten out often times.

3.2.2.4 Mercantile Bank Ltd.Mercantile bank is a third generation commercial bank. It has opened SME windows in1999 to encourage the small business activities.

3.2.2.5 Eastern Bank Ltd.Small and Medium Enterprises (SME) in Bangladesh contributed 25% of gross domestic

product (GDP) and 80% of the industrial jobs of the country in 2004. According to ADB,the country's estimated 6 million SMEs and micro enterprises firms of less than 100employees have a significant role in generating growth and jobs. This is a sector that hasits own distinct needs and requires specialized focus. Eastern Bank Ltd. (EBL) haslaunched SME Banking in early 2005 with this view in mind.

Eastern Bank Ltd. Services in SME:

Provide SMEs with easy access to financing.

Deliver products that ensure superior returns to our customers.

Orient customers with industry trends, regulatory issues etc, for theirsuccess.

Value long-term relationship banking.

3.2.2.6 BRAC Bank Ltd.

The BRAC Bank ltd started its operation in 2001. The SME portfolio includes

Prothoma Rin Exclusively designed for women

Anonno Rin This is a small-scale loan

Apurbo Rin In order to help our SME

Supplier Finance

3.2.3 Criterion for Sample Selection :The banks for comparative analysis have been chosen in the basis of the followingcriterion:

3.2.3.1 Loan size1. Prime Bank Ltd Taka 1 Lac to Taka 75.00 Lacs2. Dhaka Bank Ltd - Taka 0.50 Lac to Taka 50.00 Lacs3. Eastern Bank Ltd- Taka 1 Lac to Taka 300.00 Lacs


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4. Mercantile Bank Ltd- Taka 0.50 Lac to Taka 2.00 Lacs5. Dutch-Bangla Bank Ltd- Taka 3 Lac to Taka 50.00 Lacs6. BRAC Bank Ltd- Taka 3 Lacs to Taka 30.00 Lacs

Among the banks EBL offers the highest loan amount to the customers where as theBRAC bank offers the lowest loan to its customers.

3.2.3.2 Rate of interest1. Prime Bank Ltd 13% to 15% p.a.2. Dhaka Bank Ltd - 12% to 13% p.a.3. Eastern Bank Ltd- 14% to 15% p.a.4. Mercantile Bank Ltd- 15% p.a.5. Dutch-Bangla Bank Ltd- 13% to 15% p.a.6. BRAC Bank Ltd- 18% to 24% p.a.

In terms of interest rate the Dhaka Bank Ltd offers the lowest rate of interest to itscustomers. The highest rate is charged by BRAC Bank Ltd. The Mercantile Bank Ltd.have the only bank that offers fixed rate for any loan customers.

3.2.3.3 Loan processing fees1. Prime Bank Ltd .50 % of the loan amount.2. Dhaka Bank Ltd - .00 % of the loan amount.3. Eastern Bank Ltd- not available4. Mercantile Bank Ltd- not available5. Dutch-Bangla Bank Ltd- not available6. BRAC Bank Ltd- .50 % of the loan amount

All the banks do not provide data about loan processing fees to their customers. Theprime bank and BRAC bank limited only charges .50% as loan processing fess

3.2.3.4 Period of loan1. Prime Bank Ltd 1 to 5 years.2. Dhaka Bank Ltd 1 to 3 years.3. Eastern Bank Ltd- up to 1 year.4. Mercantile Bank Ltd- up to 2 years.5. Dutch-Bangla Bank Ltd- 1.5 to 5 years.6. BRAC Bank Ltd- 1 to 3 years.

Among the banks the highest loan maturity date is offered by DBBL and MercantileBank Limited offers the lowest maturity period

3.2.3.5 Mode of Finance1. Prime Bank Ltd Term loan and working capital loan2. Dhaka Bank Ltd Term loan and working capital loan3. Eastern Bank Ltd- Only working capital loan4. Mercantile Bank Ltd- Only term loan5. Dutch-Bangla Bank Ltd- Only term loan6. BRAC Bank Ltd- Only term loan


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All the Banks providing SME financing facilities do not provide long-term loan to itscustomers. Among the banks Prime and Dhaka Bank limited both provides term loan andworking capital loan to their customers. Other bank either provides term loan or workingcapital loan to its customers.

3.2.3.6 ManagementOverall the management of the banks engaged in SME banking is efficient and havediverse knowledge of banking sector. BRAC bank has initiated to provide training ofstaffs for well managing the SME customers.

3.2.4 Portfolio Size of different banks in SME Sector

(Tk in crore)

Serial No Name of the Bank Portfolio Size

1 BRAC Bank Ltd. 950.00

2 Eastern Bank Ltd. 300.00

3 Prime Bank Ltd. 108.44

4 Dutch-Bangla Bank Ltd. 16.38

5 Mercantile Bank Ltd. 6.63

6 Dhaka Bank Ltd. 5.72

Total 1,387.17Source: Annual Repots of Prime Bank Ltd., Dhaka Bank Ltd., Eastern Bank Ltd.,Mercantile Bank Ltd., Dutch-Bangla Bank Ltd. and BRAC Bank Ltd. 2007

From the table we can see that the BRAC bank has the highest investment in the SMEsector followed by Eastern Bank Ltd. in second position. While the Prime Bank Ltd.,

Dutch-Bangla Bank Ltd., Mercantile Bank Ltd. and Dhaka Bank Ltd. are third, forth,fifth and sixth respectively.

