FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL INCLUSION, INFRASTRUCTURE & ACCESS Financing Solutions For Micro, Small And Medium Enterprises In Bangladesh © 2019 The World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved. This volume is a product of the staff and external authors of the World Bank Group. The World Bank Group refers to the member institutions of the World Bank Group: The World Bank (International Bank for Reconstruction and Development); International Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non-commercial purposes. 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Insides Photo Credits: World Bank and IFC Photo Libraries FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL INCLUSION, INFRASTRUCTURE & ACCESS TABLE OF CONTENTS ABBREVIATIONS AND ACRONYMS V ACKNOWLEDGMENTS VII EXECUTIVE SUMMARY IX I. MSMES: IMPORTANCE AND FINANCING CONSTRAINTS 1 Introduction 1 MSMEs in Bangladesh 1 Classification 1 Structure and Role 2 The Financing Challenge 3 MSME financing constraints 3 Formal Credit Supply for MSMEs 4 Estimated Financing Gap for Microenterprises 7 Estimated Financing Gap for SMEs II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS 9 The Regulatory and Financing Policies 9 Institutional Coordination 9 Regulatory Policies 9 Financing Policies and Schemes 11 Effectiveness 15 Policy Recommendations 16 The Financial Infrastructure Gaps 18 Credit Reporting 18 Secured Transactions and Collateral Registries 20 Insolvency and Debt Resolution 21 Payment Systems 22 Policy Recommendations 22 Exploring Innovative and Alternative Financing Options 23 Risk-sharing Facilities 23 Alternative financial instruments 25 Fintech Solutions 27 Policy Recommendations 29 III. CONCLUSIONS 31 FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH I ANNEXES 33 Annex 1. Definition and Classification of MSMEs 33 Annex 2. MSME Structure and Roles (2013 Bangladesh Economic Census) 34 Annex 3. Estimation of the Small Enterprise Financing Gap Using Bangladesh Bank Loan Data 35 Annex 4. Roles and Activities of Agencies Supporting MSMEs 37 Annex 5. General Principles for Credit Reporting Systems 39 Annex 6. Principles for Credit Guarantee Schemes for SMEs 40 Annex 7. Fintech Solutions 41 REFERENCES 37 ENDENOTES 45 LIST OF BOXES Box 1: An Approach Framework to State Intervention and State-owned Banks 12 Box 2: MSME Segmentation and Prospects from a Bank’s Perspective 15 Box 3: Lessons of Positive Adaptive Experiences 17 Box 4: India’s Experience with Private Sector-led CIBs 19 Box 5: International Examples of Successful Secured Transaction Reforms 20 Box 6: Credit Guarantee Schemes in India and Thailand 24 Box 7: The United States Small Business Investment Company (SBIC) 26 Box 8: Kenya’s Success with Fintech companies 28 Box 9: General Principles for Credit Reporting Systems (CRS) 39 Box 10: Recommendations for Effective Oversight 40 LIST OF FIGURES Figure 1: Distribution of Employment 3 Figure 2: Average Labor Productivity 2013 (Tk `000) 3 Figure 3: Microcredit Members, June 2016 (million) 5 Figure 4: Distribution of Membership by Gender (%) 5 Figure 5: Loans Disbursed, June 2016 5 Figure 6: Average Loan Size, June 2016 5 Figure 7: Expansion of Banking Sector MSME Lending (Tk billion) 6 Figure 8: Distribution of Formal MSME Credit by Economic Activities, June 2016 (%) 6 LIST OF TABLES Table 1: Financial Inclusion Indicators, by Country, South Asia IX Table 2: Unified MSME Definition Adopted under the 2016 Industrial Policy 2 Table 3: MSME Loans Outstanding as a Share of Total Loans 6 Table 4: Average Demand for Loans Among Microenterprises 7 Table 5: Loan Supply for Microenterprises, June 2016 7 TABLE OF CONTENTS II Table 6: IFC Estimates of Financing Gap, 2011 versus 2017 8 Table 7: State Intervention Rationales 13 Table 8: SOFI Institutional Typologies 13 Table 9: SOFI Instrument Typologies 14 Table 10: Efficiency of the Bangladesh Regulatory Regime, 2018 — Getting Credit 18 Table 11: Definition of MSME in the 2003 Economic Census 33 Table 12: Definition of MSMEs in the Bangladesh 2010 Industrial Policy 33 Table 13: Bangladesh Bank Definition of Small Enterprises 34 Table 14: Updated Definition of MSMEs by the Bangladesh Bank, 2016 34 Table 15: Size and Employment of Enterprises in Bangladesh, 2013 35 Table 16: Distribution of Enterprises by Major Economic Activities, 2013 (numbers in `000) 35 Table 17: Banking Sector Loan Disbursements to SMEs 35 Table 18: Small Enterprise Financing Gap 36 FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH III SECTION TITLE IV FINANCE, COMPETITIVENESS FINANCE, COMPETITIVENESS INSIGHT & INNOVATION & INNOVATION | FINANCIAL INSIGHT | LONG-TERM INCLUSION, FINANCE & ACCESS INFRASTRUCTURE ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank ADR Alternative Dispute Resolution BACH Bangladesh Automated Clearing House BASIC Bank for Small Industries and Commerce BBS Bangladesh Bureau of Statistics BFID Bank and Financial Institutions Division (Ministry of Finance) BIAC Bangladesh International Arbitration Center BPC Business Promotion Council BSCIC Bangladesh Small and Cottage Industries Corporation IB Credit Information Bureau CGS Credit Guarantee Scheme CIB Credit Information Bureau CIC Credit Information Companies CRS Credit Reporting System DFS Digital Financial Services ECGS Export Credit Guarantee Scheme EFT Electronic Funds Transfer EGBMP Enterprise Growth and Bank Modernization Project FCI Finance, Competitiveness, and Innovation FIRST Financial Sector Reform and Strengthening Initiative (World Bank) FSPDSME Financial Sector Project for the Development of Small and Medium- Sized Enterprises FY Fiscal Year GDP Gross Domestic Product ICT Information and Communication Technologies IDLC Industrial Development Leasing Company IFC International Finance Corporation IFI International Financial Institution InM Institute for Inclusive Finance and Development JCAP Joint Capital Markets Initiative JICA Japan International Cooperation Agency FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH V JPY Japanese Yen LFS Labor Force Survey MFIs Microfinance Institutions MFS Mobile Financial Services MOI Ministry of Industry MRA Micro-Credit Regulatory Authority MSME Micro, Small and Medium Enterprises NBFI Non-bank Financial Institution NGO Non-governmental Organization NPL Non-Peforming Loan NSDC National SME Development Council OECD Organisation for Economic Co-operation and Development PFI Partner Financial Institutions PRI Policy Research Institute R&D Research and Development RMG Ready-made Garment RSF Risk-Sharing Facility SBA Small Business Administration SBIC Small Business Investment Company SCI Small and cottage industry SEF Small Enterprise Fund SMEs Small and Medium Enterprises SMEDP The Small and Medium-Sized Enterprise Development Project SMEF SME Foundation SMESDP Small and Medium Enterprise Sector Development Project SOB State-owned banks SOFI State-owned financial institution STR Secured Transaction Law Tk Bangladeshi taka TSL Two-Step Loan UK United Kingdom USAID United States Agency for International Development US$ United States Dollar VC Venture Capital WBG World Bank Group ACRONYMS AND ABBREVIATIONS VI FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL INCLUSION, INFRASTRUCTURE & ACCESS ACKNOWLEDGMENTS T his report was prepared by the World Bank’s Finance, Competitiveness, and Innovation (FCI) Global Practice team, led by Mihasonirina Andrianaivo (Senior Financial Sector Specialist), Ilias Skamnelos (Lead Financial Sector Specialist) and Aminata Ndiaye (Financial Sector Specialist). It is based on the findings of a report produced by Specialist) and Muhammad Mustafizur Rahman the Policy Research Institute (PRI) of Bangladesh, (Consultant). The report also benefited from the with inputs from the World Bank, including a guidance of Harish Natarajan (Lead Financial desk review and a field mission in August 2017. Sector Specialist), Shah Nur Quayyum (Senior The data collection, analysis, and interviews with Financial Sector Specialist) and A.K.M. Abdullah government officials and stakeholders, as well (Senior Financial Sector Specialist). as the formulation of policy recommendations, The team is also grateful to the peer reviewers, were made possible thanks to the dedication and including Ghada O. Teima (Lead Financial diligence of Sadiq Ahmed and his team at PRI. Sector Specialist) and Alper Ahmet Oguz (Senior The report was prepared as a sub-task of the Financial Sector Specialist) for their valuable Bangladesh Financial Sector Development comments. Programmatic Approach. The team is grateful for The team would like to express its particular the overall guidance and advice of its Task Team appreciation to Qimiao Fan (Country Director, Leader Korotoumou Ouattara (Senior Financial Bangladesh), Esperanza Lasagabaster (Practice Sector Specialist). This report owes much to Manager, FCI South Asia region) and