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Scaling up Micro Finance to SME Finance


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									                         Scaling up Micro Finance to SME Finance

                                                                                The World Bank

Ladies and Gentlemen, let me welcome you to a session on Scaling up Micro Finance to
SME Finance. My name is Hasan Zaman. I’m a Senior Economist at the World Bank. I work
on small enterprise issues and micro finance issues. It gives me great pleasure to introduce
three distinguished panelists today.

We have Dr Sajjad Zaheer, we have Mr Shawkat Hussain, and we have Mr Anil Sinha. I’ll
introduce them more fully once they start their presentations.

I’ll try and limit my fellow panelists who I’m sure have a lot to say but I’ll try and limit them to
about 10 minutes each and then it should leave at least a half an hour to 40 minutes for
discussion. So let me start possibly with Anil.

Mr Anil Sinha is the General Manager of IFC’s Small and Medium Enterprise program called
the South Asia Development Facility located in Dhaka, Bangladesh but operated regionally
and he has been with the IFC for about 12 years, working on SME development issues and
was previously the manager of IFC’s very successful SME program in Vietnam.

Anil, with those words, maybe I can hand the floor to you. I think part of SEDF’s brief is to
work on local financial institutions to lend to SMEs so maybe we could invite you to share a
few thoughts. Thank you very much.

Presentation by Mr Anil Sinha

Thanks very much Anil. I think as this is an international conference, there are many
Bangladeshi participants over here, so they may have specific questions as to what SEDF is
doing in Bangladesh, that could be one theme of discussion that forms on its own.

Let me now hand it over to Dr Sajjad Zaheer. Dr Zaheer is a Senior Research Fellow at the
Bangladesh Institute of Development Studies. In terms of the work that he has done which is
relevant to this, he has recently written a paper on SME issues in Bangladesh, and earlier
led the Impact Assessment study of PKSF, the large apex micro finance institution in
Bangladesh. So I think Dr Zaheer is extremely well placed to talk about the scaling up of
microfinance to small enterprise issues given his background. So look forward to your

Presentation by Dr Sajjad Zaheer

Thank you very much Dr Zaheer. As usual you raised some extremely interesting points that
I’m sure will be debated. Clearly the issue of definition, particularly in Bangladesh is
especially topical and no doubt in other countries as well. And your idea of NGOs themselves
being considered as small and medium enterprises is also an extremely interesting one.

I think in both presentations you heard about BRAC Bank and without further ado, let me
introduce Mr Shawkat Hussain, who is the Vice President of the Small and Medium
Enterprise Unit of BRAC Bank. Mr Hussain was also the Head of Finance at BRAC. For
about 6 years and hence is in a very good position to talk about this idea of scaling up from
micro finance to small enterprise finance.

Presentation by Mr Shawkat Hussain

Thank you very much Mr Hussain. I know we would have loved to hear a lot more detail from
all our presentations but in the interest of time, I’ve had to cut everybody short. Let me just
open the floor up and maybe take some questions and group them and ask then the panel to

                              Scaling up Micro Finance to SME Finance

                                                                      Mr. Anil Sinha, General Manager,
                                                            South Asia Enterprise Development Facility,
                                          Small and Medium Enterprise Program, IFC, Dhaka, Bangladesh

It’s a great honour for me to be here this afternoon and to share my thoughts with you. Really
what I want to do is just share my thoughts, not to give any particular advice. The issue at
hand is scaling up from micro to small and medium enterprise. I think it’s important to
segment the various sectors that we are talking about. Between small and medium, there is a
wide gap, even in the definition in Bangladesh. Small and medium are really two different
aspects and you need different products and services to serve these aspects. So from my point
of view, really we’re looking at perhaps upscaling from micro to small and I would like to
share with you what IFC’s experience has been in this.

IFC, as you know, is the private sector arm of the World Bank group. It lends and provides
advisory services to the private sector directly. IFC has a micro and small lending
department based in Washington which on average does about 500 million dollars worth of
financing of micro and small business financial institutions. It also has advisory services
program which is grant funded, multi donor funded, which provides technical assistance and
advisory services to the development of the small and medium enterprise sector. We have 9
such programs.

The SEDF is a program which is based in Dhaka, covers Bangladesh and north east India
And I have my colleague here who runs our financial markets program, Dr. Zia Ahmed here
and I would also like to recognize the presence of Frank Maxer who’s the donor to SEDF.

So the target segment is the small business segment. The first aspect for us is to understand
what the segment needs in terms of products and services. If one just opens the website of
American Express Bank or Citibank in the US, one sees a variety of products and services
designed for the small business sector, all this done on a commercial basis. What are these
products and services and what is relevant to our part of the world is something that we have
to work towards. But it can be done sustainably and it can be done viably.

