STUDY ON THE ACCESS OF SMEs TOWARDS CREDIT FROM COMMERCIAL BANK

Submitted by: Parmita Shrestha Roll No: 940193 Registration No: 2009-2-22-0109

A Graduate research report submitted to Ace Institute of Management Pokhara University

Submitted for the degree of Master of Business Administration

Kathmandu September, 2011

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AcknowledgementIt is my great privilege to complete this thesis under the guidance and supervision of Mr. Sohan Babu Khatri, instructor of Ace institute of Management, who has supported me by giving guidance, advice, valuable suggestion and necessary material throughout my research work. I also thank Dr. Mahendra P. Shrestha and Mr. Pravat Uprety, Instructors Ace Institute of Management for their sessions on GRP. I thank Mr. Pravat Uprety for his guidance in completing the statistical portions of this research. I thank various experts from different commercial bank and all the respondents for their cooperation and participation in filling the questionnaire. Lastly, I take this opportunity to thank Ace Institute of Management for providing a great platform to expand my knowledge in the field of my interest.

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Certificate of authorshipI hereby declare that this submission is my own work and that, to the best of my knowledge and belief, it contains no material previously published or written by another person nor material which to a substantial extent has been accepted for the award of any other degree of university or other institution of higher learning, except where due acknowledgements. Parmita Shrestha

Approval sheet

iiiRecommendation for Approval This GRP report prepared and submitted by Parmita Shrestha in partial fulfillment of the requirements for the degree of Master of Business Administration has been supervised by me and recommends it for acceptance. Sohan Babu Khatri ... Date: Acceptance of the External Examiner I approve the GRP submitted by Parmita Shrestha. The grade sheet has been submitted to the Dean, School of Business, Pokhara University through the college on a separate evaluation sheet. External evaluator .. Date: Viva Examination The candidate has successfully defended the GRP. We recommend it for acceptance. The grade sheet has been submitted to Dean, Pokhara University through the college on a separate evaluation sheet. External Examiner .. Sohan Babu Khatri . Dat e:

List of abbreviationsIFC NIC International Finance Corporation Nepal Industrial and Commercial Bank

ivNPL NRB NSBL OECD SCBNL SMEs Non-Performing Loan Nepal Rastra Bank Nepal SBI Bank Ltd Organization For Economic Cooperation and Development Standard Chartered Bank Nepal Limited Small and Medium Enterprise

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Table of ContentAcknowledgement...........................................................................................i ..................................................................................................................i Approval sheet...............................................................................................ii List of abbreviations......................................................................................iii Table of Content.............................................................................................v List of Table....................................................................................................x List of Figure.................................................................................................xii Executive summary.....................................................................................xiii CHAPTER 1 INTRODUCTION..............................................................................................1 Background .....................................................................................................................1 1.2 SMEs in Nepal............................................................................................................2 1.2.1 Major Sector of SMEs in Nepal......................................................................3 1.2.2 Definition of SMEs in Nepal...........................................................................3 1.2.3 Significance of SMEs in Nepal ......................................................................4 1.2.4 SMEs of Nepal ..............................................................................................5 1.2.5 Financing - The Prerequisites for SMEs Development...................................5 1.2.6 Role of Commercial Bank in SMEs Financing ..............................................6 1.2.7 Most common types of loan provided by commercial bank for SMEs............7 1.3 Statement of the problem ...........................................................................................7 1.4 Purpose of the Study .................................................................................................8 1.5 Significance of the study ............................................................................................8 The research deals with SMEs financing scheme of commercial bank, its usage and satisfaction level on SMEs. The study is significant in the following ways:.................8 1.6 Research Questions...................................................................................................9 1.7 Limitation of the study.................................................................................................9 1.8 Operational Definitions and Assumptions ................................................................10

vi 1.8.1 Operational Definitions................................................................................10 LITERATURE SURVEY AND THEORETICAL FRAMEWORK.......................................14 2.1 Literature Review ...........................................................................................14 A review of literature is a critical analysis of a segment of a published body of knowledge. Various studies on a number of issues concerning small and medium enterprises and role of financial institution for financing SMEs had been studied in order to provide base for this research. Among them some of the past studies which have been considered are mentioned in this section. ...............................................................14 ............................................................................................................................21 2.2 Theoretical Framework.............................................................................................21 2.2.1 Theoretical Framework................................................................................21 CHAPTER 3................................................................................................... 25 METHODOLOGY............................................................................................25 3.1 Research Plan and Design ......................................................................................25 3.2 Description of the Sample.........................................................................................26 3.2.1 Research Population...................................................................................26 3.2.2 Research Sample........................................................................................26 3.4. Data collection procedure and time frame................................................................28 3.4.1. Primary Data Collection..............................................................................28 3.4.2 Secondary Data Collection..........................................................................28 3.4.3 Time Frame.................................................................................................29 CHAPTER 4................................................................................................... 32 RESULTS AND DISCUSSIONS........................................................................32 4.1 Expert Interview Result ............................................................................................32 4.1.1 Narrative analysis of Open Ended question ................................................32 4.1.1.1 Details of Selected Old commercial Bank expert response ......................32 4.1.1.2 Details of Selected Medium range commercial Bank expert response .....34 4.1.1.3 Details of Selected New range commercial Bank expert response .........36 4.1.1.4 Narrative Analysis of some common response given by Expert:...............39 4.1.2 Presentation and Descriptive analysis from the response of expert ............41 4.1.2.1 SMEs categorization on the basis of Loan Limit.......................................41

vii 4.1.2 .2 Service Charge on each loan product .....................................................42 4.1.2.3 Time taken to approve SMEs Loan ..........................................................42 4.1.2.4 Interest Rate for SMEs loan .....................................................................43 4.1.2.5 Commercial Bank having Separate SMEs department ............................43 4.2 Presentation of the result from respondents ............................................................46 This section helps to deal with the presentation and analysis of the 40 respondent as per the questionnaire mentioned in Annex 2..................................................................46 4.2.1 Age of Respondent .....................................................................................46 4.2.2 Education Level of respondent ...................................................................46 Among the 40 respondents, 55 percentages the respondent has education qualification of bachelor degree. And 25 percentage of the respondent has education qualification of higher secondary. So, we can see that most of the people having education qualification of bachelor degree are entrepreneur....................................................47 4.2.3 Ownership Pattern ......................................................................................47 4.2.4 Industry .......................................................................................................47 Among the 40 respondent equal number of respondent has been selected from each industry i.e. 25 percentage of respondent in each industry. .....................................47 4.2.5 Total Number of Employees........................................................................48 4.2.6 Organization Structure.................................................................................48 4.2. 7 Industry Attractiveness ...............................................................................49 4.2.8 Organization Strength..................................................................................49 4.2.9 Problem faced by entrepreneur in business growth ....................................49 4.2.10 Annual Turnover .......................................................................................50 4.2.11 Fixed Assets ............................................................................................51 4.2.11 Equity and Debt Ratio ...............................................................................51 4.2.12 Loan Size...................................................................................................52 4.2.13 Loan taken from commercial bank ............................................................52 4.2.14 Details of Credit history .............................................................................52 4.2.15 Motivating factor to take loan from commercial bank ................................53 4.2.16 Problem Faced by Entrepreneur while raising finance from commercial bank ..................................................................................................................54