Christian Simon Bell (Global Lead for SME finance) who Eigen-Zucchi (Program Leader, Equitable Growth, led an initial knowledge-sharing mission with the Finance and Institutions [EFI]) for their overall Bangladesh authorities and provided guidance and guidance and review. The team would also like feedback on earlier versions of the work. to thank all government officials and stakeholders Inputs were provided by Ananya Kader (Senior who patiently responded to interview questions. Financial Sector Specialist), Colin Raymond We also thank Aichin Lim Jones for design and (Lead Financial Sector Specialist), Nina Pavlova production services, Barbara Balaj for editorial Mocheva (Senior Financial Sector Specialist), support, as well as Vanda Melecky and Aza Rashid Murat Sultanov (Senior Financial Sector for their operational support. Specialist), Ashutosh Tandon (Financial Sector Note: This paper summarizes the main outcomes of a survey that received responses from 10 countries. Because of confi- dentiality restrictions, the country specific results have been made anonymous in the present report FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH VII ACRONYMS AND ABBREVIATIONS VIII FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL INCLUSION, INFRASTRUCTURE & ACCESS EXECUTIVE SUMMARY I mproving access to finance for micro, small and medium enterprises (MSMEs) is a fundamental challenge at the heart of a country’s financial and economic development; debates continue over the design and effectiveness of MSME policy. This report presents a desk review of the financing gap, constraints and policies related to the MSME financing in Bangladesh. It aims to provide relevant policy recommendations at a critical time when past policies can be objectively evaluated, and as innovative and alternative instruments emerge, thereby presenting as a unique opportunity to address these financing challenges. Despite significant knowledge gaps, MSMEs While recognizing the multi-sectoral challenge are undoubtedly the backbone of non-farm job of MSME policy making, improvements in creation in Bangladesh. The country lacked a strategic vision and coordination can yield uniform MSME definition until the 2016 Industrial significant results to MSME development Policy. It now needs to promote this as a unified and finance. MSME policy invariably involves definition at the policy level, while also improving several agencies. However, there is currently little relevant data collection and analysis. Nevertheless, institutional coordination and no strategic vision or the 2013 Economic Census and Enterprise Survey overarching policy framework. Among a multitude of the same year provide important insights. Some of agencies, the Ministry of Industry has taken 99 percent of all non-farm enterprises fall into the an active role in MSME development, and the micro and small enterprises categories, providing Bangladesh Bank has led MSME finance policy, employment to 20.3 million Bangladeshis workers including direct interventions such as refinancing in 2013. Most of these enterprises are informal and windows. Based on international experience, focus primarily on trading activities. As such, they Bangladesh would benefit from establishing a face a substantial productivity challenge. Women’s central coordinating, multi-party body to promote economic participation lags expectations given the MSME development and finance. country’s current development stage. The Bangladesh Bank’s efforts appear to have Access to formal finance by MSMEs is limited increased MSME financing overall from a low compared to the average for the South Asia base; however, its impact and effectiveness could region, with an estimated financing gap of be enhanced by reviewing past and present Bangladeshi Taka (TK) 237 billion (US$2.8 financing schemes and institutions. Most of the billion). Small and medium firms perceive access success has been with medium enterprises that to finance as the third most important obstacle. In do not necessarily face the strongest financing line with its Vision 2021, the government has sought constraints — and most of the financing is short- to improve MSMEs’ access to finance through term in nature. The Bangladesh Bank should multiple channels. Bangladesh is famous for refocus its attention on the most constrained among pioneering the global micro-credit revolution based the MSMEs. In addition, the Bangladesh Bank’s on group guarantees and the total banking sector policy emphasis on banks does not appear to be lending to MSMEs almost tripled from 2010 to fully internalized. Indeed, the banks’ response can 2016. Nevertheless, there still appears to be a sizable best be characterized as one of passive compliance. financing gap for MSMEs, estimated at TK 237 The reasons appear to be based on persistent billion (US$2.8 billion) (building on International underlying financial infrastructure weaknesses and Finance Corporation [IFC] calculations). banks’ risk perceptions. Nevertheless, success cases FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH IX such as Brac Bank, the Industrial Development Payment systems, in particular, hold promise Leasing Company (IDLC), and Prime Bank in expanding MSME financial access through deserve some credit. The Bangladesh Bank would Digital Financial Services (DFS). Technology benefit from undertaking an evaluation of past is transforming the global economy and MSME schemes, guidelines and success stories to inform financing. Several enabling factors are critical to future MSME finance policies. Lastly, state-owned successfully galvanizing this technology, and the financial institutions, which would traditionally regulatory environment is particularly important. support MSME development, are faced with The Bangladesh Bank has made significant significant challenges – notably with regard to advances toward the adoption of a digitized their mandate and governance, profitability, capital payment system, and has encouraged mobile adequacy, and non-performing loans. It is important financial services. The rapid growth of information that the government clarifies the long-term goals, and communication technologies (ICT) services mandates and objectives of the state-owned has led to the increasing use of technology for the financial institutions, and undertakes the necessary delivery of financial services, but penetration is reforms to enhance their role. limited. Among the key challenges, the legal and regulatory structure of the mobile-payments system There are significant financial infrastructure is restrictive by only allowing for a bank-led model. weaknesses that need to be addressed to encourage The goal should be to transform this into a mobile- market-driven MSME financial inclusion. The financial system with a broader range of financial 2018 World Bank Group’s Doing Business survey services. Therefore, the Bangladesh Bank needs ranks Bangladesh at 159 (of 190 countries) for to review its strategy and policy relating to DFS, the ‘Getting Credit’ indicator, a measure of credit including making the eco-system more supportive information sharing and legal rights of borrowers for the growth of Fintech. and lenders. In future, the credit bureau coverage should include all commercial loans, regardless Several innovative and alternative financing of value. It should also mine all available data to options can be further explored, including risk- strengthen MSME credit information. Furthermore, sharing facilities (RSFs), factoring, warehouse loans are primarily secured through property-based receipt finance, and/or start-up capital policies. collateral (that face a challenge regarding property RSFs can partially cover the risks of MSME lending rights), whereas movable collateral is not yet and help de-risk lending decisions by commercial accepted for secured lending. Therefore, MSME banks. Bangladesh can launch a MSME-focused financing would benefit from the expansion of the scheme that learns from its past experiences, registry’s mandate to include movable collateral, specifically by addressing governance concerns. the enactment of the Secured Transactions Law In addition, a range of pre-bank financing options and the creation of a register. Notwithstanding has emerged to support young and dynamic firms. several legal avenues in place, insolvency and However, the requisite enabling environment is debt resolution are, in practice, very difficult and still under development. As financial infrastructure costly. A Small Claims Court could lead to faster improves and digital technology develops, asset- adjudication with lower costs for cases relating to based solutions — such as factoring and warehouse MSMEs. In this regard, it is important to codify and receipt financing — are likely to become more operationalize mediation within the Money Loan attractive. Finally, start-up capital is