And IFC’s basis of involvement in this sector is on a commercial basis. IFC’s micro and small
business lending has 5 approaches, firstly establishing Greenfield financial institutions ,
upscaling and transforming NGOs into formal financial institutions , introducing micro and
small business finance windows in commercial banks, so downscaling, developing linkages
between micro financial institutions and commercial banks and so the hybrid structure
between the MFIs and the formal financial institutions, FFIs. Also creating wholesale
investment vehicles that channel capital to microfinance institutions.

The issue which is under debate is whether it’s better to upscale from micro to small or to
downscale from formal financial institution to the small sector.

What are the issues? Advantages and disadvantages.

The advantage for a micro finance institution is that it’s committed to that particular segment,
the staff are trained up, they are used to dealing with borrowers who do not have financial
information and records.

The disadvantage is that firstly the products are designed really for the alleviation of poverty
and really for the micro entrepreneur just going into business. It’s not for the formal business
as such. Secondly, the organizational structure, the financial structure is set and that makes
it slightly difficult to expand the products and services. Small businesses need a variety of
financial products whereas the micro financial institutions are normally offering one or a few
limited financial products. For example, small business may need to finance fixed investment
which needs longer term maturity, it may need a gestation period before a project can
generate cash flow, it may need different forms of services, not only working capital but
letters of credit, it may need equity. These products are quite often produced by the larger
financial institutions. But the problem with them is that they feel small business lending is
risky, it’s high cost to serve. So both aspects are possible.

For the micro finance institutions or the small business or for the FFIs to enter that segment,
it’s clear that we need a new organization, whether it is a division or a department.
Experience shows, including from the leading microfinance institution like IPC, that you can’t
just do that in the existing structure. It’s better to produce a new structure of some kind so
that you have different financial structure. You may need long term financing. One may need
an equity structure in a financing institution then can do small business lending. Different
skills are needed. And this is the IFC experience.

We have with us BRAC BANK, which is a good example of such a new financing institution
being promoted by micro credit financing institution. But is it just an either and or situation ?
In IFC’s experience it’s not. One can also have a hybrid structure. It could be, at the lower
level, just formal financing institution providing line of credit to a microfinancing institution
to one that’s a joint venture. And many of these combinations have been tried and

The new financing institutions that have set up have different models. The model that I would
like to share with you is one of mixed finance which is a combination of equity, quasi-equity
and loan. An example of this is the Business Partners in South Africa which is a financial
institution set up to serve the emerging entrepreneurs in South Africa. This is a model that
IFC’s trying to replicate in other parts of the world and we’re trying to see whether there’s a
fit here. And the key to that is that we provide a number of financial instruments, not just a
lending instrument and you do that in synergy. Along with that, you provide technical
assistance which you feel is key. So that came from one of the grant funded programs and it’s
clearly understood that initially to start such a financial institution, it is needed to provide
technical assistance for at least a few years. It can vary from 2 to 4 years. But this experience
is positive.

And with that I’d like to close here, to say that this is not just the one model. It can be done in
both ways or it can be done in a hybrid of ways. But it’s important to know what one is
doing, the segment one is serving and to design the organization structure and products and
services to serve that. Thank you.

                              Scaling up Micro Finance to SME Finance

                                                                             Dr Sazzad Zaheer
                                                                  Senior Research Fellow, BIDS

I’ll basically talk based on the experience in Bangladesh so I may not be able to generalize
at the world level of what’s happening across the globe. There are a few key questions that I
raised in this presentation, more like food for thought.

We’re thinking in terms of SME financing or more generally in terms of SME development
strategy. The very first thing that I raised is whether SME financing is merely a scaled up
activity or not. And when we talk of scaling up MFI financing into SME financing, obviously
one has in mind its relating whatever is happening in the MFI experience in terms of scaling
up which largely amounts to increasing the size of loans to its borrowers, other than few
other elements in it also. Whether that’s what we really mean, venturing into basically scaling
up into aggressive SMEs. Is that all to SME financing or not?

Then there’s the second question, can SME financing be meaningfully undertaken which
Anil had mentioned towards the end of his presentation. Can it be provided without
provisioning of non-financial services? What is SMEs ? I mean there are so many ideas
about SMEs, there are historical perceptions about what SMEs are, there are legal
definitions of what SMEs are. So one has to clearly identify what really we mean by SMEs
when we talk about scaling up, or as I put it later, scaling down of the operations of the
commercial banks into addressing SME sectors. And this was also covered in Anil’s
discussion regarding search for appropriate delivery mechanism.

What is the right delivery mechanism to address these SMEs ? At the end, I throw some
questions, more as observations on whatever are being observed in Bangladesh MFI sector
that we can draw upon to address the SME sectors in future. But primarily the focus would
be on SME financing.