viii 4.2.17 Level of satisfaction with various aspect of obtaining finance from commercial bank ...............................................................................................54 4.2.18 Reason for not applying loan from commercial bank ................................55 4.2.2 Types of Statistical Test Performed ............................................................55 4.2.2.1 Cross tabulation: Ownership of business and Accounting System............55 4.2.2.2 Cross Tabulation between Industry and educational qualification ............56 4.2.2.3 Cross Tabulation between Industry and Industry attractiveness ..............57 4.2.2.4 Cross Tabulation between industry and annual turnover ........................57 4.2.2.5 Cross Tabulation of industry and loan taken from commercial bank .......58 4.2.2.6 Cross-Tabulation between Industry and Loan size:..................................58 4.2.2.7 Cross-Tabulation between Industry and Equity -Debt ratio:......................59 4.2.2.8 Cross Tabulation between loan taken from commercial bank and industry attractiveness ...................................................................................................59 4.2.2.9 Cross Tabulation of loan size and loan taken from commercial bank .......60 4.2.2.10 One Sample T-test of level of satisfaction with various aspects of obtaining finance ...............................................................................................60 Inferential Analysis and Discussion ................................................................................61 The respondent has stated their industries as attractive or very attractive on the basis of the following reason: market potentially, high industries profitability, good annual sales and turnover, good public relation, high customer satisfaction and year of business experience. The respondent has stated their industries as low attractive or moderate attractive on the basis of the following reason: slow growth and profit margin, political instability, seasonal nature of business, high risk industries and intensity of competition. .............................................................................................................66 SUMMARY AND CONCLUSIONS.....................................................................68 5.1 Summary of Findings................................................................................................68 5.1.1 Findings from Expert view ...........................................................................68 5.1.2 Findings from analysis of data collected through respondent ......................70 The major findings based on the analysis of data collected through respondent are as follows: .........................................................................................................70 5.2 Conclusion and Recommendation ...........................................................................74 5.2.1 Conclusion .................................................................................................74 5.2.2 Recommendation ........................................................................................75

ix 5.2.2.1 Recommendation to Commercial Bank ....................................................75 5.2.2.2 Recommendation to SMEs ......................................................................77 5.2.2.3 Recommendations for future research......................................................77 From the research done, some recommendations can be provided to the future researchers which are mentioned below:...........................................................77 Bibliography.................................................................................................78 ANNEX..............................................................................................................................i Industrial Policy of Nepal, 2010...............................................................................x

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List of TableTable 1: Number of industries registered by scale.........................................3 Table 2: Contribution to employment by registered industries......................3 Table 3: SMEs definition in Nepal...................................................................4 Table 4: Respondent Segmentation according to industry...........................26 Table 5: List of selected commercial bank ..................................................27 Table 6: SCBNL credit product for SMEs......................................................32 Table 7: NSBL credit product for SMEs........................................................33 Table 8: Everest Bank credit product for SMEs............................................34 Table 9: NIC bank credit product for SMEs...................................................35 Table 10: Laxmi Bank credit product for SMEs.............................................35 Table 11: Siddhartha Bank Limited credit product for SMEs........................36 Table 12: Global Bank credit product for SMEs............................................37 Table 13: Sunrise Bank Limited credit product for SMEs..............................38 Table 14: Mega bank credit product for SMEs..............................................39 Table 15: Financial Factor to evaluate SMEs creditworthiness.....................43 Table 16: Nonfinancial Factor to evaluate SMEs creditworthiness...............44 Table 17: Reason for rejection of an application for loan ...........................45 Table18: Organization Structure.................................................................48 Table 20: Problem entrepreneur are facing in its growth............................49 Table 21: Details of Credit History...............................................................52 Table 22: Motivating factor to take loan from commercial bank ...............53 Table 23: Difficulties while raising finance from commercial bank...............54 Table 24: Level of satisfaction with various aspect of obtaining finance .....54 Table 23: Reason for not applying loan from commercial bank...................55 Table 26: Industry and Education Qualification...........................................56 Table 27: Industry and Industry Attractiveness...........................................57

xi Table 28: Industry and Annual turnover.......................................................57 Table 29: Industry and Loan taken from commercial bank.........................58 Table 30 : Loan size and Industry.................................................................58 Table 30: Industry and Equity-Debt ratio ....................................................59 Table 32: Loan size and loan taken from commercial bank ........................60 Table 33: Level of satisfaction with various aspects of obtaining finance....60 Table 34: Mean of industry and level of satisfaction with amount granted by bank relative to the amount requested ......................................................61 Table 35: Mean of industry and level of satisfaction with simplicity of application form ..........................................................................................62 Table 36: Mean of industry and level of satisfaction with interest rate........62 Table 37: Mean of industry and level of satisfaction with service fee..........63 Table 38: Mean of industry and level of satisfaction with time to obtain approval....................................................................................................... 64 Table 38: Mean of industry and level of satisfaction with guarantees required by the institution............................................................................64 Table 39: Mean of industry and level of satisfaction with behavior of bank staff.............................................................................................................. 65

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List of FigureFigure 1: Theoretical Framework..................................................................22 Figure 2: SMEs categorization on the basis of loan limit.............................41 Figure 3 : Percentage of Service charge on each loan product....................42 Figure 4: Time taken to approve SMEs loan.................................................42 Figure 5: Interest Rate for SMEs loan...........................................................43 Figure 6: Commercial bank having separate SMEs department...................43 ..................................................................................................................... 46 Figure 7: Age of respondent........................................................................46 Figure 8 : Education Qualifcation.................................................................46 Figure 9: Ownership Pattern of enterprise...................................................47 Figure 10: Industry ......................................................................................47 Figure 11: Total Number of Employees.......................................................48 Figure 12: Industry Attractiveness...............................................................49 Figure 13 : Annual Turnover.........................................................................50 Figure 14: Fixed Assets ...............................................................................51 Figure 15: Equity and Debt Ratio.................................................................51 Figure 16: Loan size.....................................................................................52 Figure 17: Loan Taken from commercial bank.............................................52

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Executive summarySmall Medium Enterprise (SMEs) constitutes the backbone of developing countries like Nepal. They not only provide employment and therefore income opportunities to a large number of people, but are also at the forefront of technological innovation and export diversification. Acknowledging this fact, we can say that there is also an urgent need to create a strong competitive SMEs sector that is able to play a leading role in the development process, in order to be able to face the various challenges posed by global economic developments. For this purpose financing is one of the necessary prerequisites for SMEs development. But, it cannot be deniable that, SMEs traditionally lacked access to formal credit, particularly long-term finance. This is because SMEs are generally considered of high risk due to insufficient assets, low capitalization, less efficient production process and technology, poor knowledge and information about business opportunities and marketing and lack of collateral as well as high vulnerability to market conditions. Experiences with SMEs development efforts worldwide suggest that the most successful efforts were those that sought to stimulate intermediaries to provide competitive finance to SMEs, rather than the provision of direct financial assistance in the form of support programs, which have proven to be costly and inefficient. In such context, the banking sector - specifically commercial banks have several ways to get involved in SMEs finance, ranging from the creation or participation in SMEs finance investment funds, to the creation of a special unit for financing SMEs within the bank. Therefore this research attempts to understand nature and capacity of SMEs, the effectiveness of SMEs financing scheme provided by commercial bank, factor commercial bank take into consideration to evaluate SMEs creditworthiness, current level of satisfaction and obstacles SMEs is facing while accessing credit from commercial bank and ultimately suggest some measure to commercial bank to promote and support SMEs so that it will be easy for SMEs to raise finance from commercial bank.

The study can be important to the commercial banks as well as government and non government organization to understand SMEs nature and problem SMEs are facing to access credit from formal sector. The study will be also important to entrepreneur to understand about the varieties of product and services provided by commercial bank for SMEs and factor bank take into consideration to evaluate SMEs creditworthiness. The research is conducted under different limitations like time constraints, limited to Kathmandu valley, limited sample size, focuses only on the SMEs financing scheme of commercial bank and response error. Various studies on a number of issues concerning small and medium enterprises and role of financial institution for financing SMEs had been studied in order to provide base for this research. For the analysis purpose access of SMEs towards credit from commercial bank is