much needed, Courts and the general courts. To settle disputes but still missing. In this regard, public policy can involving small claims or recovering loans to small help to reduce the risks associated with this segment. enterprises, the Small Cause Courts Act will require Table 1 provides a summary of key recommendations amendments. Institutionalizing Alternative Dispute found in this report. Resolution (ADR) mechanisms for commercial dispute settlement could also help address contract enforcement processes. EXECUTIVE SUMMARY X Table 1: Financial Inclusion Indicators, by Country, South Asia Short-term Medium-term Institutions Promote the use of a unified definition at the policy level and improve • data collection and analysis. Establish a multi-party, central coordinating body to promote MSME • development and financing. Undertake an evaluation of past schemes and Bangladesh Bank • guidelines to inform future MSME finance policies.H Refocus attention on the most constrained among the MSMEs – the • ‘missing middle’.a Clarify the long-term goals of the government and the mandates and objectives of state-owned financial institutions and undertake the • requisite reforms.H Infrastructure Improve the credit information infrastructure, expanding the reach of • the credit information bureau.H Enact the Secured Transaction Law and create a register. • Establish a Small Claims Court and institutionalize ADR mechanisms. • Innovation Promote an effective payment system and financial infrastructure to • support the rollout of DFS and the evolution of Fintech.H Pursue the necessary legal and infrastructure needs for the • introduction or expansion of alternative finance.H Introduce a Risk-Sharing Facility for SMEs. • Note: ADR=Alternative Dispute Resolution; DFS= Digital Financial Services; MSME= micro-, small and medium enterprises; SME= small and medium enterprises. H = High priority reform. Short-term is within 9 months, and medium-term is within 18-24 months. a The ‘missing middle’ refers to small firms and firms at the low-end of the medium-sized enterprise segment that have the most difficulty in accessing bank finance. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH XI SECTION TITLE XII FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL INCLUSION, INFRASTRUCTURE & ACCESS I. MSMES: IMPORTANCE AND FINANCING CONSTRAINTS Introduction D espite limited data, micro, small and medium enterprises (MSMEs) are undoubtedly the backbone of non-farm job creation in Bangladesh. Some 99 percent of all non-farm enterprises fall within the micro and small enterprise categories, providing employment to 20.3 million Bangladeshi workers in 2013. Yet, the use of formal finance by small firms is limited compared to the South Asia average, with an estimated MSME financing gap of Bangladeshi Taka Tk 237 billion (US$2.8 billion).1 Improving MSME access to finance is a including risk-sharing facilities, asset-based fundamental challenge at the heart of a solutions, and Fintech (financial technology). country’s financial and economic development. Finally, Section C concludes with an overview of Development theory emphasizes the role of key findings from the report. finance in achieving growth and income equality. However, one of the most important issues facing MSMEs in Bangladesh MSMEs is their difficulty in accessing finance. Given market imperfections, the role of state Classification policy is critical — from promoting an enabling environment to more active market interventions. Bangladesh has lacked a uniform MSME definition, which has resulted in fundamental This report presents a desk review of the knowledge gaps,3 as well as an inability to financing gap, constraints and policies related quantify the impact of government and donor to the MSME financing in Bangladesh.2 In financial assistance. There have been multiple doing so, it aims to provide relevant policy definitions deployed since 2003 (see annex 1), recommendations at a critical time when past including by the Economic Censuses conducted policies can be objectively evaluated, and as by the Bangladesh Bureau of Statistics (BBS), innovative and alternative instruments are the Bangladesh Industrial Policy, and surveys by emerging, thereby presenting a unique opportunity international organizations, such as the World to address these financing challenges. Bank Group’s (WBG) Enterprise Surveys. Some Section A outlines the structure and role of special-purpose sample surveys have also been MSMEs in the economy of Bangladesh, as well as used occasionally to diagnose constraints, albeit their financing constraints. Section B.1 turns to the in a limited manner. regulatory and financing policies pursued by the The MSME definition set by the 2016 Industrial authorities, examining coordination challenges Policy is now broadly accepted as a unified and the effectiveness of efforts toward formulating definition at the policy level. It is based on the key recommendations. Section B.2 focuses on value of fixed assets (excluding land and buildings) the challenges and recommendations in the realm and/or the number of employees (see table 2). This of financial infrastructure, specifically credit unified national definition should be followed by reporting, secured transactions and collateral all government entities. Notably, the Bangladesh registries, insolvency and debt resolution, and Bank has updated its definition accordingly (see payment systems. Section B.3 outlines innovative annex 1). and alternative financing options for MSMEs, FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 1 Table 2: Unified MSME Definition Adopted under the 2016 Industrial Policy Type of Industry Amount of Investment in Tk (Replacement Number of Cost and Value of Fixed Assets, excluding Employed Land and Factory Buildings) Workers Cottage Industry Below 1 million Maximum 15 Micro Industry 1 to 7.5 million 16-30 Manufacturing 7.5 to 150 million 31-120 Small Industry Service 1 to 20 million 16-50 Manufacturing 150 to 500 million 121-300 Medium Industry Service 20 to 300 million 51-120 Source: National Industrial Policy, Government of Bangladesh, 2016. Structure and Role and especially among small firms. Some 90 percent of microenterprises and 95.5 percent of small Despite the absence of consistent data over enterprises are engaged in providing informal time, there are still some useful conclusions services for the domestic market. The average size that can be drawn, primarily from the 2013 of these firms — while slightly increasing — is Government Economic Census and the Enterprise still low, at 4 employees in urban areas, and even Survey (World Bank 2013). lower in rural areas. There is limited value chain MSMEs are the backbone of non-farm job integration among this enterprise segment, and creation in Bangladesh (which is broadly in negligible contribution to the export market. line with other countries in the region). The 2013 The MSME sector, in particular micro and Economic Census counts a staggering 7.8 million small enterprises, is dominated by trading enterprises, of which almost 89 percent belong to activities. The distribution of enterprises by broad the cottage and microenterprise segment, and 11 economic activities and size (table 12 in annex 2) percent to the small enterprise segment. Some 99 reveals that more than 87 and 94 percent of the percent of all non-farm enterprises fall into the micro and small enterprises, respectively, are micro and small segments, providing employment engaged in non-manufacturing services, mostly in to 20.3 million in 2013. As such, this makes trading. However, medium and large enterprises them the largest source of employment apart of are heavily involved in industrial activities, agriculture (figure 1) — and a key contributor with almost 50 and 53 percent of the medium to poverty reduction. The MSME sector overall and large enterprises, respectively, involved in provides 86 percent of total employment outside manufacturing activities. Reorienting the SME of agriculture and the public sector. Notably, sector away from trading to higher value-added the 2013 Labor Force Survey (LFS) shows economic activity remains an important challenge. that informal employment in services and manufacturing accounted for almost 87 percent of The productivity challenge for micro and small total employment. (Table 11 in annex 2 provides an enterprises is substantial. Evidence from the overview of the size distribution and employment manufacturing sector suggests that the micro and data for 2013.) small enterprises tend to have low value-added per worker and low average wages. Figure 2 shows Most of these enterprises are informal, that is, that the average labor productivity in micro and they are not registered with the government. small manufacturing is barely above the low Informality is prevalent in the private economy productivity of the