Graph 1: Portfolio Size of Six different banks in SME Sector


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Portfolio Size

68.5%

21.6%

0.5%7.8%

0.4%

1.2%

Brac Bank Ltd. Dhaka Bank Ltd. Dutch-Bangla Bank Ltd.

Eastern Bank Ltd. Mercantile Bank Ltd. Prime Bank Ltd.

In the next page the following points are analyzed in the

tabular form for the better understanding.

Comparative analysis of SME credit scheme of sixdifferent banks (Policy part) for year the 2007.

Comparative analysis of SME credit scheme of six

different banks (Example of a loan) for year the

2007. Comparative analysis of SME credit scheme of six different banks (Performance

part) for year the 2007.

Table 10 COMPARATIVE ANALYSIS OF SME

CREDIT SCHEME OF DIFFERENT BANKS

(Policy part ) Year2007

Particulars Prime Bank

Ltd.

Dhaka Bank

Ltd.

Eastern

Bank Ltd.

Mercantile

Bank Ltd.

Dutch-Bangla

Bank Ltd.

BRAC Bank

Ltd.

Loan Size Tk.1.00 Lac to Tk.0.50 Lac to Tk.1.00 Tk.0.50 Lac to Tk.3.00 Lacs to Tk.3.00 Lacs


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Tk.75.00 Lacs Tk.50.00 Lacs Lac toTk.300.00

Lacs

Tk.2.00 Lacs Tk.50.00 Lacs to Tk.30.00Lacs

Rate of

Interest

13.00% -15.00% p.a.

12.00%-13.00% p.a.

14.00%-15.00%

p.a.

15.00% p.a. 13.00% -14.00% p.a.

18.00% -24.00% p.a.

Loan

ProcessingFee

0.50% of the

Loan amount(once for thewhole period)

1.00% of the

Loan amount(once for the

whole period)

--------- --------- --------- 0.50% of the

Loan amount(once for thewhole period)

Risk Fund --------- 1.00% - 2.00%p.a. of the

Loan amount

--------- 1.00% of theLoan amount(once for thewhole period)

--------- ---------

Supervision

Fee

1.00% - 2.00%p.a. of the

Loan amount

--------- 1.00% of theLoan amount(once for thewhole period)

--------- ---------

Utilization

Fee

0.75% p.a.(Semiannually

Charged)

1.50% .p.a.(QuarterlyCharged)

--------- --------- --------- ----------

Period of

Loan

01 Year to 05

Year

01 Year to 03

Year

Up to 01

Year

Up to 02 Years 1.5 Year to 05

Year

01 Year to 03

YearMode of

Finance

Term Loan aswell as

WorkingCapital Loan

Term Loan aswell as Working

Capital Loan

OnlyWorking

CapitalLoan

Only Term Loan Only Term Loan Only TermLoan

Past

Experience of

the Owner

02 Years 03 Years 02 Years 02 Years 02 Years 02 Years

Security:

a) Primary PersonalGuarantee

PersonalGuarantee

PersonalGuarantee

PersonalGuarantee

PersonalGuarantee

PersonalGuarantee

b) Secondary CollateralSecurity

provision

depends oncase-to-case

basis.

Up to Tk.5.00lacs Collateral

Free

(Case to Case)Above Tk.5.00lacs Collateral

Mandatory

CollateralSecurity

Mandatory

--------------- CollateralSecurity

Mandatory

(Forced SaleValue 1.25

Times of Loanamount)

Up toTk.8.00 Lac

without

CollateralSecurity &

aboveTk.8.00 Lac

withCollateralSecurity

Source: Primary sources (Data are collected from banks through personal communication)

Table - 11 COMPARATIVE ANALYSIS OF SME CREDIT

SCHEME OF DIFFERENT BANKS- (EXAMPLE OF A

LOAN)

Year 2007

Example

of a

Loan

Prime Bank

Ltd.

Dhaka Bank

Ltd.

Eastern Bank

Ltd.

Mercantile

Bank Ltd.

Dutch-Bangla

Bank Ltd.

BRAC

Bank Ltd.


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PrincipalAmount

Tk.1.00 Lac Tk.1.00 Lac Tk.1.00 Lac Tk.1.00 Lac Tk.1.00 Lac Tk.1.00 Lac

Period ofLoan

01 Year 01 Year 01 Year 01 Year 01 Year 01 Year

No. OfInstallment

12 12 12 12 12 12

InstallmentSize

Tk.8,978.00 Tk.8,931.00 Tk.9,025.00 Tk.9,025.00 Tk.8,978.00 Tk.9,168.00

TotalInstallmentPayment

Tk.1,07,736.00 Tk.1,07,172.00 Tk.1,08,300.00 Tk.1,08,300.00 Tk.1,07,736.00 Tk.1,10,016.00

LoanProcessingFee

Tk.500.00 Tk.1,000.00 ---------- ----------- ---------- Tk.500.00

Risk Fund --------- Tk.2,000.00 ----------- Tk.1,000.00 ----------- ----------

Supervision Fee

--------- Tk.2,000.00 ----------- Tk.1,000.00 ----------- -----------

UtilizationFee

Tk.750.00 Tk.1,500.00 ----------- ----------- ----------- -----------

Total

Payment

Tk.1,08,986.00 Tk.1,13,672.00 Tk.1,08,300.00 Tk.1,10,300.00 Tk.1,07,736.00 Tk.1,10,516.

00


Table 12 COMPARATIVE ANALYSIS OF SME CREDIT

SCHEME OF DIFFERENT BANKS (PERFORMANCEPART)

Year 2007

Performance Prime

BankLtd.

Dhaka

Bank Ltd.