xivdependent variable whereas nature of product, evaluation of SMEs creditworthiness, nature of SMEs, industry attractiveness, capacity, obstacles and customer level of satisfaction are the independent variables. On the basis of analysis of this independent variable the research has attempt to understand how convenient it is for SMEs to access finance from commercial bank. The study has used both the primary as well as secondary resources for the data collection. .For primary sources of data collection two different questionnaires were prepared to interview with the expert of commercial bank as well as to collect data with 40 respondents. The respondents selected were entrepreneurs who had taken loan and were related with four industries i.e. Manufacturing, Trading, Restaurant and Travel & Tourism .The research duration was two months within which literature review, data collection; analysis and report presentation is completed. Data analysis of interview with the expert of 9 different commercial bank shows that most of the bank has their own categorization for SMEs based on loan size. The loan products provided by most of the bank are same and all the commercial bank considers both financial factor and non financial factor to evaluate SMEs creditworthiness. The one-sample T-test shows that all the non-financial factor and financial factor are important to evaluate SMEs creditworthiness. From the 40 respondents the personal and enterprise information like age group, education level, industry, years of experience, industry entrepreneur belongs, ownership pattern and total number of employees were analyzed. In addition information regarding organization structure, industry attractiveness, capacity, customer level of satisfaction and obstacles SMEs are facing to access credit form commercial bank was also analyzed. SMEs categorization was done on the basis of loan size up to Rs 10 million. On the basis of this assumption research shows that 97.5 percent of the respondent falls in SMEs group. Hence, this research has been concluded by stating that commercial bank seems lacking behind for providing effective service to SMEs as the entrepreneur seems unsatisfied with various aspects of obtaining finance from commercial bank like interest rate, service fees, time to obtain approval and guarantees required by the institution .In addition most of the commercial bank doesnt have separate SMEs department and has trend of evaluating SMEs creditworthiness on the basis of factor similar to corporate loan. This trend shall be changed as SMEs usually has informal organization structure and low income as compare to large borrowers. Therefore this research has suggested the commercial bank some specific recommendation in order to cater the unique needs of SMEs, which will ultimately plays a great role to enhance self entrepreneurship, employment generation and sustainable growth in banking, economy and other areas of development.

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CHAPTER 1 INTRODUCTIONBackgroundSmall and Medium Enterprises have played a significant role in the economic development, particularly emerging countries.SMEs not only provide employment and therefore income opportunities to a large number of people, but are also at the forefront of technological innovation and export diversification. This sector has been a breeding ground for entrepreneurship. Small businesses are particularly important for bringing innovative products or techniques to the market. Example: Microsoft started off in typical SMEs fashion, as a dream developed by a young student with the help of family and friends. Previously Bill Gates and his colleagues had only some saleable product which they were used to take it to the marketplace and look for investment from more traditional sources. But, today it is software giant that is forefront at the technological innovation and even provides employment opportunities to wide number of people. So, promoting and supporting the small and medium enterprise is crucial in order to create giant enterprise in future which plays a sustainable role for the economic development. The definition of SMEs varies from country to country. The classification can be based on the firms assets, number of employees, or annual turnover. SMEs can be defined - according to European Union - as firms with less than 250 employees, annual turnover less than 50 million euro and balance sheet total of 43 million euro as Medium sized enterprise and firms with less than 50 employees, annual turnover less than 10 million euro and balance sheet total of 10 million euro as Small sized enterprise and firms with less than 10 employees, annual turnover less than 2 million euro and balance sheet total of 2 million euro as Micro enterprise. Although the EU thresholds are very high for most developing countries, this denition is presented as an example because the EU has made the greatest effort to standardize the SME denition. Currently, at least 27 countries follow the EU denition. But, whatever is the definition, the SMEs account for significant share of employment and GDP around the world, especially when taking into account the informal sector. Studies indicate that formal SMEs contribute up to 45 percent of employment and up to 33 percent of GDP in developing economies; these numbers are signicantly higher when taking into account the estimated contributions of SMEs operating in the informal sector. However the barrier like corruption, lack of development of proper infrastructure i.e. electricity, transport system, communication, political instability, lack of managerial training and experience as well as lack of adequate financing creates obstacles for the establishment and growth of SMEs. Among them access to finance remains a key constraint to SMEs development in emerging countries. Various data sources and studies indicate that small firms rely on internal financing much more than large firms do and that likelihood of a small firm having access to

2bank loan in low-income countries is about a third of what it is for a medium sized firm and less than half of what it is for a larger firm. The main reason behind this financing gap is that SME sector may not have the security required for conventional collateral based bank lending, nor high enough returns to attract formal venture capitalists and other risk investors. In addition, markets may be characterized by deficient information limiting the effectiveness of financial statement-based lending and credit scoring. Thus, understanding this credit gap nowadays SMEs development had became focal attention for governmental as well as nongovernmental organizations including donor agencies as it plays a great role for poverty elevation and generates employment. More and more commercial banks are interested in entering the SMEs finance market, which has proven to be profitable and less risky compare to corporate lending by the experience of several banks. As far as direct loan support to SMEs, banks are increasing their involvement but remain discreet about it. Commercial banks are increasingly viewing SMEs as a business opportunity and a way to attract new customers. Banks benefit from their involvement in SMEs finance, by increasing their client base and thus diversifying into new areas of business that will eventually reflect positively on the banks portfolio, since SMEs provide a good opportunity for the growth of banks assets and liabilities. This gives banks a greater opportunity to grow with their customers, and thus reap long term benefits. This is in addition to the positive outlook on the banks, as they are seen to be playing a role in developing the community and the economy. Therefore this research attempts to understand the effectiveness of SMEs financing scheme provided by commercial bank, financial and non financial factor used to evaluate SMEs creditworthiness, nature and capacity of SMEs, current level of satisfaction and obstacles SMEs is facing while accessing credit from commercial bank and ultimately suggest some measure to commercial bank to promote and support SMEs so that it will be easy for SMEs to raise finance from commercial bank.

1.2 SMEs in NepalNepal has a population of 29,391,883 (July 2011 est.) and GDP growth rate 4.6 % that places Nepal at one of the poorest countries of the world. The land locked geophysical location, limited resource endowments, economic isolation, rugged mountainous terrain have contributed to the social and political backwardness of this Himalayan Kingdom. Since 1950, supported by pouring external aid, Nepal started to divert its public resources to economic and social development. However developments so far have not been able to alleviate poverty especially from the rural areas constituting the national average of 24.7 percent (2008) people living below the poverty line. As per 2010 estimate the percentage contribution of agriculture is 32.8 %, industry is 14.4 % and service sector is 52. 8 % to total GDP. In Nepal SMEs plays an important role in sustaining economic growth, increasing trade, generating employment and creating new entrepreneurship. In keeping in view its importance, the promotion and development of SMEs has been an important for the sustainable growth of

3Nepalese economy. According to the industrial statistics of fiscal year 2009/2010 the number of SMEs in Nepal is 90.64 % of total industry registered and has contributed 81.16 % in employment .The number of industries has been significantly increased as compare to previous year and has created a greater employment opportunities. The number of industries registered and employment created by register industries in various year data as per (Industrial Statistics) are as follows : Table 1: Number of industries registered by scale Scale Large Medium Small Total 2062/63 13 27 51 91 2063/64 72 19 85 111 2064/65 13 34 103 150 2065/66 27 54 127 208 2066/67 48 58 152 258

Table 2: Contribution to employment by registered industries (in million)

1.2.1 Major Sector of SMEs in NepalMost of the Nepalese SMEs are involved in processing and manufacturing of food items, Scale Large Medium Small Total 2062/63 2929 3829 1827 8644 2063/64 1005 1622 3031 5658 2064/65 3769 2476 3415 9663 2065/66 7603 3998 4913 16514 2066/67 5162 4129 5219 14510

consumer and household goods, and textiles and related products, both for exports as well as the domestic market. Other areas of SMEs involvement include forest fiber based industries, wooden and metal handicrafts, handmade paper and products, apparels and garments, woollen carpets, pashmina shawls and rugs and leather. In addition, investment in the modern agrobusiness sector like tea, off-season vegetables and horticulture products, dairy and milk products, animal husbandry and floriculture, among others, have also been seen during the last decade. Due to the opening up of investment for infrastructure development to the private sector, investment in micro hydropower and tourism resorts and complexes have also been witnessed in some regions.At the micro, cottage and family level, a sizeable number of unregistered enterprises operate off-farm on a seasonal basis. A majority of these unregistered units are reliant on agro-based and forest -based raw materials and produce household and consumption goods, particularly food items, handicrafts and household utility articles. (Overview of Nepalese Small and Medium Enterprise)

