Among the 400 million Small and Medium Enterprises (SMEs) in the developing world, about half have unmet financing needs amounting USD2.1-2.6 trillion (IFC, 2017, Alternative Data Transforming SME Finance). In the Bangladeshi context, Micro and Small Enterprises (MSEs) are crucial to the nation’s growth. 7.8 million MSEs directly contribute towards 25% of the national GDP by pumping USD55.5 billion into the economy each year (Economic Census 2013, BBS, 2015). This impact is further magnified considering that every 4 out of 5 employed adults are engaged in MSEs (Figure 1). Operating an MSE, however, is a constant struggle with a diverse range of adversities. Among these, access to finance has stymied MSE growth the most – 70% of all micro, small and medium-sized enterprises lack access to credit (World Bank, 2015).
Financial inclusion has evolved in various stages in this country. The BOP segment has traditionally been deprived of access to finance. A microfinance revolution in the ‘70s pioneered a product that provided credit to the unbanked without any collateral. A segment in Bangladesh has reaped the benefits of this innovation. However, the arena of MSE financing has been left inadequately addressed and it is now crucial to focus on this to ensure the continued growth of the economy.
pi STRATEGY conducted a field study to gain deeper insights into the MSE landscape with some behavior-focused lines of inquiry. The study was conducted in 2016 in four locations across Bangladesh – Chittagong, Rajshahi, Khulna and Bagerhat. In the study, 630 respondents were asked about their day-to-day business operations, their financial situation and their motivations and aspirations.
A discussion of the insights generated from the study first warrants a definition of MSE. The study has found a contrast between the formal and practical definitions of an MSE. The working definition of an MSE is set through a number of factors, where the number of people employed in an enterprise serves as the principal criterion. But in order to define the gaps that an MSE faces and zoom in on them, it is logical to expand the principal criterion from level of employment to the revenue size per month (Figure 2). According to the definition, an MSE registers a revenue within the range of BDT 100,000-500,000 per month. The product basket includes 250 unique types of products. The typical owner has a profit within the range of BDT 20,000-50,000 per month, at a net profit margin of 10%. The average owner has an education up to SSC. These outlets operate for 14 hours per day on average.
The study finds that the frequency of loan applications is highest among the segment with monthly revenue in the range of BDT 100,000-200,000, which reflects the market demand of this particular segment. This segment also happens to be the biggest chunk of the MSE universe – more than 50%. Yet, this segment is drastically underserved when it comes to access to finance from formal Financial Institutions (FIs). The areas where MSEs face difficulties obtaining financing from formal FIs are manifold. These pain points can be categorized into two groups: problems faced while applying for loans, and factors that reduce the success rate of loan applications. Figure 3 provides a snapshot into these factors, and the levels of difficulty associated with factors regarding loan application as reported by the MSEs in the study.
The process of applying for formal loans is not suitable for MSEs mainly due to two reasons. Firstly, MSEs often face urgent needs for loans. 91% of the segment stated urgency as one of the key requirements in their financing needs. It has been observed that there is a 14-day time lag on an average from application to disbursement by the FIs. This is often too long to meet an MSE’s urgent need. Therefore, applicants resort to either loan sharks, who provide loans at very high interest rates, or cooperative societies that can provide loans at a short notice based on prior working relationships with the applicants through other products such as savings.
Secondly, loan applications are very expensive for MSEs. It has been observed that an applicant usually spends BDT 3,000 for obtaining required documents. An additional BDT500 is spent on transportation for multiple visits to the FI branch during the application process. From the banks’ perspective, the cost incurred in vetting a loan application is close to BDT 12,000. Such a high overhead per loan application is a key reason FIs do not find MSE financing interesting from a financial perspective, especially because the amount of loan sought by a typical MSE owner from the study is very low, typically in the range of BDT50,000-200,000.
MSEs that manage to apply for loans, after having jumped through numerous hoops, get rejected by FIs quite often. The reasons for loan rejections are critical for understanding where support is required. The primary reason is lack of proper documentation. MSEs seldom have records of business transactions that are acceptable by FIs, who require more formalized documentation of business performance. Another key reason is the lack of tailored products from formal FIs for MSEs. The MSE owners rarely have collateral, and it is both difficult and expensive to perform credit assessments of MSEs. Thus FIs have to assume very high risks, which spikes up interest rates. This contributes to the fact that traditional FIs fail to address the needs of the MSEs because the size and prospect of these businesses do not closely fit the FI’s loan product structure.
While the MSEs cannot easily obtain loans from formal FIs, they are also not ideal candidates for microfinance. Microfinance Institutions (MFIs) have requirements from borrowers that sometime make it difficult for an MSE owner to receive the type of financing they need. Consequently, a large segment of the MSE pyramid is currently underserved in terms of access to finance – their ventures cannot be readily addressed under the current product portfolio and business models of these institutions.
MSEs find it difficult to obtain financing, whereas FIs lose chunks of business due to a strategic blind spot in assessing the needs of MSEs. Addressing these needs will help FIs design loan products suitable for MSEs, not only adding to their bottom line, but also improving the case of financial inclusion in Bangladesh.
The insights presented in this article are extracted from a year-long research on micro and small enterprises conducted by pi STRATEGY in partnership with Robi Axiata.