Eastern

Bank Ltd.

Mercantile

Bank Ltd.

Dutch-

BanglaBank

Ltd.

BRAC

BankLtd.

Year ofOperation

2001 2001 2001 1999 2001 2001

Disbursement (Upto 31.03.07)

108.44

Crore

5.72

Crore

300.59

Crore

6.63

Crore

16.38

Crore

950.00

Crore

Rate of Recovery 100% 100% 97% 79% 99% 98%(Actual

92%)

No. OfManpower at

H/O Level

02 03 02 03 03 24



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Chapter 4

Why Banks are Not Interested

in Financing the SMEs


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4.1 Why Banks are not interested in financing the SMEs

In Bangladesh, several Banks are financing the SME sector but as mentioned earlier,

many of them do not have good experience regarding the loan servicing in this sector.Banks lend the projects for making profit, but if the principal amount does not come backto the bank, then there will surely be adverse affect in the balance sheet of the bank. Thisis because of banks general function. A Banks general function is intermediationbetween borrower and lender. Bank takes deposit from the surplus unit i.e. lender anddeploy fund or credit to the deficit unit i.e. borrower. It is very clear that the amount thata bank provides to the deficit units may not be its own. So, it must repay the amount tothe depositors on demand. But if the disbursed amount does not come back to the bank,then it may incur loss.

This is the reason why banks are so conscious while lending any project. In recent years,

it is observed that there are many defaulters in the SME sector. Many banks are facingthis default problem today. Still many banks are willing to invest in this sector.

Though mentioned earlier, from the table 07, we see that Sonali Banks credit recoveryrate from Small and Cottage Industry sector is only 51.44% compared to the IndustrialCredit. The bank has a huge outstanding of credit in the SCI sector.Actually this is the main reason behind why banks are not interested in financing in SMEsector. Banks feel unsecured in financing this sector. Because the credit recovery ratefrom this sector is not good enough.

4.2 Problems for financing SMEs:

SME sector faces a number of problems (Ahmed, 2000) to facilitate institutional credit.These problems were looked into from the perspective of both borrower and lenders.

4.2.1 Problems from borrowers perspective: Access to loan

Collateral

Complexity increases cost of loan

Extremely short grace period

Absence of comprehensive guidelines

Longer loan processing time and associate cost of uncertainty

Lack of basic infrastructure, inputs, managerial efficiency and inadequatesanction

4.2.2 Problems from lenders perspective: Lack of information on loan application requirement among the SME loan seekers Absences of an appropriate and clear-cut legal framework for enforcing quick

recovery.


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In addition, the following problems are identified in the SME sector:

a. Inadequate allocation of fund for public sector.b. Lack of co-ordination among lending agencies.c. Shortage of long-term credit.d. Unstable share market.

e. Lack of technological information.f. Lack of uniform delivery model and training.g. Absences of utilization of BSCIC services of NCBs for utilization of surplus

fund.h. Lack of technology assessment, innovation and adaptation of technology.i. Lack of marketing effort and exploring new markets.j. Competitive product market because of market economy.

As we see from the pints noted above, borrowers of SME loans are facing some severeproblems that are discussed below:

4.3.1 Access to loan:SMEs encounter great difficulties while rising fixed and working capital because of thereluctance of banks to provide loans to SMEs. Banks are shy to lend to SMEs because ofhigh processing and monitoring costs of loans to SMEs. The loan application forms forinvestment financing from banks are long, tedious, and redundant. Since the removal ofthe interest rate subsidy without the removal of interest band, financial institutions findlittle incentive to lend to SMEs. SMEs find it difficult to use non real estate assets ascollateral to obtain loans from the banks. In the past, the government has attempted toprovide SMEs with access to finance through targeted lending. There was a governmentdirective that 5 per cent of a bank's loan portfolio be set aside for small and cottageindustry financing. A new bank, namely, the Bank of Small Industries and CommerceBangladesh Ltd (BASIC) was set up in 1988 with the objective of financing the small andcottage industries. There were also attempts to channelize fund received frominternational agencies such as the Asian Development Bank (ADB) to the sector throughprivate banks. There were provisions of favorable debt equity ratio, special interest ratesand credit guarantee scheme. The central bank also issued directives to both public and private commercial banks regarding working capital loans, use of standardizeddocumentation procedure and time limits for credit sanctioning and loan disbursement.

4.3.2 Collateral:The main problem of SMEs is that, they do not have enough collateral for getting fundfrom the bank. The banks have some regulation of taking a minimum amount ofcollateral against credit, but many small and medium entrepreneurs cannot fulfill therequirement. Thats why banks are also reluctant to provide credit to them, as it would be

violation of their policy regulation.

4.3.3 Lack of experience:Small and Medium Industry Entrepreneurs, in Bangladesh, have lack of experience in thebusiness field. They do not have any training programs and they do not even have anybusiness exposure. As a result, they cannot follow the right way of entrepreneurship inthe related field. So they incur loss in many cases.


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4.3.4 Extremely short grace period:In our country, grace period of repaying any credit is very low. According to the SMEentrepreneurs, almost all the Banks structured the loan in such a way that entrepreneurshave to start the repayment of credit within a very short time after disbursement of credit.This is really a big problem for the entrepreneurs because the entrepreneurs are bound to

generate profit instantly to fulfill the Banks requirement. But this is impossible, as abusiness needs a minimum time to be in a stable position and to generate profit.