1.2.2 Definition of SMEs in NepalThe definitions of industrial enterprises in Nepal, like in other countries, have undergone change over the passage of time due to change in industrial policy and thrust in the assistance

4programs. The prevalent definition of SMEs in Nepal is based on their investment in fixed assets. Definitions of SMEs as per various Industrial Enterprises Act and Industrial Policy Act are as follows: Table 3: SMEs definition in Nepal Policy Industrial Enterprises Act, 1961 Industrial Enterprises Act, 1974 Industrial Policy, 1981 Industrial Policy, 1992 Small Industries Capital investment of Rs 50,000 Fixed capital investment between Rs 0.2 million to Rs 1 million Fixed capital investment of up to Rs 2 million Fixed capital investment not exceeding Rs 10 million Fixed assets not exceeding Rs 30 million Medium Industries Investment between Rs 50,000 and Rs 0.5 million Fixed capital investment between Rs 1 million and Rs 5 million Fixed capital investment between Rs 2 million and Rs 10 million Fixed capital investment between Rs 10 million and Rs 50 million Fixed assets between Rs 30 million and Rs 100 million

Industrial Policy, 1997 (amended)

Source: Compiled from Industrial Enterprise and Industrial Policy Act

1.2.3 Significance of SMEs in NepalThough there still is a dearth of highly competitive and growth oriented SMEs in Nepal, the importance of existing SMEs to the national economy cannot be undermined. They have grown as a critical sector of growth providing employment and income to many. Thus we can say that SMEs have been playing great role for poverty alleviation by providing employment opportunities. While there is no dispute that there is a dearth of fast growing SMEs in Nepal, dynamic SMEs provide competitive edge in two ways as leading subcontractors and as venture firms in their own right. They also create jobs, thus multiplying their impact on economic growth. One of the most important features of SMEs is the strong backward linkage that they have. SMEs in Nepal have provided the foundation for private sector growth. The growth in trade and output seen by Nepal, especially since the government adopted liberal economic policies, is a strong testimony to this assertion. One of the important significance of SMEs arises by virtue of investment. Small and medium industries create employment opportunities with less investment as compare to large industries. This is an indication of the degree of importance that SMEs hold in the Nepalese context. Thus, these significance of SMEs shows fact that for an intensive industrial expansion, promotion of small and medium scale industries is essential.

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1.2.4 SMEs of NepalNepals SMEs share the characteristics that are usually common in SMEs of developing countries and LDCs. (Overview of Nepalese Small and Medium Enterprises) The common characteristics are as follows: SMEs are family-level enterprise set up with family savings and sometimes supported by kith and kin. The ownership and management is usually controlled by the same individual with powers over all decision issues of the enterprise. Since personal and family savings are the major sources of equity capital, credit worthiness of SMEs is low, which impedes their development. Managerial competence requirements are perceived as not important the enterprise relies on entrepreneurial skills and initiatives of the founder/s. Recruitment of staff is often carried out without a proper job analysis and a job description. Even when employees are deemed to be competent, they are rarely delegated with authority and power to decide on their own. The technology used is usually locally innovated, limited in capacity and efficiency with frequent breakdowns which causes high wastage. Most SMEs produce and cater only to the local markets and export oriented SMEs are few. Those that are export oriented are not able to expand due to various inherent constraints like poor quality control, unable to meet timely delivery and limited production. Access to institutional credit for SMEs, despite provisions for the same, is limited due to individual entrepreneurs inability to contribute to equity capital and collateral security. Most of the enterprises in SME sector have informal structure and they are poor in documentations.

1.2.5 Financing - The Prerequisites for SMEs DevelopmentFinancing is one of the necessary prerequisites for SMEs development. It is necessary for SMEs to set up and expand their operations, develop new products, and invest in new staff or production facilities. Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business. But if they are successful, there comes a time for all developing SMEs when they need new investment to expand or innovate further. That is where they often run into problems, because they find it much harder than larger businesses to obtain financing from banks, capital markets or other suppliers of credit like leasing and factoring. This is because SMEs are considered of high risk due to insufficient assets, low capitalization, and lack of collateral as well as high vulnerability to market conditions. In addition as mention in Annex 4 some of directives and regulation of NRB also creates impediments for SMEs to access finance from formal sector.

6Besides owners own source of financing, different sources of financing for SMEs can be Government, Financial institutions, Leasing companies, Venture capitalist etc. Among them financing from financial institutions like Commercial Bank, Development Bank, Finance Company, Micro Finance Development Bank, Rural Development Bank, Co-operatives and NGOs are the most common sources of financing for SMEs.

1.2.6 Role of Commercial Bank in SMEs FinancingAs per Bank and Financial Institution Regulation Department, Mid- July 2010 : Commercial Banks held dominant share on the major balance sheet components of financial system. Of the total deposits Rs.794328.3 million in Mid - July 2010, the commercial banks occupied 79.4 percent. Similarly, finance companies held 9.8 percent, development banks 9.7 percent and micro finance development banks 1.1 percent. Likewise, on the loans and advances the share of commercial banks stood at 75.2 percent, development banks 10.6 percent, finance companies 12.4 percent and micro finance development banks 1.8 percent in Mid - July 2010. In the same year the share of commercial banks in the borrowings, liquid funds and investments constitute 52 percent, 65.7 percent and 92.1 percent respectively. This shows that commercial Banks are the dominant player among all other financial institution for providing different financial services to customers as well as development of Nepalese economy. Up till now the number of commercial bank has reached to 31. With the rapid number of increase in commercial bank within few decade service and facilities provided by bank has been also increased. Among them providing loan to customer at appropriate interest rate is one of the main motive of commercial bank to withstand in this competitive growing market. Commercial bank mainly divides its loan portfolio in three groups i.e. Personal loan, corporate loan and SMEs loan. However, the focus of commercial bank for providing loan to small and medium enterprise has been increasing due to its significant importance for the growth of Nepalese economy as well as diversifies the loan portfolio of the bank in product, sector and cliental base for its goodwill as well as profit. For this purpose the commercial bank has taken several initiatives to get involved in SMEs finance, ranging from the creation or participation in SMEs finance investment funds, to the creation of a special unit for financing SMEs within the bank. Normally ,commercial bank services provided to SMEs, take various forms, such as (1) short term loans, compatible with SMEs business and income patterns (2) repeated loans, where full repayment of one loan brings access to another, and where the size of the loan depends on the client's cash flow (3) very small loans, or bank overdraft facilities are also appropriate for meeting the day-to-day financial requirements of small businesses (4) factoring and invoice discounting, asset finance and equity finance, all being within the framework of a customerfriendly approach.

7Among different other financial institution the focus of this research is on commercial bank because it plays an important role for growth and support of SMEs as compare to others financial institution because its several advantages. Some of its advantages are as follows: Clear regulations illustrating the conditions of ownership, financial disclosure, and capital adequacy that help them ensure prudent risk management Physical infrastructure, including a large network of branches, which enables them to reach a substantial number of small and medium sized clients Well-established Internal Controls, administrative and accounting Systems which facilitate keeping track of a large number of transactions Ownership Structures increasingly dominated by Private Sector which tends to encourage sound governance practices, seeking cost-effectiveness and profitability. Provision of giving timely and adequate credit and upgrading the technology for better quality and competitiveness of their products.