Now as I said, one could pose it as scaling up of MFI operations into addressing SMEs.
Alternatively, one could see it as commercial banks scaling down their operations and trying
to reach out the smaller segment in the market with smaller sized loans with some additional
supervision and other advisory services attached to that kind of financing.

Historically in the seventies, sixties even, we had experience with development financial
institutions on trying to channel finance to develop the industrial sector which largely is
acknowledged to have failed. I’m not getting into the reasons for such failure . But in the
meantime we had the successful stories over the two decades or more with MFI lending.
And increasingly we are talking about scaling up of MFIs. Several rationales which we
normally associate with arguments for scaling up is nominal value of loan size increases with
inflation. With time more clients have proven records of repayment and demand large
amounts of loans from more than one source which led to overlapping and was considered
to be harmful to the industry in general. And with apparent saturation, there was the belief
that many of the MFIs with saturation in the poorer segment in the market, you tend to reach
out to the relatively better off segment in the market who demand larger sized loans.

And then there is the rationale of scaling up. I’m going back into the conventional notion of
what we tend to associate with scaling up. Obviously this whole issue of scaling up, the

rationale did never actually address the issue of addressing the SME sector for justifying why
MFI sector has to scale up its size of loans and the other activities.

If we look into the historical perspective in terms of what went wrong, I did mention about
development financial institutions dealing with large scale lending to industries which largely
had failed. Then we had the MFIs, then we had the micro enterprise. In Bangladesh context,
and we had BRAC’s Mela .We had SEED, SEL, several other programs, which are mostly
run by the larger national level MFIs. And the loan sizes, if I may quote it off the head in taka
terms, is basically in the range of Tk 20,000 to about Tk 200,000 to Tk 250,000 which is the
average loan size lent out to the microenterprise sector.

Subsequently, we have the BRAC Bank which happens to have its root in the MFIs
experience and has its SME unit, which you will hear from Shawkat Hossain, which has
extended to units giving loans of sizes in the range of Tk 400,000 to Tk 500,000 most of
them. And going up to Tk 800,000. Pardon, I’m sticking to the taka terms here. And that’s
the collateral free loans. What the experience shows is that every time you try to scale up,
you’re defining a new program. You’re not defining it in the old set of programs. So Mela
had to be introduced, microenterprise program had to be introduced when you moved or
scaled up the size of loans.

Then you move into SME units for scaling up, if you use that term “scaling up” what it
involves is two aspects. One is on scaling up does address different groups of clients who
obviously have different kinds of demand for loan services. And for different reasons. So
often you have to associate those things with different kinds of non-financial packages.

At the same time, on the supply side, I believe the management staff who are acquainted
with dealing with small sized loans and those who deal with large sized loans differ in skill.
So, on both sides, there are reasons for packaging different things for addressing different
sizes of loan. And we can’t just say that within the same program, by just merely scaling up,
we can achieve what we want to in terms of addressing the SMEs. That’s the first point I
want to make. So scaling up seems to be a bit of a misnomer if we use it in the context of
SME financing.

Having said that, one ought to recognize that historically these two experience, I mean, on
the one hand, we have this is going across the globe, the Rabu Bank experience in China
which suggests that commercial banks can come up with innovations to address groups who
require smaller size loans with supervision.

And on the other hand, we have the experience in Bangladesh context I would say, moving
up from micro credits to micro enterprise then to SME units within the BRAC Bank.

One possibly ought to recognize that these two trends, upscaling and downscaling are in
progress and one has to choose somewhere in between. And depending on the specific
experience of a country, one ought to pick up which side it should be tilted. Should it borrow
more from the institutional arrangements and experiences of the MFIs or should it borrow
more from the larger corporate banking, commercial banking sector. This is possibly
something where no straitjacket solution can be given. It should depend on each individual
country’s own experience and the state of institutional development that the country is in.

Now I will address little bit on definition and targeting because we often use this term, SMEs.
Here is a table which essentially compiles the limits the way various countries in their legal
documents or in their policy document define small enterprises, in terms of asset value. This
maximum asset value quoted in terms of dollar thousand, T stands for thousand. You’ll

notice that this is for some of the selected countries in Asia and Pacific and you’ll notice that
for a poor country like Bangladesh, relatively I’m speaking, the small is defined at a level
which accommodates almost 100% of the medium and many of the large existing enterprise
which is 1.78 million dollar is how the small is defined. Whereas in a country like Japan, I’m
confining to wholesale trade enterprises, 250,000 dollar is the maximum. This is the ceiling
on the asset value.

What one observes is there are large discrepancies in the way various countries define their
small medium and large. Historically, the issue of SME arose both from considerations on
extending financial net and capturing the small and medium enterprises. But it also evolved
in the context of developing an industrial development strategy and much of the definition is
rooted in the 2nd trend which is defining an industrial development strategy and therefore you
see these large things.