4.3.5 Cost of loan:Another problem is that extremely high interest rate for the entrepreneurs. Manyentrepreneurs is having problem because of high interest rate. Banks, in many cases,maintain high spread as a result there remains reckless competition of making more profitfrom the Banks perspective. And, sufferers are general entrepreneurs who borrow fromthe Bank.

4.3.6 Absence of comprehensive guidelines:Another problem is that, there is an absence of comprehensive guidelines in the SMEsector. Most of the SMEs do not have any guidelines for controlling their business. Theydo not maintain any deliberate procedure in managing the enterprise; rather they go onwith the time-to-time changes in the business operation. As a result they cannot generateexpected profit from the business and fail to payback credit to the banks. Hence, Banksare reluctant to provide credit to them.

4.3.7 Longer loan processing time and associate cost of uncertainty:Credit in this sector requires longer processing time. Though it is Small and Medium

Enterprise Sector, processing time for loan is not short. As a result banks are unwilling toenter in this sector. Moreover, associate cost of uncertainty is also another issue andbanks do not want their funds to be invested in an area where recovery of the fund isuncertain.

4.3.8 Lack of basic infrastructure, inputs, managerial efficiency:Most of the SMEs do not have basic infrastructure of their own i.e. there is a lack ofplanned infrastructure in this sector. Inputs of the production are also not planned andinsufficient. Moreover, managerial efficiency is also a big issue in this regard. If there ispoor managing efficiency, then the organization will never prosper in associate field. Forbetter performance, good managing efficiency is needed.

4.3.9 Inadequate sanction:And, inadequate sanction of loan should also be stated here. The loan provided to thissector is inadequate. As almost all SMEs do not have enough capital to start the business,they need adequate amount of fund in order to support the unexpected loss initially. Butas they do not get that, they cannot absorb the initial loss and eventually fail to paybackthe bank credit.In addition, some problems identified as these are from lenders perspective:


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4.3.10 Lack of information on loan application requirement among the

SME loan seekers:As credit application requires availability adequate information, most of the SMEs do nothave adequate information. They do not maintain their financial statement appropriatelyof the business; even they do not feel the necessity of doing so. Thats why Banks are not

getting appropriate information regarding their business and themselves as well.

4.3.11 Absence of an appropriate and clear-cut legal framework for

enforcing quick recovery:Even Banks do not have appropriate legal framework in order to recover their disbursedcredit. Their recovery framework is not clear-cut as a result they fail to control theservicing of loan.These are the reasons why Banks are reluctant to finance the SMEs in Bangladesh.

Chapter 5Minimum Requirements forSME Financing according toBangladesh Bank


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5.1. Minimum Requirements for SME Financing according to

Bangladesh Bank:Apart from the specific regulations given under each mode of financing separately, the banks while undertaking Small Enterprise financing should also follow generalrequirements laid down here. It may by noted that these are the minimum requirementsand should not in any way be construed to restrict the role of the management processesthrough establishing comprehensive credit risk management systems appropriate to theirtype, scope, sophistication and scale of operations. The Board of Directors of the banksare required to establish policies, procedures and practices to define risks, stipulateresponsibilities, specify security requirements, design internal controls and then ensurestrict compliance with them.

5.2 Pre-Operation:Before embarking upon or undertaking Small Enterprise financing, the banks shallimplement/follow the guidelines given below. The banks already involved in Small

Enterprise financing will ensure compliance with these guidelines within six month of thedate of issuance of Small Enterprise Financing Prudential Regulations.Banks shall establish separate Risk Management capacity for the purpose of SmallEnterprise financing, which will be suitably staffed by personnel having sufficientexpertise and experience in the field of consumer finance/business.The banks shall prepare comprehensive Small Enterprise credit policy duly approved bythe Board of Directors, which shall interalia cover loan administration, includingdocumentation, disbursement and appropriate monitoring mechanism. The policy shallexplicitly specify the functions, responsibilities and various staff positions,powers/authority relating to approval/sanction of consumer finance facility.

For every type of Small Enterprise finance activity, the bank shall develop a specificProduct Program Guide (PPG). The program shall include the objective/quantitativeparameters for the eligibility of the borrower and determining the maximum permissiblelimit per borrower. The PPG will also indicate the maximum permissible exposure bankswill take against each product.Bank shall put in place and efficient computer based MIS for the purpose of SmallEnterprise finance, which should be able to effectively cater to the needs of SmallEnterprise financing portfolio and should be flexible enough to generate necessaryinformation reports used by the management for effective monitoring of the bank'sexposure in the area. The MIS is expected to generate the following periodical reports:

Reports interrelating delinquencies with various type of customers of various attributes ofthe customers to enable the management to take important policy decisions and makeappropriate modifications in the lending program.

Quarterly product wise profit and loss account duly adjusted with the provision onaccount of classified accounts. These profit and loss statements should be placed beforethe Board of Director in the immediate next Board Meeting. The branches of foreignbanks in order to comply with these conditions shall place the reports before a committee


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comprising of Chief Executive Officer, Chief Finance Officer and Head of SmallEnterprise.The banks shall develop comprehensive recovery procedures for the delinquent loans.The recovery procedures may vary from product to product. However, distinct andobjective triggers should be prescribed for taking pre-planned enforcement/recovery

measures.The institutions starting consumer financing are encouraged to `impart sufficient trainingon an ongoing basis to their capability regarding the various aspects of Small Enterprisefinancing.The banks shall prepare standardized set of borrowing and recourse documents (dulycleared by their legal counsels) for each type of Small Enterprise financing.