agriculture sector. I. MSMES: IMPORTANCE AND FINANCING CONSTRAINTS 2 Figure 1: Distribution of The Financing Challenge Employment (%) MSME financing constraints 50 45 Small firms’ use of formal finance is limited 40 compared to larger firms, as well as in 35 comparison with the average for the South Asia 30 region. The 2013 Enterprise Survey estimates that 20 only 27.5 percent of small firms have bank loans/ 20 lines of credit compared to 44 percent of large firms and 30 percent observed in the region. Small firms 10 rely more on internal funds to finance investments. They face higher collateral level requirements 0 relative to the value of loans received. Agriculture Non-Farm Other MSEs Non-Farm Small and medium firms perceive access to finance as the third most important obstacle in Source: BBS, LFS 2013 and Economic Census 2013. the business environment. According to the 2013 Enterprise Survey, all firms perceive political Figure 2: Average Labor instability and electricity as the top obstacles to Productivity 2013 (Tk `000) the business environment. Unlike smaller firms, large firms rank corruption — not access to finance — as the third most important obstacle. Total 196 Notably, there appears to be a segment, known as the ‘missing middle’, of small firms and firms at the low-end of the medium-sized enterprises that Services 323 have the most difficulty in accessing bank finance. SS Manufacturing 77 Financial constraints faced by MSMEs in Bangladesh are widely recognized in the academic LS Manufacturing 352 literature and other studies.4 The 2017 International Finance Corporation (IFC) SME Finance Gap Study Agriculture 71 observed that 55 percent of all MSMEs reported at least being partially financially constrained, of 0 100 200 300 400 which 39 percent reported being “fully constrained”. Daniels (2003) reported the availability of financing Note: LS=Large Scale. SS=Small Scale. as the top problem faced by MSMEs (based on a nationwide survey of private enterprises), with Women’s participation in economic activity lags limited credit from formal sources. In another study, behind most low-income countries according to Alam and Ullah (2006) also identified the lack of the 2013 Enterprise Survey. The share of women medium to long-term credit among the reasons for in ownership and management is less than half slow growth among MSMEs. Likewise, Haider and that of low-income countries across all firm sizes. Akhter (2014) found that 50 percent of SMEs did Although women’s participation in the workforce not have any access to bank financing. Focusing is higher (16 percent), especially for larger firms, on the manufacturing sector, a survey conducted it is still significantly lower than the average (34 by the Bangladesh Integrated Support to Poverty percent) and that of low-income countries (25 and Inequality Reduction through Enterprise percent). Development5 found that 69 and 45 percent of small FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 3 and medium enterprises, respectively, identified Formal Credit Supply for MSMEs access to finance as a major constraint (Bakht and Basher 2015). Finally, a 2016 study by the Institute for The financial system is bank dominated, along Inclusive Finance and Development concluded that, with a vibrant microfinance sector. Banks despite the growth of micro-finance, access to credit account for about 70 percent of total financial remains a major constraint for microenterprises. It system assets and 73 percent of gross domestic is exacerbated by the high interest rate elasticity of product (GDP). Among the 57 scheduled (licensed) demand. In this context, a one percent reduction in banks, there are six state-owned commercial interest rate increases demand for microenterprise banks, two state-owned specialized developmental credit by 5.6 percent. banks, nine foreign commercial banks, and 40 domestic private commercial banks, including Globally, several factors on the demand and eight Islamic finance banks. In addition, there supply sides can explain the large financing are four nonscheduled specialized public banks, gap for MSMEs. On the demand side, the lack of which operate under their own individual laws. financial capabilities and low level of formalization The financial sector also consists of microfinance are key constraints. High financing costs also act institutions (including 784 licensed institutions, as a deterrent to demand for financing. On the dominated by 10 large microfinance institutions supply side, the lack of appropriate credit appraisal [MFIs] and Grameen Bank), non-bank financial policies, credit infrastructure and risk management institutions (34 in total), the capital market (with tools lead to a high risk-aversion on the part of two stock exchanges) and the insurance sector financial institutions in lending to MSMEs. The (with 78 insurance companies). The capital market crowding-out of commercial bank financing to and insurance sector account for about 20 and just MSMEs by public sector organizations also leads 3 percent of financial system assets, respectively. to further credit constraints for MSMEs. Capital markets are equity driven, very shallow and small, thereby restricting diversification of Bangladeshi MSMEs are subject to a number funding and access to long-term finance.6 Market of financing constraints, among them, poor capitalization of all listed securities stands at quality of collateral, inadequate documentation roughly 20 percent of GDP, with a dominance and ill-defined business plans. Several studies of equity securities. There are only 2 corporate found that commercial banks regard MSMEs bonds and 8 debentures among a total of 564 listed as high-risk borrowers because of their low securities, and there is no active trading of the 221 capitalization, insufficient assets and high government Treasury (T)-bonds listed on the two mortality rates (Bhattacharya and others 2000; stock exchanges. Hossain 1998; and Sia 2003). One of the major obstacles for micro and small enterprises is the In line with its Vision 2021, the Government banks’ reliance on ‘collateral-based lending’, of Bangladesh has increasingly focused on whereby banks consider fixed asset ownership, MSMEs, including access to finance. Under the especially land, as the basis for credit extension — Bangladesh Bank’s leadership, the initial focus irrespective of the worthiness of the borrower or was on micro-credit, with an increasing emphasis project (Bhattacharya and others 2000; Challenges on SMEs since 2011. Consulting 2012; Meagher 1998). Whereas some commercial banks have innovative products or Bangladesh is famous for pioneering the services for MSMEs, most banks repackage their global micro-credit revolution based on group existing products as MSME products (Siddique guarantees through the Nobel-prize winning and others 2007). The same study also found Grameen Bank initiative.7 This is further that commercial banks disburse loans to small supported by the Government through several enterprises only when the government introduces initiatives, including the establishment of the Palli credit guarantees. Karma Sahayak Foundation (PKSF), a second- I. MSMES: IMPORTANCE AND FINANCING CONSTRAINTS 4 tier not-for-profit company providing services As of June 2016, a total of 37.7million members through partners (non-governmental organizations have benefitted from microcredit programs, [NGOs]/ MFIs) and the Micro-Credit Regulatory of which over 80 percent are rural female Authority (MRA). The role of micro-credit as a members. The main features of the microcredit major policy instrument has also been incorporated expansion are illustrated in figures 3-6. Total into the national development plans as well as the loans disbursed through microcredit schemes national budget. MFIs are not permitted to take any have grown to Tk 956 billion (US$11.4 billion) (or collateral from borrowers. Rather, they use group 5.6 percent of fiscal year [FY]16 GDP), with an guarantees. In this context, microenterprise loans average size of Tk 29,600 (US$354). Agriculture, are usually given to repeater borrowers with credit livestock and fisheries account for 50 percent histories (for instance, those who have repaid a of the loans, followed by 30 and 4 percent for microloan). Available evidence suggests that the trading and transport, respectively. Borrowing for spread of microcredit has contributed to poverty manufacturing activities is small at just 2 percent. reduction by facilitating higher consumption and helping the poor to build assets. Figure 3: Microcredit Members, Figure 4: Distribution of June 2016 (Million) Membership by Gender (%) 40 37.7 100 90.7 33.1 80 30 60 20 40 10 4.6 20 9.3 0 0 Total Rural Urban Female Male Source: Credit and Development Forum, 2016. Source: Credit and Development Forum, 2016. Figure 5: Loans Disbursed, Figure 6: Average Loan Size, June 2016 (Tk Billion) June 2016 (Tk `000) Total 956 Total 30 Rural 824 Rural 29 Urban 132 Urban 39 0 500 1,000 1,500 0 10 20 30 40 60 Source: Credit and Development Forum, 2016. Source: Credit and Development Forum, 2016. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 5 Total MSME lending from the formal banking Figure 7: Expansion of Banking sector nearly tripled from 2010 to 2016, with Sector MSME Lending (Tk billion) an 18 percent annual growth rate. Unlike microcredit, the focus on SME lending is more 2,000 recent and has been spearheaded by the Bangladesh 2016 June Bank. The market dynamics are illustrated in 1,526 1,500 figures 7 and 8. MSME credit as a share of total private sector credit grew from 20 to 25 percent from mid-2010 to mid-2016. In this regard the 1,000 743 credit share of micro and small enterprises in the 567 635 total MSME portfolio grew from 44 percent to 51 500 316 251 percent. In terms of economic activities, although 147 0 the Bangladesh Bank’s policy accorded priority to 0 manufacturing and services, the bulk of credit was Total Medium Small Micro channeled to trading activities (60 percent overall, Source: Bangladesh Bank. with 74 percent for small enterprises).8 This is consistent with the dominance of “trading” in SME activities as compared to industry, manufacturing, Figure 8: Distribution of Formal and value-added services. MSME Credit by Economic Domestic private commercial banks account Activities, June 2016 (%) for 76 percent of the total outstanding MSME loans, and MSME loans in turn account for Micro about 27 percent of their portfolios. The public commercial banks account for 19 percent of the Services total outstanding MSME loans, and non-bank Small Trading financial institutions (NBFIs) and foreign private Manufacturing banks have a nominal presence. Table 3 shows Medium the total portfolio of outstanding MSME loans compared to the total amount of loans provided Total by all five categories of financial institutions as of June 2016. However, it should be noted that there 0 20 40 60 80 has been a rise recently in the non-performing loan (NPL) rate for SME loans, particularly among Source: Bangladesh Bank. state-owned banks (estimated at about 40 percent). Table 3: MSME Loans Outstanding as a Share of Total Loans Percentage Percentage Total Loans MSME Loans of MSME Share of Bank Category (Tk Billion) (Tk Billion) Loans SME Loans Public Commercial Banks 84,039.89 285.6 18.4 18.7 Public Specialized Banks 31,213.60 12.4 29.7 0.8 Foreign Banks 23,853.26 18.6 9.5 1.2 Private Commercial Banks 315,328.57 1,152.2 27.1 75.5 Non-bank Financial Institutions (NBFIs) 31,449.30 56.8 11.4 3.7 Total 485,884.62 1,525.6 23.9 100 Source: Bangladesh Bank. I. MSMES: IMPORTANCE AND FINANCING CONSTRAINTS 6 Estimated Financing Gap for compiled by with the total credit, amounting to Microenterprises Tk 566.5 billion. (table 5).10 Comparing supply with demand shows a sizeable financing gap of Estimated Credit Demand Tk 170 billion (US$2 billion). However, this may The total loan demand for cottage and be a substantial underestimation, as it is based on microenterprises is estimated at Tk737 billion prevailing interest rates and does not account for (US$8.8 billion). A 2016 comprehensive survey the high interest rate elasticity of loan demand by of 600 microenterprises conducted by the Institute microenterprises.11 for Inclusive Finance and Development (InM) Estimated Financing Gap for SMEs estimated the average demand for credit by cottage and microenterprises in rural and urban Estimating the demand for credit by SMEs is locations. The survey found that enterprises with difficult due to data constraints. The absence higher employment or those located in urban areas of firm-level demand data, or time-series/ cross- have, on average, higher loan demand, which is sectional data on enterprise profitability, income, consistent with conventional wisdom.9 The 2013 costs, or production prohibits the estimation of Economic Census is then used to estimate the total demand functions based on secondary data. demand for credit based on employment size and SME financing gap estimate by IFC12 spatial distribution. Multiplying the average loan demand by the number of enterprises provides an IFC attempted to formulate an estimate of estimate of the total loan demand (see table 4). the SME financing gap in Bangladesh in 2011, and projected it to be Tk 237 billion (US$2.8 Estimated Financing Gap billion). The average financing gap per SME There appears to exist a sizable financing gap was estimated at US$2,288 — which when of Tk 170 billion (US$2 billion equivalent). combined with an estimated total number of SME The 2016 Credit and Development Forum shows enterprises of 804,041 — yields a total financing the amount of credit disbursed by source, as gap estimate of about US$1.8 billion (Tk 150.5 Table 4: Average Demand for Loans Among Microenterprises Number of Average Loan Total Loan Demand (Tk Employees Demand (Tk) Number of Microenterprises Billion) Urban Rural Urban Rural Total Urban Rural Total Cottage 1-9 107,710 104,283 1,730,150 5,112,734 68,42,884 186.4 533.2 719.6 Micro 10—24 228,750 133,333 41,112 62,895 1,04,007 9.4 8.4 17.8 Source: InM Microenterprise Survey, 2016, and Economic Census, 2013. Table 5: Loan Supply for Microenterprises, June 2016 Total Amount Amount Disbursed to Disbursed in 2015-16 Microenterprises (Tk Supply Source (Tk Billion) Billion) Percentage Share Banks 63.1 63.1 11.1 Public Institutions 11.8 11.8 2.1 MFIs 955.8 491.6 86.8 Total 1,030.7 566.5 100.0 Source: Credit and Development Forum, 2016. Note: MFIs= Microfinance Institutions. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 7 billion) (table 6). Not surprisingly, the largest gap In 2017, the IFC MSME financing gap emerges for the very small enterprises. Estimating improved on the 2011 methodology by defining the financing gap for 2017 by inflating the Tk the counterfactual more concretely,13 as well as by financing gap with the domestic rate of inflation clearly defining the regulatory and macroeconomic increases it to Tk 193 billion (US$2.3 billion). changes required for the gap to become evident. The IFC survey uses enterprise data for 2011, Thus, it estimated the MSME financing gap at which had a lower enterprise headcount than the $US39 billion. 2013 Economic Census. Thus, adjusting it to the 2013 data increases the financing gap to Tk 237 billion (US$2.8 billion). Table 6: IFC Estimates of Financing Gap, 2011 versus 2017 Total value Total value Financing Number of Average gap (US$ gap (Tk Gap (Tk Enterprise Type Enterprises Value Gap ($) billion, 2011) billion, 2011) billion, 2017) Very small 727,840 1,989 1.44 102.5 151.7 Small 72,935 3,489 0.25 17.8 26.4 Medium 3,266 42,033 0.14 10.1 15.0 Total SME 804,041 2,288 1.83 130.4 193.1 Source: IFC, 2013. I. MSMES: IMPORTANCE AND FINANCING CONSTRAINTS 8 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL INCLUSION, INFRASTRUCTURE & ACCESS II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS The Regulatory and Financing Policies T he effectiveness of past and ongoing MSME finance policies appears modest. Improvements in MSME policy making, focused on the strategic vision and coordination among several agencies, can yield significant results. A central coordinating, multi-party body would benefit Bangladesh by promoting MSME development and financing. Bangladesh Bank would also benefit from undertaking an evaluation of past schemes, guidelines and success stories to inform future MSME finance policies. Notably, it should refocus attention on the most constrained segments among MSMEs, and shift the weight of policy beyond the banks. The authorities should also redouble their efforts in addressing persistent underlying financial infrastructure weaknesses, clarifying the mandates, objectives and the long-term goals of the state-owned financial institutions. Institutional Coordination The MOI is of the view that it could implement a more effective financial support program through MSMEs are multi-sectoral and involve several the SMEF and the BSCIC, and strongly favors agencies in setting policy, including the Ministry subsidized interest rates. of Finance, the Ministry of Commerce, the Ministry of Industry (MOI) and the Bangladesh Other countries have a more focused and Bank. Several special bodies have also been coordinated approach to MSME financing and established to support the MSMEs, including the development. The United States has the Small SME Foundation (SMEF), the Bangladesh Small Business Administration (SBA), a dedicated and Cottage Industries Corporation (BSCIC), agency that provides coordinated comprehensive the Bangladesh Industrial Technical Assistance support to small business entrepreneurs. In Centre, the Bangladesh Council of Scientific Malaysia, the National SME Development Council and Industrial Research, the Business