And possibly such policy discrepancy had benefited some segment in the market by getting
privileges in the financial market. I’ll not delve much into it but in a summit on micro finance,
if one takes the root from how much experiences, how much lessons can be learned from
the MFI experience to address the issues of SMEs, there is a paper which I have in the
handout by Holtman and Winkler on SME Financing -- Lessons from MFIs which came out in
the SME issue by the World Bank SME division in November 2000.

I just quote few things from it.

SME credit projects often, I’m borrowing from them, wrongly assume commercial banks lack
funds, incorporate training to impact state-of-the-art western credit know-how and ignore that
the owners and managers of partner institutions are not interested in institutional
transformation that involve changing the target group orientation, credit technology, and the
way lending operations are organized.

And case for a micro based approach, the two points that are made, the core elements of a
successful micro lending program can be applied to SME lending operations because
underlying problems in both cases are the lack of reliable information, lack of collateral and
difficulty of inputs in contracts.

But choice between a bottom-up approach, upgrading an NGO into a formal financial
institution and a top-down approach, which is downscaling operations of commercial banks.
The Bangladeshi experience seems to suggest that maybe we got to learn the lesson from
both sides but at the end, the delivery mechanism was to be a third choice, neither here nor
there kind of thing. I’m not getting into the details. If the discussion permits me, I’ll get into
why this should be that way. I’ll end in a minute.

These are a few odd observations. One is, we have dealt with the issue of private sector in
developing countries and in particular in the context of Bangladesh and erstwhile East
Pakistan, the government has tried to create in a supervised way the private sector
entrepreneurs through what we had is the EPIDC or Pakistan Industrial Development
Corporation, and this bank financing was actually largely meant to create the private sector,
we had that experience. We have a private sector which has evolved, out of to some extent,
plundering of public money from the nationalized commercial banks. And we now have a
separate kind of private sector in the name of NGOs and MFIs who also happen to have
tampered with grant funds from the donors.

But without getting into any kind of judgment, it is worth pondering whether this is a different
kind of private sector which ought to be acknowledged as a private sector .

The second part within the context of SMEs is, in the context of Bangladesh, many of the
MFIs have gone beyond lending operations. Lending itself is an enterprise activity which has
enabled the MFIs to develop the managerial capacity at a very micro level. At even the
smaller administrative level, you have local MFIs who have that capacity now.

And for their own sustenance, many of these MFIs have engaged in commercial activities
which are, in many contexts, linked up with the welfare of the clients they deal with. Either in
terms of the marketing of their products or bringing in things from outside to provide or to
create the extension services.

Now that has given them an edge in certain areas over an individually run private sector
enterprise. It is possibly time to think whether we start acknowledging that some of these
microfinancing institutions are effectively SMEs who also deserve to be supported in terms
of bank financing.

This is an issue which I know will create a lot of debate but obviously under the right kind of
legal framework, right kind of legal umbrella.

Then the third element is, I avoid the issue of choice of delivery mechanism but a public
investment in certain areas is critical. One thing is to ensure that the markets developed by
developing the providers of the non financial services which Anil was referring to. But
beyond that, there has to be some public investment in certain areas like information
infrastructure, the financial infrastructure also and that has to be take care of.

Lastly, interest rate has been a thorny issue in the area of MFIs. And if one has to address
the SMEs, it is very likely that the operational cost will increase by some proportion. It’ll be
more than what it is under the MFI sector. What that means is in order to recoup that, you
ought to raise the interest rate that you charged your clients. But at the same time we have a
situation where SMEs may need equity funding where it’s a long term financing which
normally one is encouraged to engage in if the interest rate is low. I mean there are
rationales for that.

So there is a dilemma here. One possible area which can resolve this is to include that part
of the cost in the project cost rather than try to recover that from the interest rate.

Thank you very much

Question and Answer Session

Thanks very much. I’m not even going to try and summarise any of this discussion or to find
any common threads. I think possibly one common thread is the fact that Anil’s SEDF clearly
operates at the higher end of the SME ladder. BRAC Bank on the other hand focuses on the
smaller end and that relates really a lot to what Dr Zaheer was saying on the issue of
definition. The definition put forward in industrial policy I think, in many of our views, really
doesn’t make that much sense. And that ought to be revised and that’s a view that’s
increasingly gaining a lot of currency with a lot of actors working in this field. And that’s
definitely something the World Bank will take up in its dialogue.

My role here is to be a moderator, not to say any more. So let me thank Anil Sinha very
much, Mr Shawkat Hussain, Dr Sajjad Zaheer. Thanks very much for the participation in the
audience. Enjoy the rest of the summit. Thanks.


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