5.3 Operations:Small Enterprise financing, like other credit facilities, must be subject to the Bank's riskmanagement process setup for this particular business. The process may include,identifying source of repayment and assessing customer' ability to repay his/her past

dealings with the bank, the net worth and information obtained from a Credit InformationBureau approved by Bangladesh Bank.At the time of granting facility under various modes of Small Enterprise financing, banksshall obtain a written declaration from the borrower divulging details of various facilitiesalready obtained from other institutions. The banks should carefully study the detailsgiven in the statement and allow fresh finance/limit only after ensuring that the totalexposure in relation to the repayment capacity of the customer does not exceed thereasonable limits as laid down in the approved policies of the banks. The declaration willalso help banks to avoid exposure against an enterprise having multiple facilities fromdifferent institutions.

Internal audit and control function of the bank, apart from other things, should bedesigned and strengthened so that it can efficiently undertake an objective review of theSmall Enterprise finance portfolio from time to assess various risks and possibleweaknesses. The internal audit should also assess the adequacy of the internal control andensure that the required policies and standards are developed and practiced. Internal auditshould also comment on the steps taken by the management to rectify the weaknessespointed out by them in their previous reports for reducing the level of risk.

The banks shall ensure that their accounting and computer systems are well equipped toavoid charging of mark-up. For this purpose it should be ensured that the mark-upcharged on the outstanding amount is kept separate from the principal.

The banks shall ensure that any repayment made by the borrower is accounted for beforeapplying mark-up on the outstanding amount.

5.4 Disclosure/Ethics:The banks must clearly disclose all the important terms & conditions. Fees, charges and penalties, which are internal including interest rate, pre-payment penalties and the


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conditions under which that apply. For ease of reference and guidance of their customers,banks are encouraged to publish brochures regarding frequently asked questions.

Chapter 6

Prudential Regulations for SME

Financing By Bangladesh Bank


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6.1 Prudential Regulations for SME Financing By Bangladesh

Bank:Prudential regulation establishes the outside limits and constraints placed on banks toensure the safety and soundness of banking system. They are the key elements to prevent,limit or stop the damage caused by poor management. The establishment of anappropriate regulatory framework is essential to ensure that government supervisors cancarry out and enforce their responsibilities. In the following prudential regulation ofBangladesh Bank has been given by which supervisors can smoothly check and balancethe operation of SME in Bangladesh.

Regulation -1

6.1.1 Source and capacity of repayment and cash flow backed lending:

Banks shall specifically identify the sources of repayment and asses the repaymentcapacity of the borrower on the basis of assets conversion cycle and expected future cashflows. In order to add value, the banks must assess conditions in the particular sector /industry they are lending to and its future prospects. The banks must be able to identifythe key drivers of their borrowers businesses, the key risks to their businesses and theirrisk mitigates.The rationale and parameters used to project the future cash flows shall be documentedand annexed with the cash flow analysis undertaken by the bank. It is recognized a largenumber of SMEs will not be able to prepare future cash flows due to lack ofsophistication and financial expertise. It is expected that in such cases banks shall assistthe borrowers in obtaining the required information and no SE shall be declined access to

credit merely on this ground (for details, refer Regulation 10).

Regulation -2

6.1.2 Personal guarantees:

All facilities to SMEs shall be backed by the personal guarantees of the owners of theSMEs. In case of limited companies, guarantees of all directors other than nomineedirectors shall be obtained.

Regulation -3

6.1.3 Per party exposure limit:

The minimum and maximum exposure of a bank on a single SE shall remain within therange of Tk 2 lac and Tk.50 lac respectively subject to the following:

In case of working capital finance - Maximum up to 100% of the net requiredworking capital or 75% of the sum total of inventory and receivables whichever is


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lower.

In case of fixed assets purchase - Maximum up to 90% of the purchase price.

Regulation -4

6.1.4 Aggregate exposure of a bank on small enterprise sector:The aggregate exposure of a bank on SE sector shall not exceed the limits as specifiedbelow:

% OF CLASSIFIED SE ADVANCES TO TOTAL

PORTFOLIO OF SE ADVANCES

MAXIMUM LIMIT

a. Below 5% 10 times of equity

b. Below 10% 6 times of the equity

c. Below 15% 4 times of the equity

d. Up to and above 15% Up to the equity

Source: Prudential Regulations by Bangladesh Bank for SME Financing, Bangladesh BankQuarterly April-June 2006

Regulation -5

6.1.5 Limit on clean facilities:In order to facilitate growth of smaller loans, banks are free to determine securityrequirements for loans up to Tk.5 lac. Guidelines for security requirements for loans ofamounts more than Tk.5lac are given in Regulation-6.

Regulation - 6

6.1.6 Securities:Consequent to the regulation stated in Regulation -5, facilities provided to SEs shall besecured by banks as follows:For loan amounting Tk. 2 lac to Tk. 5 lac

As a minimum banks must take charge over assets being financed.

For loan amounting Tk. 5 lac to Tk. 50 lac

a) Hypothecation on the inventory, receivables, advance payments, plant &machineries.

b) Equitable mortgage over immovable properties with registered Power ofAttorney.

c) Personal Guarantees of Spouse/Parents/other family members.

d) One third party personal guarantee,

e) Post dated cheques for each installment and one undated cheque for full loan


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value including full interest.

Regulation - 7

6.1.7 Loan documentation:For all facilities, banks must obtain (as applicable) and not limiting to following

documents before disbursement of loan can be made:

1) Loan Application Form duly signed by the customer.

2) Acceptance of the terms and conditions of Sanction Advice.

3) Trade License.4) In case of Partnership Firm:

Copy of Registered Partnership Deed duly certified as true copy or partnershipDeed on non-judicial stamp of Tk.150 denomination duly notarized.