Promotion (NSDC) is the highest policy-making body for the Council and the Bangladesh Bank’s MSME development of SMEs. It is chaired by the Prime Department (see annex 4). Minister and is comprised of 13 Ministers, as well as the Chief Secretary to the Government, the Currently, there is very little institutional Director-General of Economic Planning Unit and coordination and no strategic vision or the Governor of Bank Negara Malaysia.14 overarching policy framework to support MSMEs. Among the three concerned line Regulatory Policies ministries, the MOI has taken central stage, with its new industrial policy focused on the development The Bangladesh Bank has been designing of SMEs in manufacturing in particular. Most and implementing initiatives for SME sector of these specialized agencies are managed by development, including women entrepreneurs.15 the MOI. On the financing side, the government It adopted the Small and Medium Enterprise established the Bank for Small Industries and Credit Policies and Programs in 2011. This Commerce (BASIC) in 1988. In this context, the included a formal definition of MSMEs, targets Bangladesh Bank has played the most important for MSME lending by commercial banks, a role in deploying various regulatory actions and refinancing scheme, priority MSME activities, and financing schemes to support the market segment. an emphasis on lending to female entrepreneurs.16 FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 9 It also eased the procedures and requirements • The Bangladesh Bank sets an indicative target for lending to small enterprises, including the for MSME loan disbursement for a year and relaxation of collateral requirements. A new coordinates closely with the banks and financial department, the “SME and Special Programs institutions to achieve it. Department”, was also created in the Bangladesh • Following an ‘Area Approach Method’, banks Bank to accelerate MSME activities and provide and financial institutions try to attain their effective monitoring. The main regulatory support indicative targets separately by dividing them by policies are as follows: branch, region and sector. Loan provisioning. The Bangladesh Bank offers • Each bank/ financial institution can follow attractive loan-provisioning options to support a separate business strategy with the least MSME financing, with only 0.25 percent for formalities in executing documentation for easy general provisioning. The equivalent rates for and speedy loan sanction and disbursement. housing, consumer and corporate finance are 2, 5, and 1 percent, respectively. • For small entrepreneurs, the credit limit ranges from Tk 50,000 to Tk 5 million (US$600 to Capital allocation. Capital is charged against risk- US$60 thousand). At least 40 percent of the weighted assets. A loan of less than Tk 3 million total disbursement target should be reserved for (US$35.9 thousand) to an MSME with unrated small entrepreneurs. Priority is given to potential assets receives a 75 percent risk weight. If the women entrepreneurs. loan is above Tk 3 million, then the risk weight is 100 percent. For any large unrated group, the risk • Each bank/ financial institution is to establish a weight is 125 percent.17 separate ‘Women Entrepreneurs’ Dedicated Desk’ with the requisite, suitable manpower. It should Cluster approach to MSME financing. Banks and provide staff with training on MSME financing NBFIs have received advice from the Bangladesh and also appoint a woman officer as chief of the Bank regarding the development of customized dedicated desk.19 Banks and financial institutions financing solutions to suit 50 MSME clusters that may approve loans of up to Tk 2.5 million (US$30 it identified based on locations conducive to the thousand) to women entrepreneurs against development of an industry. personal guarantees. In that case, group security/ Credit rating. The Bangladesh Bank has social security may be considered. Overall, recognized a specialized credit rating agency for 15 percent of the total MSME credit would be MSMEs called the Bangladesh Rating Agency allocated to women entrepreneurs. Limited. It has established the guidelines for the • The Department of Banking Inspection-3 of credit rating of MSMEs, known as the “Credit the Bangladesh Bank conducts regular on-site Rating Methodology for Small and Medium inspections to monitor compliance with the Enterprises”.18 above guidelines. The success of MSME loan Directive to increase MSME loans. The disbursements is considered to be a yardstick for Bangladesh Bank has also issued directives that further approval of new branches of the concerned 20 percent of all bank/ financial institution loans bank. Licenses for new branches will be issued should be to MSMEs. This will be increased to for financing priority sectors, such as MSMEs 30 percent by 2021. The Bangladesh Bank’s and agriculture. (From 2010, these were provided SME and Special Programs Department has been under the name of the ‘MSME/Agriculture charged with the responsibility of formulating Branch’ instead of the ‘MSME Service Centre’.) financial policy, facilitating credits and monitoring • Each bank/ financial institution can set the interest the development of MSMEs. The formulated rate on MSME loan sector/ subsector. However, guidelines are as follows: for women entrepreneurs, it would be the bank II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS 10 rate +5 percent, not exceeding 10 percent.20 As completing its disbursement in September 2009. noted, the Bangladesh Bank also instructed banks As of mid-2014, Tk 3.3 billion (US$39.5 million) and NBFIs to reserve 15 percent of total MSME had been recovered. funds exclusively for women entrepreneurs.21 • ADB Fund-2 “The Small and Medium-Sized Enterprise Development Project” (SMEDP): Financing Policies and Schemes The fund aimed to enhance medium- to long- The Bangladesh Bank opened an equity fund term financing to eligible MSMEs. The total fund and refinancing windows to channel low- amounted to US$95.0 million, of which ADB cost credits received from various donor and provided US$76.0 million and the Government international organizations. These funds, in of Bangladesh (through the Bangladesh Bank) addition to its own resources, are used as the US$19.0 million, which was transferred from the banking channel for disbursements.22 Some 46 balance of the earlier ADB-1 (SMESDP) Fund. banks and NBFIs have signed a participation Disbursements were completed in end-2013, agreement with the Bangladesh Bank under the with Tk 7.5 billion (US$89.7 million) to banks following schemes: and financial institutions for a total of 13,645 enterprises. As of mid-2014, Tk 2.6 billion Refinance schemes with assistance from various (US$31.1 million) had been recovered. donors and the Bangladesh Bank’s own fund. • Japan International Cooperation Agency • The World Bank’s “Enterprise Growth and (JICA) Two-Step Loan (TSL) Fund, “Financial Bank Modernization Project” (EGBMP): This Sector Project for the Development of Small project aimed to stimulate investments through and Medium-Sized Enterprises” (FSPDSME): small enterprises to offset employment losses The objective is to create a medium- to long- from closed SOEs (for example, Adamjee Jute term finance market for MSMEs, especially for Mills). The Small Enterprise Fund included Tk productive investments. The fund size amounts to 6 billion (US$72 million equivalent) from the Japanese Yen (JPY) 5 billion (US$45.5 million Bangladesh Bank, US$10 million from the World equivalent), including technical assistance, as Bank through the EGBMP, and Tk 0.6 billion well as the TSL of JPY 4.79 billion (US$43.5 (US$7.2 million) from the Government, for a total billion). Some 25 banks and 21 NBFIs signed of Tk 1.2 billion (US$14 million). The scheme participating agreements. As of mid-2014, a total was extended to banks and NBFIs at the bank rate of Tk 2.0 billion (US$23.9 million) had been against their financing to small entrepreneurs, refinanced for 271 enterprises. The TSL was and demonstrated high market demand. Recovery later extended to provide up to Tk 100 million against refinanced loans is used as a revolving (US$1.2 million) for retrofitting, rebuilding and fund for financing MSMEs. In this context, Tk 3.1 relocation of factory buildings of the ready-made billion (US$37 million) has been provided to 32 garment (RMG) and knitwear factories as part of banks and NBFIs to support 3,160 enterprises on the FSPDSME. a revolving basis. Disbursement was completed in mid-2011 and, as of mid-2014, Tk 3.0 billion Agro-based product processing industries. The (US$34.8 million) had been recovered. Bangladesh Bank launched a scheme in 2001 from its own funds for agro-based product-processing • Asian Development Bank (ADB) Fund-1 “Small industries outside the Divisional Head Quarters and Medium Enterprise Sector Development