1.2.7 Most common types of loan provided by commercial bank for SMEsThe most common types of credit product provided by commercial bank to SMEs are as follows: a) Credit Product Fund Based i. Working Capital facilities ii. iii. iv. Short term loan Demand loan Cash credit Post-shipment credits

Term loan Trust Receipt Loan/Import loan Export Loan

b) Credit Product - Non Fund Based i. ii. Letter of Credit (LC) Bank Guarantee

1.3 Statement of the problemSMEs, more often than not, are unable to generate enough credit to carry out relatively larger volume of work. The SMEs informal organization structure and lack of awareness on the part of entrepreneurs regarding financial institutions that may give them credit are the most common reason for their inability to raise financial resources. The other reason for their inability to generate funds is the practice of the financial institutions to provide credit on the basis of

8relationship rather than based on feasibility of the projects. Even when SMEs manage to get credit relatively short time for repayment and high interest rates do not help their cause. So, most SMEs tend to rely on the personal resources of their owners, and/or loans from friends and relatives to fund the enterprise. The expectation has been that, after the initial take off of the small scale enterprises, the business should be able to raise funds from the formal sector especially banking industries to expand its operations. This has not been the case for a number of reasons like the perception of small and medium enterprises as high risks, inability of the SMEs to prepare acceptable or viable banking business plans, Weak capacity on the part of entrepreneur to provide enough guarantees, Weak capacity on the part of banks to down-scale their lending to SMEs and high transaction cost of small and often segmented loans. As the result, it is often noticed that banking industries prefer to lend to big businesses and to engage in investment and foreign exchange related transactions which they consider less risky. Since, SMEs need to have access to appropriate, reliable and efficient sources of credit to be able to operate effectively, so the continuous support and motivation from banking sector of Nepal is essential for its growth and increase its ability to compete with regional and global players. Although, various studies has been conducted in context of national as well as international level on the different issues related to SMEs. However, this study is probably one of the kinds that have rarely been conducted in context on Nepal as it focus on how convenient it is for SMEs to access finance from commercial bank .

1.4 Purpose of the StudyThe general objectives of the research is study SMEs financing scheme of commercial bank , its usage and satisfaction level on SMEs .In consistence with the general objectives, the specific objectives are as follows : To know about the various SME financing schemes of commercial banks To know the major factor that bank takes into consideration to evaluate SMEs creditworthiness.

To know the nature and capacity of SMEs. To know the problems faced by SMEs in getting credit from commercial banks. To check the satisfaction level of SMEs regarding various aspects of obtaining finance from commercial bank.

To suggest the mechanism to commercial bank that is necessary to substantially develop SMEs lending.

1.5 Significance of the studyThe research deals with SMEs financing scheme of commercial bank, its usage and satisfaction level on SMEs. The study is significant in the following ways: a) It is beneficial for the new as well as existing entrepreneur to gain information about varieties of SMEs financing scheme provided by different commercial bank and its benefits.

9b) It also gives information about different factors that commercial bank take into consideration in order to evaluate SMEs creditworthiness.

c) It gives information about nature of SMEs, capacity of SMEs and nature of productgenerally taken by SMEs.

d) It also provides insights for commercial banks to know about the important factor thatcreate obstacles for SMEs to apply for loan from Commercial Bank. e) It shows the level of satisfaction of entrepreneur with various aspects of obtaining finance from commercial bank and suggests commercial bank appropriate measures to provide better service and support to promote SMEs. f) It also provides useful information for other government and non-government organization who wants to render service to support and promote SMEs.

1.6 Research QuestionsThe overall aim of this research is to know how convenient it is for SMEs to access finance from commercial bank. Thus considering this issue, this study will be specifically addressing the following research questions: 1) What are the varieties of SMEs financing scheme provided by commercial bank? 2) What are the financial and non financial factors the commercial bank relied on to evaluate SMEs creditworthiness? 3) What is the nature and capacity of SMEs of Nepal?

4) What are the factors that are creating obstacles for SMEs to raise finance fromcommercial bank?

5) Whether entrepreneurs are satisfied with various aspects of obtaining finance fromcommercial bank?

1.7 Limitation of the studyDue to constraints of time and resources, the study is likely to suffer from certain limitations. Some of these are mentioned here under so that the findings of the study may be understood in a proper perspective. The limitations of the study are as follows: The research was carried out in a short period. Therefore the sample size is based on Kathmandu valley only to finish the work within the given time frame.

Among the different types of financial institution the research focuses only on the SMEs financing scheme of commercial bank. The information given by the respondents might be dishonest due to their unwillingness to share information, lack of knowledge and their tight business schedule.

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1.8 Operational Definitions and Assumptions1.8.1 Operational Definitionsa) Small and Medium Enterprise (SMEs) Based on the industrial policy needs, the definition of SMEs varies from country to country. For most of the countries, the criteria for defining small enterprises are related to the fixed assets, no of employees and annual turnover .According to Industrial Policy Act of Nepal industries with a fixed assets between NRs. 30 million and NRs 100 million fall in medium industries and industries with investment up to NRs 30 million in fixed assets fall in small industries. SMEs play important role in the economic development and creating employment opportunities.

b) Loan: A loan is a type of debt. In a loan, the borrower initially receives or borrows anamount of money called the principle from the lender and is obligated to pay back or repay an equal amount of money to the lender at a later time. Typically money is paid back in regular installments or partial repayments in an annuity; each installment is the same amount. The loan is generally provided at a cost, referred to as interest on the debt which provides an incentive for the lender to engage in the loan.

c) Short term loan: Short term loan can be advanced to client for financing working capitalrequirement for short period of time, maximum for 1 year period. This loan shall be provided for very short period of time and renewal shall be conditional.

d) Demand Loan: Demand loan will be provided in a lump sum repayable either in fixedinstallment or in lump sum. Once it is granted, it shall not be considered as a running loan account and shall be debited for the offered amount and only credits after repayment thereafter. Once it is repaid in full or part, the borrower shall not be allowed to draw again. In case, the borrower requests for further accommodation, the Bank should treat the same as separate transaction.

e) Cash Credit: A cash credit is a short-term cash loan to a company. A bank provides thistype of funding, but only after the required security is given to secure the loan. Once a security for repayment has been given, the business that receives the loan can continuously draw from the bank up to a certain specified amount.

f) Overdraft: Overdraft facility is a kind of working capital loan. It is a running loan account andshall be operated by cheques on a current account. The borrower shall be allowed to overdraw his/her current account within prescribed limit and stipulated time period offered by the competent authority. The borrower can deposit any amount in this account. Thus, the balance will be fluctuating due to withdrawal and repayment of money by the borrower.

11Overdraft will generally be granted to the businessmen for the fulfillment of their short-term credit needs and have tenor of 1 year and is revolving in nature.

g) Term loan: Term loan is provided in the form of medium/long term loan .It will be granted forindustry to finance fixed assets whose gestation period is high. The repayment period will generally be more than 3 years. The maximum length of term loans should not exceed 15 years in duration for infrastructure projects and 7 years for other activities. Such loan is repayable on installments over the period of loan. The ability to repay over a long period of time is attractive for new or expanding enterprises, as the assumption is that they will increase their profit over time. Term loans are a good way of quickly increasing capital in order to raise a business supply capabilities or range. The purpose of term loan are usually for project financing, financing for capital items, hire purchase for financing vehicles, construction equipment, civil construction works etc.

h) Trust Receipt Loan/Import loan: Trust receipt loan is made suitable in financinginternational and local trade transactions carried out through Letters of Credit. For retirement of L/C bills, import loan is grated in the form of Trust Receipt Loan or Time Loan, which needs to be settled within a specified period. It is a written legal document between a bank and a person borrowing from that bank. The trust receipt states that the bank will give merchandise to the borrower but the bank will still retain the title to the merchandise and can repossess it if the buyer does not uphold the terms decided upon in the trust receipt. Typically, items used in trust receipts are large items with serial numbers that are easy to record and keep track of. For example, automobiles, TVs, large appliances, and trailers can all be given to a borrower by signing a trust receipt. The borrower then promises to pay the loaner back an amount of money worth the property loaned to him. It usually has tenor of maximum 120 days.

i) Export Loan: There are two types of financing in export credit, i.e. Pre-shipment and Postshipment.

j) Pre-shipment credits : Pre-shipment credit are usually required by exporters to purchaseand procure raw materials, process and manufacture export goods, pack the goods for export, pay for transporting goods to the sea ports for export, pay the freight, insurance and export duty.

k) Post-Shipment credits: The Bank will extend post-shipment credit throughpurchase/discount of export bills or by way of advance against such bills. The nature of the bill as well as the term of payment as agreed to by the exporter with the buyer shall be two important considerations for the bank to provide post-shipment finance. The loan period will not usually 120 days. Post-shipment credits will be generally applied to liquidate pre-

12shipment credits. The types of bills against which post-shipment credit is normally extended to exporters are: Demand Bills, Bills for Collection and Bills under Documentary L/C.