5) In case of limited company:

a) Copy of Memorandum & Articles of Association of the companyincluding Certificate of incorporation duly certified by Registrar Joint StockCompanies (RJSC) and attested by the Managing Director accompanied byan up-to-date list of Directors,

b) Copy of Board Resolution of the company for availing credit facilities andauthorizing Managing Director/ Chairman/Director for execution ofdocuments and operation of the accounts,

c) An Undertaking not to change the management of the company and the

memorandum and articles of the company without prior permission of thebank.

d) Copy of last audited financial statement up to last 3 years (as applicableand subject to Regulation-10)

e) Personal Guarantee of all the Directors including the Chairman andManaging Director,

f) Certificate of registration of charges over the fixed and floating assets ofthe company duly issued by RJSC,

g) Certificate of registration of amendment of charges over the fixed andfloating assets of the company duly issued by RJSC in case of repeat loan orchange in terms and condition of Sanction Advice regarding loan amount,securities etc.,

6) Demand Promissory Note

7) Letter of hypothecation of stocks and goods


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8) Letter of hypothecation of book debts & receivables

9) Letter of hypothecation of plant & machinery

10) Charge on fixed assets.

11) Personal Letter of Guarantee

12) Wherever practical, insurance policy for 110% of the stock value covering allrisks with banks mortgage clause in joint name of the bank and client.


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Regulation -8

6.1.8 Margin requirements:Banks shall adhere to the minimum margin requirement as prescribed by BangladeshBank (if any).

Regulation -96.1.9 Credit information bureau (CIB) clearance:While considering proposals for any exposure, banks should give due weightage to thecredit report relating to the borrower and his group obtained from a of Bangladesh Bank.The condition of obtaining CIB report will be governed by rules & regulations asprescribed by Bangladesh Bank from time to time.

Regulation -10

6.1.10 Minimum conditions for taking exposure:Banks shall, as a matter of rule, obtain a copy of financial statements duly audited by a

practicing Chartered Accountant, relating to the business of every borrower who is alimited company or where exposure of a bank exceeds Tk.40lac, for analysis and record.However, financial statements singed by the borrower will suffice where the exposure isfully secured by liquid assets.It is recognized that a large number of enterprises other than limited companies (i.e., soleproprietorship/partnership firms etc.) may not have proper books of accounts includingbalance sheet, profit & loss account and they may not be able to prepare current andfuture cash flows due to lack of sophistication and expertise. It is expected that in suchcases, banks shall assist the borrowers in obtaining/developing such books of accounts asper forms/formats prescribed by each bank. Reference with regard to how the formatsshould be prepared has been made in the development guidelines.

Each Bank shall develop its own Loan Application Form and Borrowers Basic FactSheet. Banks shall not approve and/or provide any exposure (including renewal,enhancement and rescheduling) until and unless the prescribed Loan Application From isaccompanied by a Borrowers Basic Fact Sheet under the seal and signature of theborrower.

Regulation -11

6.1.11 Proper utilization of loan:The Bank should ensure that the loans have been properly utilized by the SEs and for thesame purposes for which they were acquired / obtained. Banks should develop andimplement an appropriate system for monitoring the utilization of loans.

Regulation -12

6.1.12 Restriction on facilities to related parties:Banks shall not take any exposure on a SE in which any of its director; shareholder,employee or their immediate family members is holding 5% or more of the share capitalof the SE.

Regulation -13


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6.1.13 Classification and provisioning for assets:

Loans / AdvancesBanks shall observe the prudential guidelines given at in the matter of classification oftheir SME asset portfolio and provisioning there-against.

In addition to the time-based criteria, subjective evaluation of performing and non- performing credit portfolio shall be made for risk assessment and, where considerednecessary, any account including the performing account will be classified, and thecategory of classification determined on the basis of time based criteria shall be furtherdowngraded. Such evaluation shall be carried out on the basis of credit worthiness of theborrower, its cash flow, operation of the account, adequacy of the security, inclusive ofits realizable value and documentation covering the advances.

Apart from specific provisioning requirement as prescribed above, banks will createadequate general provision over the entire credit portfolio of Small Enterprise business.

Therefore, all banks shall maintain at all times a general provision of 5% of SE assetsoutstanding in its books.

Submission of returnsBanks shall submit the borrower-wise annual statements regarding classified loans/advances to the Banking Inspection Department.

Timing of creating provisionsBanks shall review, at least on a quarterly basis, the collectibles of their loans / advancesportfolio and shall properly document the evaluations so made. Shortfall in provisioning,if any, determined, as a result of quarterly assessment shall be provided for immediately

in their books of accounts by the banks on quarterly basis.

Reversal of provisionThe provision held against classified assets will only be released when cash realizationstarts exceeding.

In case of loss category the net book value of the assets. In case of doubtful category 50% of the net book value of the assets; and In case of sub-standard category 25% of the net book value of the assets.

Further, the provision made on the advice of Bangladesh Bank will not be reversedwithout prior approval of Bangladesh Bank.

Verification by the AuditorsThe external auditors as a part of their audits of banks shall verify that all requirements ofRegulation- 12 for classification and provisioning for assets have been complied with.Bangladesh Bank shall also check adequacy of provisioning during their on-siteinspections.