and Narayanganj town. It was increased from an Project” (SMESDP): Subsequently, the ADB original amount of Tk 1.0 billion (US$12 million) placed an additional US$30.0 million in the Small in 2001 to Tk 2.0 billion (US$23.9 million) in Enterprise Fund (SEF) in 2005. An amount of Tk 2012 — and then again to Tk 4.0 billion (US$47.8 3.4 billion (US$40.7 million) was provided to million) in 2013. Refinancing is provided to banks banks and NBFIs for a total of 3,264 enterprises, FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 11 and NBFIs at the bank rate. Since mid-2014, a of Islamic banks in SME financing. Specifically, total of Tk 5.0 billion (US$59.8 million) has been it will do so by refinancing the loans provided by disbursed to 1,897 enterprises on a revolving basis. Islamic banks to agro-based industries and small entrepreneurs (including women-led enterprises). New entrepreneurs in the cottage, micro and small segment. The Bangladesh Bank has At the same time, state-owned financial created a fund of Tk 1.0 billion (US$12 million) institutions — which would traditionally support from its own sources to provide start-up capital MSME development — are faced with significant to new cottage, micro and small enterprises. challenges. State-owned banks include four state- The entrepreneurs are selected and trained by owned commercial banks, and two state-owned recognized public and private training providers specialized banks. They account for a quarter of the and will receive financing at the bank rate +5 total banking system assets and are significantly percent. Refinancing from this fund is expected to weaker than private banks, thereby posing a start soon. financial and fiscal stability risk. Measurement issues aside, they underperform on profitability, Islamic Finance (Sharia-based) refinance scheme capital adequacy, and non-performing loans.23 for Islamic banks. The Bangladesh Bank created They suffer, among other things, from poor this fund with the objective of enhancing the role governance practices, weak internal controls and Box 1: An Approach Framework to State Intervention and State-owned Banks Governments justify state ownership in the financial sector based on various grounds (table 7). A frequently used justification in the academic literature is the effort to address a set of market failures attributable to asymmetric information problems and externalities (World Bank, 2012; Cull, Martinez Peria, and Verrier, 2017). State intervention has also been justified based on its contribution to social goals, specifically by financing projects with negative net present value — but with positive social returns (Levy-Yeyati, Micco, and Panizza, 2004). The justification is that the state has the ability to overcome coordination failures (De la Torre, Gozzi and Schmukler, 2017), or that it can be a way to promote better competition in the financial sector. The recent literature has also identified the important countercyclical and safe-haven role that state-owned financial institutions (SOFIs) can play during financial crises or economic recessions (World Bank, 2012; Rudolph, 2009; Micco and Panizza, 2006; Bertay, Demirgüç-Kunt, and Huizinga, 2015; Choi et al., 2016; Coleman and Feler, 2015; Brei and Schclarek, 2013). Although not frequently reflected in the academic literature, governments have also promoted SOFIs as world-class champions—a matter of national pride and global outreach—or simply as a source of returns through their shareholding position. Nonetheless, evidence on the countercyclical role of banks is mixed (Luna-Martinez and Vicente, 2012; Cull and Peria, 2013) and, if credit allocation is poor, SOFIs’ countercyclical role becomes questionable (Bertay, Demirgüç-Kunt, and Huizinga, 2015; Coleman and Feler, 2015). Several studies also convey the criticisms of state ownership in the financial sector. Agency problems (Shleifer and Vishny, 1998; Iannotta, Nocera, and Sironi, 2007; Dinç, 2005; Acharya et al., 2010, Iannotta et al. 2013) may exacerbate the efficient delivery of financial products and services, damaging banking system performance (Barth, Caprio, and Levine, 2006). These arguments emphasize the need to resolve the underlying market failure directly. For example, credit or collateral information weaknesses should be addressed by strengthening the country’s financial infrastructure, and long-term finance should be promoted by reforms related to capital markets and institutional investors. II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS 12 Table 7: State Intervention Rationales State Intervention Rationale Example (i) Market failures, leading to a lack of competition and SMEs, agriculture, research and development underserved segments. Financing financially profitable (R&D) and capital-intensive sectors. International projects that would not receive financing due to market trade. Long-term finance (including infrastructure). failures (for example, asymmetric information). Broader commercial banking. (ii) Promoting social/ developmental goals. Rural and isolated areas. Financing financially unprofitable projects that are socially valuable. This encompasses socio-economic, environmental and/or other goals. (iii) Countercyclical/ safe haven issues. Financing Labor-intensive sectors. Wide geographic branch financially profitable projects that do not receive presence. Broader commercial banking. financing when private bank risk appetite declines in reaction to recessions. Reduce employment volatility. Provide a safe haven for depositor flight and contagion circuit breaker during a crisis. (iv) Promoting state champions. Promoting the Broader commercial banking. creation of globally relevant institutions as a matter of national pride and global outreach. (v) Enhancing returns. Provide returns to the state Broader commercial banking. as shareholder. SOFIs encompass a broad range of financial intermediaries and can be classified from the purely commercial to the purely developmental. Although trying to categorize state ownership of financial institutions into strict types is difficult, in broad terms one can differentiate among three key types of SOFIs (see Table 8). At the one extreme, pure state commercial banks are practically full-fledged, profit-maximizing, taking deposits from the general public and extending loans directly to the final customers, without a policy mandate. At the other end of the spectrum, pure state development financial institutions operate under a narrow policy mandate. They may not collect deposits and rely on direct lending instruments and the provision of technical assistance. The underlying rationale is important in defining performance expectations. For example, the social goal focus of a state development-oriented institution could emphasize capital preservation rather than profit maximization. In any case, government transfers in support of social goals and their transparency are fundamental to sustainability. Table 8: SOFI Institutional Typologies Typology State Intervention Rationale (i) State commercial banks. They do not have a policy mandate. (i) Return; (ii) Countercyclical/ safe They are profit maximizers with operations practically indistinguishable haven; (iii) Competition; (iv) State from those of private commercial banks. They collect deposits from the champions. public and use them to lend directly to firms and individuals. In many cases, they are universal banks, either directly or through affiliates. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 13 Typology State Intervention Rationale (ii) State hybrid banks. They have a policy mandate. They perform (i) Return; (ii) Countercyclical/ safe commercial banking activities. They collect deposits from the public haven; (iii) Competition; (iv) State and use them to lend directly to firms and individuals. They act as a champions; (v) Market failures; (vi) government agent in administering state subsidies and other programs. Social goals. (iii) State development financial institutions. They have a (i) Market failures; (ii) Social goals; policy mandate. They usually do not take deposits and are funded (iii) Countercyclical. by international financial institutions (IFIs), bonds or government transfers. They lend directly or on-lend to firms in specific sectors (SMEs, exports, agriculture, and so on), as well as deploy partial credit guarantee schemes or other financial instruments. Table 9 summarizes a range of financial instruments. The selection of instruments by SOFIs should depend on the intervention rationale, whereas the structure and degree of institutional development of the country’s financial system is an important determinant. In general, direct lending by state development-oriented institutions should be undertaken according to market segments (for example, client type, location, maturity, underlying security, and so on) not covered by the