l) Letter of Credit (LC): LC is a written undertaking or obligation of a bank made at therequest of a customer to honor drafts or any other demand of payment and acceptance made upon the bank by the seller, provided the seller has complied with terms and conditions of letter of credit.

m) Bank Guarantee : Bank Guarantee is a definite undertaking issued by bank as behalf ofcustomer to pay a certain sum of money to named beneficiary upon its claim provided all the terms and conditions of the guarantee is met.

n) Financial Institution: Financial institution is an organization that invests chiefly infinancial assets such as loans and securities rather than in tangible assets such as land, building, and so on. Financial institutions include banks, trust companies, consumer finance companies, savings and loans, credit unions, pension funds, insurance companies, and mutual funds.

o) Commercial Bank: A commercial bank is a financial intermediary which collects creditfrom lenders in the form of deposits and lends in the form of loans. A commercial bank holds deposits for individuals and businesses in the form of checking and savings accounts and certificates of deposit of varying maturities while a commercial bank issues loans in the form of personal and business loans as well as mortgages.

p) Creditworthiness: Creditworthiness refers to a creditor's measure of an individual's orcompany's ability to meet debt obligations. The better one's creditworthiness, the more likely it is that a bank or other financial institution will extend credit. One establishes creditworthiness by repaying loans and other bills on time, spending prudently, and generally showing that one can behave in a financially responsible way. Many banks use certain specific credit rating tools to measure the individual creditworthiness and help them to decide the limited credit size that can be given to individual customers.

1.8.2 Assumptions To calculate one sample t-test T-value is assumed to be 3.

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For the significance of the test, the significance level is assumed to be 5 percentagesfor one-sample T- test and one-way Anova making the confidence level 95 percentages. Error in responses may occur due to unavoidable factors such as ignorance of the respondents, hesitation of respondents, misinterpretations etc. The sample error is assumed to be 0.10 for the calculation of the sample size.

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CHAPTER 2 LITERATURE SURVEY AND THEORETICAL FRAMEWORK2.1 Literature ReviewA review of literature is a critical analysis of a segment of a published body of knowledge. Various studies on a number of issues concerning small and medium enterprises and role of financial institution for financing SMEs had been studied in order to provide base for this research. Among them some of the past studies which have been considered are mentioned in this section.

(OECD, 2006) policy brief Financing SMEs and Entrepreneur has excelled the the extent of the SME financing gap and has given suggestion about what governments can do to make it easier for them to obtain the funding they need to start, grow and prosper, and thus contribute to creating jobs and economic growth. The policy brief states that SMEs are vital for economic growth and development in both industrialized and developing countries, by playing a key role in creating new jobs. But, obtaining adequate financing creates a great problem to them to grow and develop especially in emerging countries. One fundamental problem in dealing with the SME financing gap is lack of basic information about just how big such a gap may be. Moreover, the definition of an SME varies between countries and financial institutions, some only compile figures by size of loan, not by size of the company borrowing, and some do not keep regular statistics of SME lending at all. The difficulties that SMEs encounter when trying to access financing can be due to an incomplete range of financial products and services, regulatory rigidities or gaps in the legal framework, lack of information on both the banks and the SMEs side. Banks may avoid providing financing to certain types of SMEs, in particular, start ups and very young firms that typically lack sufficient collateral, or firms whose activities offer the possibilities of high returns but at a substantial risk of loss. In most countries, commercial banks are the main source of finance for, so if the SME sector is to flourish it must have access to bank credit. The overall SME financing gap is particularly pressing in non-OECD countries, since the bulk of them report a widespread shortage of financing for all categories of SMEs. Even though SMEs account for a large share of enterprises, and represent potential employment and economic growth in emerging economies, they receive a very low share of credit. Indeed, most of them are denied any access to formal financial markets. So, to bridge this financing gap the policy has suggested that government can play an important role in supporting the SME sector, particularly where there is market failure or where incomplete markets inhibit the provision of adequate financing on terms suitable for the SMEs stage of development. (Harif & Md. Zali) conducted the research What factors affect Small and Medium-sized to investigate the factors that have been considered by banks in providing the financing to SMEs

15in Malaysia. The finding of the research shows that 15 factors classified as a success factors in getting the business financing for SMEs. From the 15 factor listed, 7 factors were included in core factor and others 8 factors were included in supplement factor. The core factors include Financial statement, Knowledge, Market involved, Business ability/product, Purpose, and Experience/track record and Competence management. The supplement factor includes Capital, Conduct of current account, Industry risk, Economic condition, Collateral, Strategic planning, Character and Capacity. (Teima, Berthaud, & Bruhn, 2010) report on Scaling-up SME Access to Financial Services in the Developing world had aimed to provide the G-20 Leaders with a summarized but comprehensive framework to understand the SME finance gap and its challenges. The first part of the report has been conceptual and primarily consisted of a review of the literature on SME Finance in the developing world. It has stated that SMEs financing remains as challenge due to SME intrinsic weaknesses, has awed in provider delivery models and, most importantly, lingering deiencies in the enabling environment for nancial services: nancial infrastructure (accounting and auditing standards, credit reporting systems, and collateral and insolvency regimes), and the legal and regulatory framework for nancial institutions and instruments. The second part of the report has discussed the analysis of 164 cases of SME Finance interventions compiled through a collective effort involving G-20 member countries, non-member countries, development finance institutions, and private sector players which has entailed the collection of 164 SME nance models spanning across a broad spectrum of interventions, including: (i) legal and regulatory framework; (ii) nancial information infrastructure; (iii) public support schemes; and (iv) private sector initiatives. Finally, the report has highlighted key recommendations that have been proposed to the G-20 Leaders in order to achieve significant and sustainable scaleup of SME access to financial services across the developing world. They are as follows:

Endorsed a set of recommendations for policymakers in the developing world to establish a supportive enabling environment for SME access to financial services in their respective countries by developing country specific diagnostics and strategies, developing a supportive legal and regulatory framework, strengthening the financial information infrastructure, designing effective government support mechanisms , building consistent and reliable data sources on SME finance and building capacity of the financial institutions.

Establish a Global SME Finance Forum as a knowledge sharing and monitoring platform to further identify and promote best practices across countries and institutions, establish baselines, and monitor progress.

Scale up previous G-20 successful development interventions in the SME Finance space by setting up a global funding platform to build capacity, provide technical assistance, mitigate risks, and create incentives for the delivery of sustainable and scalable financial services to SMEs, by means of a collaborative effort implemented by its bilateral and multilateral development finance institutions.

16 Lead the efforts to gather better SME finance data in a coordinated fashion by establishing a platform to consistently collect the cross country data. (Bhd, July 2005) study on SMEs access to financing: Addressing the supply side of SMEs financing objectives was to discover the factors that inhibit SME lending by financial institutions by examining the institutional, legal and regulatory framework present in ASEAN member countries. SME in ASEAN draw financing primarily from internal funds and the informal sector was seen. Formal sector financing was observed to make less than 25% of funding needs. Government supported initiatives have not been as successful as intended, as indicated by the low rate of formal sector financing achieved by SME. The legal and regulatory framework existing in many ASEAN countries was seen to provide the right support infrastructure to facilitate SME lending by the formal sector. As for financial institutions, the study found that some are risk adverse to lending to informationally opaque SME, while others simply do not have the skills needed to understand and evaluate SME. In some large banking institutions, the prevailing mindset has still been one of bigger is better. Non-bank financial institutions and smaller boutique banks are usually found to be more perceptive and knowledgeable about SME financing than their larger cousins. However, a positive trend is seen to appear among financial institutions armed with the lessons learnt from the Asian Crisis and faced with greater competitive pressure, increased lending has been observed to medium and small sized enterprises. The availability of newer technologies such as credit scoring has facilitated the progress of some banks foray into this segment. The research has been concluded with several recommendations that could facilitate greater access to financing by SME at the national level. According to their respective needs, countries could consider to, among other measures, improve the outreach of credit guarantee programmes, promote greater engagement by non-bank financial institutions, standardize SME definition and promote informal debt workout mechanisms for SME while banks in the region could facilitate SME financing by improving the credit evaluation skills of their officers, establish specialized SME units and consider greater interaction with SME associations. (Zhao, Wu3, & Chen, 2006) study on Business Financing for Small and Medium Enterprise objective was to investigated the factors affecting SMEs to borrow from bank by methods of empirical study. The findings of this paper have been observed that whether SMEs can provide collateral or guarantee is a decisive factor, factors such as firm size, willingness to accept banks clauses, close relationship with bank play an important role. But in contrast to intuition, correlation analysis and regression result has shown that SMEs financial variables such as income, net profit, asset-debt ratio and credit score is not obvious to affect their ability to get bank loan. Based on theory prediction and qualitative analysis it has been stated that firm size is the most important factor to affect SMEs ability to borrow from bank. The regression results of this paper have reflected information asymmetry between SMEs and banks, and that banks had taken a simple way to protect them. The findings of paper have even shown that most of SMEs are in growth phrase, with small or medium size, by themselves and cannot provide