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Chapter 7

Guidelines by BangladeshBank for SME Financing


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7.1 Guidelines by Bangladesh Bank for SME Financing:

The purpose of the Development Guidelines is to provide directional guidelines to thebanks that are considering introduction of Small Enterprises financing to entrepreneursall across Bangladesh. These Guidelines will assist banks to develop and implement pragmatic and value added products, efficient Credit Approval & Risk Managementprocesses, sound organization structure, strong credit administration and robust collectionprocedures.

It may be noted here that these are the minimum requirements and should not in any way be construed to restrict the role of the management processes through establishingcomprehensive credit risk management systems.The Process Guidelines have been organized into the following sections:

Policy Guidelines1. Product Program Guidelines2. Segregation of Duties3. Credit Approval

Procedural Guidelines1. Approval Process2. Credit Administration3. Risk Management4. Collection & Remedial Management

Preferred Organizational Structure & ResponsibilitiesSenior executives of retail banking from different foreign, private sector and nationalizedcommercial banks prepared these guidelines. It is the expectation of Bangladesh Bankthat these guidelines will assist banks towards creating a long term sustainable and aprofitable Small Enterprises business in Bangladesh.

7.2 Policy Guidelines:Before embarking upon Small Enterprises financing, banks shall develop fullydocumented product program guidelines. These guidelines shall include

objective/quantitative parameters for the eligibility of the borrowers and determining themaximum permissible limit per borrower.

These fundamental guidelines will be the key elements that would support each bankscredit culture and they will dictate banks behavior when dealing with customers andmanaging lending portfolio of such loans. Any deviations from these guidelines must inall cases, will require approval from competent authority.


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Fundamentally, credit policies and procedures can never sufficiently capture all thecomplexities of the product. Therefore, the following credit principles are the ultimatereference points for all concerned bank staff making consumer-financing decisions:

Assess the entrepreneurs character for integrity and willingness to repay

Only lend when the entrepreneur has capacity and ability to repay

Only extend credit if bank can sufficiently understand and manage the risk

Use common sense and past experience in conjunction with thorough evaluationand credit analysis.

Do not base decisions solely on customers reputation, accepted practice, otherlenders risk assessment or the recommendations of other officers

Be proactive in identifying, managing and communicating credit risk

Be diligent in ensuring that credit exposures and activities comply with therequirement set out in Product Program

A generic Product Program Guideline (PPG) has been developed for Small Enterprises

Financing. Banks should take this as a reference and have the right to alter/amend theseguidelines in terms of their own policy with out compromising the fundamentals of creditprinciples.

7.2.1 Product Program GuidelineBanks have the right to alter / amend these guidelines in terms of their policy with outcompromising the fundamentals of credit principles. While developing Product ProgramGuidelines (PPG) for any product - the following guidelines must be included in the PPGdocuments. The guidelines are suggestive but not limited to this list, based on therequirements further guidelines to be incorporated in the PPG to ensure that the PPG iscovering all the aspects of risk and return for the particular product.

PPG Guideline No. 1: Customer Segment

PPG Guideline No. 2: Purpose

PPG Guideline No. 3: Nationality

PPG Guideline No. 4: Age Limit - Minimum age (years) / Maximum age(years)

PPG Guideline No. 5: Minimum Income

PPG Guideline No. 6: Loan Size

PPG Guideline No. 7: Loan to Price Ratio

PPG Guideline No. 8: Security/ Collateral

PPG Guideline No. 9: Legal Documents

PPG Guideline No. 10: Interest Rate

PPG Guideline No. 11: Maximum Term of Loan

PPG Guideline No. 12: Repayment Method PPG Guideline No. 13: Disbursement Mode

PPG Guideline No. 14: Disbursement pre-condition

PPG Guideline No. 15: Debt Burden Ratio (DBR %)

PPG Guideline No. 16: Verification of Personal Details and Quotation

PPG Guideline No. 17: Substantiation of Income


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7.2.2 Segregation of DutiesAdequate segregation of duties is a prerequisite of an effective system of internal control.To be adequate, segregation must ensure that persons independent of each other performthe following functions, although, within limits, certain may be combined so long there isadequate supervision:

Credit approval, monitoring and recovery by Credit unit Credit documentation and administrations Loans processing and disbursement

unit Sales and marketing Sales and Branch Credit recovery by Credit unit

The credit approval team will be independent from the sales and branch team who willevaluate and approve the loan. The Credit Administration under Operations departmentwill check and ensure the documentation and disburse the loans. This will ensure thebetter control of the bank asset and mitigate the risk of compromise of the duties.

7.2.3 Credit Approval

Applications are received at Credit Approval unit from sales team / branches. Asmentioned in Regulation- 10 part 2, banks should develop their own set of comprehensiveLoan Presentation Forms (LPF), which should at minimum include the followingdocuments:

a) Credit Memorandumb) Work sheet for Working Capital Requirementc) Income Statementd) Balance Sheete) Cash Flow Statementf) Financial Ratiosg) Checklists

Applications will bee evaluated / assessed by Credit Analysts / Managers on the basis ofa fully documented Loan Presentation Forms (LPF). The evaluation process is carried out based on the agreed and standard guidelines for different loans product and thedocuments checklist as per the PPG. The detailed credit and risk assessment should beconducted prior to the approving of any loans.The sales team / branch staff responsible for loan sales and should be the owner of thecustomer relationship, and must be held responsible to ensure the accuracy of the loanapplication submitted for approval. They must be familiar with the banks LendingGuidelines and should conduct due diligence on new borrowers, purpose of the loans andguarantors.All banks should have established and Money Laundering guidelines, which should be

adhered to at all times.Credit Applications should include, as a minimum, the following details:

Amount and type of loan(s) proposed.

Purpose of loans.

Loan Structure (Tenor, Covenants, Repayment Schedule, Interest)

Security (if any)


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7.2.4 Credit Approval AuthorityLending Authority is delegated to individual credit analysts and credit manager or seniorcredit executives by the Head of Consumer banking responsible for the Consumerbusiness. Records of such authority are retained with country credit manager. Copies ofall Delegation of Lending Authorities are also retained by Loan Administrations

Department.

7.3 Procedural Guidelines:

This section outlines the main procedures that are required to ensure compliance with thepolicies contained in Section 1.0 of these guidelines.

7.3.1 Approval Process

Credit approval authority must be delegated in writing from the Head of Small Enterpriseresponsible for the Small Enterprise business, acknowledged by recipients and records ofall delegation retained.The credit approval function should be separate from the marketing / sales function.Approvals must be evidenced in writing, or by electronic signature. Approval recordsmust be kept on file with the Credit Applications.

Credit approval should be centralized within the Credit function. Regional credit centersmay be established, however, all large loans (as defined in the PPG) must be approved by

the Head of Credit or delegated Head Office credit executive. Any credit proposal thatdoes not comply with Lending Guidelines, regardless of amount, should be referred toHead Office for Approval.Any breaches of lending authority should be reported to MD/CEO, Head of InternalControl, and Head of Credit.It is essential that executives charged with approving loans have relevant training andexperience to carry out their responsibilities effectively. As a minimum, approvingexecutives should have:

At least 5 years experience working in Branch / Sales team as a relationshipmanager or account executive.

Training and experience in financial statement, cash flow and risk analysis.

A good working knowledge of Accounting.

A good understanding of the local market.

A monthly summary of all new facilities approved, renewed, enhanced, and a list of proposals declined stating reasons thereof should be reported by Credit Team to theBusiness Head.Duplication of Check


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All approved applications must be checked against banks database to identify whetherthe applicant is enjoying any other loan in other account apart from the declared loans.

Maintenance of Negative Files

Two negative files one listing the individuals and the other listing the employers - are to

be maintained to ensure that individual with bad history and dubious integrity andemployers with high delinquency rate do not get loan from banks.

7.3.2 Credit AdministrationAfter approval, Credit Team will send / forward the approved application along with thesecurity and other documents to the Credit Administration Department under OperationsUnit for processing. The Credit Administration function is critical in ensuring that properdocumentation and approvals are in place prior to the disbursement of loan facilities.Under Credit Administration there may be two-sub unit, Documentation & QC and LoanAdministration Dept who will process the document and disburse the loan.

Credit DocumentationCredit Documentation dept is responsible:

To ensure that all security documentation complies with the terms of approval.

To control loan disbursements only after all terms and conditions of approvalhave been met, and all security documentation as per the checklist of approvedPPG is in place.

To maintain control over all security documentation.

To monitor borrowers compliance with agreed terms and conditions, and generalmonitoring of account conduct/performance.

Upon performing the above, Documentation dept will forward the Limit InsertionInstruction to the Loan Administration unit for limit and other information to

input into the banks main system.

Disbursement

Loan Administration dept will disburse the loan amounts under loan facilities only whenall security documentation is in place. CIB report is obtained, as appropriate, and clean.

Custodial Duties

Loan disbursements and the preparation and storage of security documents should becentralized in the regional credit centers. Security documentation is held under strict dualcontrol, in locked fireproof storage.

Compliance Requirements

All required Bangladesh Bank returns are submitted in the correct format in atimely manner.

Bangladesh Bank circulars/regulations are maintained centrally, and advised to allrelevant departments to ensure compliance.

All third party service providers (valuers, lawyers, insurers, CPAs etc.) areapproved and performance reviewed on an annual basis.


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7.3.3 Risk ManagementCredit Risk

The credit risk is managed by the Credit & Collections unit (CCU), which is completelysegregated from business/sales. The following elements contribute to the management of

credit risks:The credit risk associated with the products is managed by the following:

1. Loans will be given only after proper verification of customers static data andafter proper assessment & confirmation of income related documents, which willobjectively ascertain customers repayment capacity.

2. Proposals will be assessed by independent Credit division (CCU) that iscompletely separated from business/sales.

3. Every loan will be secured by hypothecation over the asset financed, andcustomers authority taken for re-possession of the asset in case of loan loss.

4. The loan approval system is encouraged to be parameter driven as much aspossible which will substantially eliminate the subjective part of the assessment

procedure.5. There will be dedicated collection force that will ensure timely monitoring of

loan repayment and its follow up.6. The Credit & Collection activities will be managed centrally and loan approval

authorities will be controlled centrally where the branch managers or sales peoplewill have no involvement

Contact Point Verification:

Contact Point Verification should be done wherever possible for all applicants. Theexternal CPV includes residence, office and telephone verifications. All verifications aredone to seek/verify/confirm the declared/undeclared information of the applicant.

Third Party Risk

In case of third party deposits/security instruments, banks should verify third partyssignature against the specimen attached to the original instrument and bank will also sendthe instrument to the issuing office for their verification and written confirmation on lienmarking and encashment of the instrument. Therefore, any inherent risk emanating fromaccepting third party deposits/security instruments is minimal.Fraud Risk

There is an inherent fraud risk in any lending business. The most common fraud risks is:Application Fraud

The applicants signature may not be verified for authenticity. However, the applicants

identity should be confirmed by way of scrutiny of identification and otherdocumentation. A Contact Point Verification (CPV) agency should be in place to verifyapplicants residence, office and contact phone numbers etc.

There always remains the po