17sufficient and qualified collateral for bank loan, so its natural that many SMEs bank application might get refused. The paper has been concluded by stating that in order to improve SMEs ability to borrow from bank, building mechanism to reduce information, concern factors outside of SMEs, guarantee and venture capital industry, etc must be considered. (Obamuyi, 2007) research on An Exploratory study of loan delinquency among SMEs in Ondo State of Nigeria has showed exploratory insights into the level of loan delinquency among the small and medium enterprises (SMEs) in Ondo State of Nigeria, and the lending practices of the countrys bankers towards the SMEs .The study shows nice description of the theoretical reasoning for the restricted SMEs lending portfolio for banks. The results were based on the analysis of interview with the managers of 9 commercial banks and 115 SMEs that have been borrowers or currently have active loans from the banks. The findings of the study reveal that several factors were responsible for banks altitude of not expanding loan portfolio, principal of which are poor credit worthiness, lack of collateral security and the constraint imposed on banks capital by regulations. The research shows that loans delinquency rate was low at 6.90 per cent of total loan obligations among in Ondo State of Nigeria. Lastly, following measures were suggested to policy planners, which can be implemented, not only by Nigeria, but in other developing countries in their similar situations of growth process.

The government should collate and analyze information on SMEs, so that an informed decision could always be made on the full understanding of the problems of the sector. There is also a necessity for serious collaborations by the key stakeholders of the economy to reduce those factors militating against banks lending to SMEs, and put in place a strategy by which the perceived friskiness associated with the sector can be eliminated.

Bank support to the SMEs through Small and Medium Industries Equity Investment Scheme (SMIEIS) should be properly coordinated to reduce costs and possible chance of default.

(Popli & Rao, 2009) research on Service Quality Provided by Public Sector Banks To SME Customers: An Empirical Study in The Indian Context shows that in banking sector, the quality of customer service plays an important role, particularly in the context of growing competition and sustained business growth. The study is an attempt to ascertain the service quality provided by Public Sector Banks to Small & Medium Enterprises which play a key role in Indias economy. The major findings of the study have been that 1. Modernization and Communication affect the services to a large extent and there is a need of training to the staff for improvement of service to the SMEs customers; 2. The service quality of private banks is superior to that of Public sector banks; 3. Majority of the respondents revealed that the credit flow to SMEs sector is not sufficient and the Government will have to initiate necessary steps for making the required funds available easily on convenient terms; 4. Majority of the respondents feel that the policies for SME Sector of other countries are far better from the policies of India; 5. Delay in loan application processing due to unhelpful nature of the staff

18members, as claimed by the majority of the respondents. The banks usually provide finance against security and as high as 86% of the respondents are of the view that the banks ask for collateral security/guarantee from a third party even where the project has been assessed as viable and primary security is adequate. (Pandey, 2004) research on Problems and Prospects of SMEs in Nepal has analyzed problems of the Nepalese SMEs. He argues that traditional management, undeveloped entrepreneurial culture, outdated production technology and poor marketing skills make it difficult for SMEs to face global challenges. He adds that inability to increase the quality and technical standards of products will diminish the competitiveness of SMEs. He asserts that the development of SMEs is important not only from the perspective of balanced economic development, but also from the perspective of maintaining peace and tranquility, and social harmony. He recommends that the government and the private sector must work together to identify products and services having comparative advantage at the international level. He also adds that the government should provide support at the field level to assist SMEs in the identification of new trading opportunities. He also suggests that the government should support and initiate special mechanisms like strategic alliance and networking between SMEs and large firms, and promotion and establishment of export trading houses and free trade and export processing zones. He concludes by advocating on the need to use various trade remedy measures and subsidies to protect SMEs and provide them space to compete globally. (Khatri, 2010) research on Design of SME Rating Toolkit For Banks and Financial Institutions of Nepal objectives was to build a scientific and practical rating toolkit for the use of banks and financial institutions of Nepal, which considers hard and soft information related with the SMEs under appraisal and the relative importance of each in the context of SME lending practices of Nepal. For this purpose managers of banks and financial institutions were interviewed and entrepreneurs/managers from various SME sectors were asked to respond over a set of questionnaire. The research even explored the directive and regulation of central bank and state that it comes as an impediment in the formal access of SME sector to the formal credit. Based on the data collected from these sources analysis was done, on the basis of which the factors and parameters to be considered in rating toolkit were decided. The toolkit which was developed consists of six factors i.e. Industry, Enterprise, Capacity, Character Collateral and other factor on which the SME would be evaluated .This each factor consists of number of parameters of evaluation. Based on the weighted average of the parameter scale each factor score is calculated, whose weighted average was then used to calculate the overall rating score of the SME.The details of credit rating toolkit structure is in Annex 5. (Service & Dynamics, 2009) research on Market Survey of Micro, Small and Medium Enterprise in Nepal objectives was to gain insight in the mechanisms that are necessary to substantially develop the SME lending activities in Nepal. For this purpose this research was carried out for market survey in 8 major industrial sector i.e. Handicraft, Tourism, Educational

19services, Transportation, Agri-business, Garments, Import/export and Pharmaceutics, collect data related to general information of entrepreneur and enterprise, survey MSMEs access to finance and benchmark related to financial indicator and risk indicator .The findings of survey are as follows: Entrepreneur profile analysis is done on the basis of age, years of experience, gender; educational level .This finding shows that:

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The average entrepreneur is relatively young (37.7 years) with 11.6 years of experience. The share of female entrepreneurs is slowly increasing and is 14% of the total sample. The educational level of the owners reveals that less than a half of the owners reached at least a bachelor degree (43.8%). Percentages vary from 92% in education sector to 16%in handicraft. The level of education is not linked to the age.

Firms profile analysis is done on the basis of ownership pattern, industry sector, annual turnover, gross margin and net profit. This finding shows that: 65% of the interviewed enterprises are sole proprietorship structures, 13% are partnerships, 6% private limited companies and 16% are not registered. The distribution of the sample reveals that 73% of the enterprises have less than 6 employees and 83% have up to NPR 10 lakh assets. This survey has set a new definition on the basis of annual turnover to do analysis of MSMEs. This definition state on the basis of annual turnover u p to 5 lakhs belongs to Micro enterprise, 5 to 10 lakhs belongs to Small enterprise , 10 to 50 lakhs belongs to Small enterprise and 50 lakhs to 1 crore belongs to medium enterprise. This survey shows that most of the enterprise falls on the small enterprise group. Based on annual turnover research shows that 20% fall in Micro ,19% Mini , 42% Small, 9% Medium and 10% Large Enterprise . Small entities are more profitable, with micro enterprises having a gross margin of 59%, compared to 36% for small and 16% for large units. Net profits are respectively 34%, 16% and 8%. Profitability differences are still more pervasive by sector, net profits ranging from30% (educational services) to 3% (pharmaceutics) if we consider the full sample and from 26% (educational services) to 12% (agri-business) if we consider exclusively the MSME segment (excluding the large enterprises). Benchmarking of Financial Indicators has take into consideration the factor like growth of sales volumes, gross margins and net profits. The findings show that: Growth of sales volumes, gross margins and net profits are hieratic over the last 3 years period. Sales of the total sample grew by 11% in 2007-2008 but only by in average 3% over 3 years. For the same period MSMEs net profits grew by 0.5% in average but by 14% in 2007-2008.

20The analysis of the return on invested capital doesnt indicate a clear correlation with size, MSMEs having a return of 17%, against 16% for large enterprises. The average working capital day for MSMEs is 70, with small companies having higher working capital needs. Payables and receivables days are only 12 and 9, reflecting the predominance of cash payments. Debt level is moderate at 14% compared to 20% in Bangladesh or 50% in France. But this average rate hides the fact that 70% of the MSMEs do not have debt at all. As a consequence, indebted companies have a debt rate as high as 46%. The comparison by sector shows debt rates going from 41% for import/export entities to 4% for handicraft units. The geographic comparison reveals rates of indebtness as different as 24% in Rupandehi area and 3% in Jhapa area. An estimation of the durations of reimbursement through cash flows stresses the total inadequacy of loan terms and financial reimbursement capacities. This inadequacy reveals that lending approach is essentially collateral based and doesnt integrate a cash flow analysis. Benchmarking of Risk Indicators findings shows that: In terms of risk profiling, firms were categorized along two criteria i.e. the financial risk and the business risk Volatility of net profits is 0.07/0.08 for micro and mini enterprises, 0.3 for small and medium and 0.46 for large businesses: small companies are less sensitive to fluctuations of the macro-economy. Import/export sector presents a high financial risk due to its level of debt and the transportation activity is risky at both fronts. MSME Access to Finance analysis findings shows that:

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- Penetration rate is 39% in the MSME segment and 78% in the large enterprises segment.- 10 most frequently requested documents for an application 3 are pure administrative documents, 2 are business related business plan and cash flow projections and 5 are related to the collateralization of loans. - The duration to process a loan is 30 days; 15 days to collect all the necessary documents, plus 15 days to validate the application. - Average loan amount is NPR 1.3 million, with a 3.5 years term and interest rate of 11.7%. - Short-term loans are at 80% dedicated to working capital financing, but more surprisingly, mid- to long-term loans are also dedicated to this purpose for around 50% of them, showing the inadequacy of terms to purposes.

- Main reasons for not applying the loan are mainly due to the absence of need, the costof the credit is too high and the terms and conditions are estimated not satisfying.

21- Other sources of financing like friends and relatives, and money lenders seem lend relatively small amounts i.e. Rs 0.3 million as compare to financial institutions Rs 1.3 million. This shows that financial institutions are more the important sources of lending. Based on market survey, this research has suggested that the concerted efforts are needed to increase the credit penetration and the lending activity in the country. For this purpose it is required for all stakeholders (financial institutions along with the Central Bank, the Credit Information Bureau and the IFC - SEDF) to collaborate on the development of a specific methodology for MSME market and to reinforce the Credit Bureau, so that it becomes a tool to transform reliable data into information which will be used in the decision process directed towards optimizing the risk-return trade-off.

The perusal of literature reveals that Small and Medium enterprises face a lot of problems, and inadequate financing is the major one. Considering this fact the various research has been carried out in the context of developed and developing countries and Nepal too. The various research has attempted to excel the extent of the SMEs financing gap and its challenges, the factors that have been considered by bank in providing finance to SMEs and the factor that inhibit SMEs lending by financial institution. In context of Nepal some research has been conducted on the issues related to SMEs.Among them some notable research are Problem and prospects of SMEs in Nepal , Designing SMEs rating toolkit for bank and financial institution and Market survey of Micro, Small and Medium Enterprise in Nepal to gain insight in the mechanisms that are necessary to substantially develop the SMEs lending activities in Nepal. But, the studies made so far probably have not ventured to find out how convenient it is for SMEs to access finance from commercial bank .So, this research has attempted to fulfill this research gap.

Nature of Product

2.2 Theoretical Framework2.2.1 Theoretical Framework

Evaluation of SMEs creditworthiness

With reference to various studies on a number of issues concerning small and medium Access of SMEs Nature of towards credit of financial institution for financing SMEs, the self model was developed for from Enterprise enterprises and role commercial bank this study purpose to understand how convenient it is for SMEs to access finance from commercial bank. The model developed is presented below in Figure 1. Capacity

Obstacles

Level of satisfaction

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Figure 1: Theoretical Framework

Here in the figure, independent variables are Nature of product, Evaluation of SMEs creditworthiness, Nature of Enterprise, Capacity, Obstacles and Customer level of Satisfaction are independent variable and dependent variable is access of SMEs towards credit from commercial bank.

Nature of Products: Nature of product refers to loan size, tenure purpose of loan,value of collateral that also affect SMEs to access credit from commercial bank. Loan size: Size of the loan the enterprise is willing to take from commercial bank also affects its credibility.

Tenor: It refers to the time period for the repayment of loans. Generally commercial bank has trend of providing credit to SMEs who are willing to take loan for short term or medium term period.

Purpose of loan: The reason for which enterprise has applied for loan also plays crucial role while providing credit to SMEs by commercial bank.

Collateral: Collateral is a borrowers pledge of specific property to a lender, to secure repayment of a loan. Commercial bank take collaterals like land, building, inventory, account receivables etc as security for extending loan. The

23characteristics of such securities like size, value and coverage play an important role in the extension of loan and its probability.

Evaluation of SMEs creditworthiness: Creditworthiness refers to a creditor's measure of an individual's or company's ability to meet debt obligations .Varieties of financial and non financial factor are consider by bank to evaluate SMEs creditworthiness. Hence, these factors also affect the SMEs ability to access finance from commercial bank.

Nature of Enterprise: Nature of enterprise refers to enterprise related factors that reflect the characteristics of the SMEs under consideration as relative to the other SMEs in the same industry. The state of the Enterprise and its standing within the industry is the major factor that affects SMEs ability to access credit from commercial bank. Nature of Enterprise mainly consider the factors like ownership pattern of firm , age of enterprise, organization structure, accounting system , strength and weakness of enterprise and obstacle they are facing in its growth that influence SMEs ability to access credit from commercial bank .

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Ownership pattern of the enterprise as whether its a sole proprietorship, partnership, private limited or public limited etc should be accessed in order to ensure the level of liability of the owner and the shareholders.

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Age of enterprise also plays an important role in order to access credit from commercial bank. The probability of success is high of the enterprise that has been in the industry for longer period of time. So, bank usually provides credit to only those enterprises that is in operation for at least 2 years.

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Organization structure consists of activities such as task allocation, coordination and supervision, which are directed towards the achievement of organizational aims .It can be generally two types formal or informal structure. More formal the structure more easily will be to access credit. As such structure consist well defined authority, responsibility and accountability of individuals.

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Enterprise that keep the proper record of financial statement along with the projected statements would be consider as important factor that affect SMEs to access credit from commercial bank.

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Strength and weakness of enterprises are also important factor that effect SMEs to access credit. Enterprise having professionalism in management team, good public

24relation, quality products, reputation in market, relationship with banking are generally given priorities while providing credit.

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Obstacles SMEs are facing in its growth also affect the SMEs ability to access finance from commercial bank. The obstacles SMEs usually faces in its growth are competition, corruption, price instability of raw material, lack of managerial training and experience, lack of development of infrastructure, high tax rate, political instability, low level of social security and governance and low availability of financing.

Capacity: Capacity mainly refers the firms ability to repay the loan by analysis its

financial health. It refer to different factors like annual sales, total fixed assets, proportion of equity and debt of SMEs that affect SMEs to access credit from commercial bank.

Obstacle: Obstacles refers to the problem SMEs are facing while accessing for creditfrom commercial bank. Varieties of factor like insufficient collateral, high rate of interest, preferential treatment, too much documentation, delay in sanction of loan and lack of knowledge of loan products can create obstacles for SMEs to access finance from commercial bank.

Customer level of satisfaction: It refers to how product and services provided by bank meet or surpass SMEs customer expectation. This customer sa