private sector. Importantly, direct lending requires highly specialized risk management, strong credit underwriting skills, and operational efficiency. However, on-lending by state development-oriented institutions through other financial intermediaries limits the scope for political interference and competition distortion. At the same time, it enables the channeling of a higher volume of resources at lower costs by leveraging the infrastructure of other institutions. Risk-sharing facilities are another indirect and market-friendly means of state intervention, with the additional benefit of further leveraging public resources. In this regard, capacity-building and training programs can increase the sustainability of state financing. Table 9: SOFI Instrument Typologies Typology Benefits (i) Direct lending (also known as first-tier, retail). Targeted approach, used when the ultimate beneficiary Direct provision of finance to the ultimate beneficiary. or location is too expensive for private financial Finance can be a regular loan, leasing, or factoring. intermediaries to serve. (ii) On-lending (also known as second-tier, wholesale, Lower cost and risk management burden. Limited scope apex). On-lending to financial intermediaries for their direct for political interference and market distortion. Can provision of finance to the ultimate beneficiary. Finance can promote competition among private sector participating be a loan, leasing, or factoring. institutions and lead to a higher demonstration effect. (iii) Partial credit guarantee schemes (also known Leverage public resources. Alleviate enterprise as risk-sharing facilities). Offering of partial credit collateral constraints, reduce project risk, and financial guarantees that partially offset loan losses by private intermediary risk aversion. financial intermediaries upon the ultimate beneficiary’s default (for example, infrastructure projects, MSMEs, gender targeting, and so on). (iv) Grants. Direct or indirect (through third parties) Achieve socially desired objectives, ensure equitable provision of grants. income distribution. (v) Other financial products, such as venture capital Typically deployed to develop segments of the capital markets. and equity financing. Targeting seed start-up and early-stage enterprises. (vi) Non-financial products. Offering advisory services, Strengthen financial intermediaries or ultimate beneficiaries, capacity building, and training programs to financial typically complemented by financing. intermediaries or ultimate beneficiaries, or market creation services, such as reverse factoring platforms. II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS 14 risk management practices, as well as significant financed. Donor financing includes multilateral inefficiencies. Importantly, there is little clarity and other bilateral donor partners such as the ADB in defining ownership purpose and rationale, and JICA. The Bangladesh Bank then channels as well as in setting criteria for developmental low-cost funds to SMEs through other partner impact, and commercial and operational success. financial institutions (PFIs), with often prescribed Consequently, any potential for fulfilling a maximum interest rates to be charged by these PFIs developmental role, such as MSME support, to specific targets (such as women entrepreneurs). is significantly undermined. Box 1 describes a It is understood that around 25 percent of the framework for state intervention, its rationales consolidated loan book of the commercial banks is and typologies of state-owned banks and their dedicated to SME loans. This is notable given that instruments of intervention. in many countries this ratio is in the single digits or in the tens. Two evaluation studies of SME finance Effectiveness programs were conducted in 2016 and 2018. They noted that SME sales, profits and employment The Bangladesh Bank’s efforts appear to have increased over 2012-2014.24 The increased SME increased MSME financing. The Bangladesh lending over the same period is mainly attributed Bank’s existing refinancing schemes for SME to commercial banks, although lending from NBFIs lending have been self-financed as well as donor also increased at a higher rate. Box 12: MSME Segmentation and Prospects from a Bank’s Perspective According to the banks, there are 3 distinct segments in the micro and small enterprise lending market. They are as follows: 1. Firms to which banks lend amounts of Tk300 thousand to Tk 1.5 million (US$3.6 thousand to US$17.9 thousand equivalents). These are referred to as micro/ cottage firms. This segment is dominated by the MFIs. Although bank finance could increase maturity, lower rates and formality, there are drawbacks as the operational and supervision costs are high and there are several regulatory restrictions. 2. Firms to which banks lend amounts of Tk1.5 to Tk30 million (US$17.9 thousand to US$358.8 thousand) are referred to as small firms. This is considered a large segment with substantial opportunities. Firms are relatively dominant in their line of business. They include small retailers and suppliers of raw materials. Nevertheless, this segment is also known as ‘the missing middle’ — that is, firms that have difficulty in accessing bank finance because of collateral and other constraints (for example, the lack of proper accounts). They are also too big to qualify for loans from MFIs. Additional constraints to bank finance include being in business for an insufficient amount of time to build a credit history, or operating in rural areas. 3. Firms to which banks lend amounts of Tk30 to Tk200 million (US$358.8 thousand to US$2.4 million) are referred to as emerging small firms. This segment includes the wholesalers, large retail outlets, the large flour and rice mills, oil-ginning mills, and so on. Small firms are usually the suppliers to these emerging small firms that are more involved in the manufacturing sector. Some examples include large distributors of Grameenphone (leading telecommunications operator), BKash (mobile financial services company), and so on. This segment also has access problems, especially in rural and peri-urban areas away from Dhaka. The last two segments, unless under a mortgage, present a significant risk for banks since lending without collateral requires a solid customer assessment. Collateral-free lending is done up to amounts of Tk1.5 million (US$17.9 thousand) (and in exceptional cases of creditworthy customers, up to Tk1.5 million [US$17.9 thousand]). Nevertheless, based on the experience of BRAC, IDLC, and more recently Prime Bank, small and emerging small firms often prioritize the loan repayment. They do so because they place a premium on their bank relationship, as well as to ensure that their Credit Information Bureau (CIB) report remains clean. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 15 Most of the success has been with medium sustainability;26 the high level of bureaucracy in enterprises (that do not, necessarily, face the banks that prevents innovation and risk taking; strongest financing constraints) and most of the lack of market know-how regarding financial the financing that has been provided is short- products in the MSME segment; familiarity term in nature. In some cases, banks may have with paper-based internal activities rather than also circumvented the MSME lending targets by technology-driven, simplified procedures. In accommodating multiple accounts for medium addition, interest rate caps associated with the enterprises. Despite high MSME credit demand low-cost refinancing lines reduce the banks’ and high bank liquidity, few financial institutions incentives to participate, also affecting the credit have embedded MSMEs in their mainstream lines focused on women entrepreneurs.27 business (see box 2). Most banks are also focused Nevertheless, there are cases, such as of Brac on corporate lending based on fixed asset collateral Bank, IDCL, and Prime Bank that have been (that is, land and buildings). Making the shift from more positive in their activities vis-à-vis MSME corporate to SME lending, which is frequently based expansion. These are illustrated in box 3. on movable collateral, represents a considerable cultural change for traditional commercial banks. In addition, most of the financing is short term Policy Recommendations and does not meet the medium to longer term Promote the use of a unified definition at the financing needs of non-trading enterprises in the policy level and improve data collection and manufacturing and industrial sectors. analysis. The MSME definition set by the 2016 The Bangladesh Bank’s policy emphasis on Industrial Policy is already broadly accepted commercial banks for MSME finance does not and should be widely promoted. Improving data appear to be fully internalized. Most banks/ collection and analysis is urgently needed. This NBFIs have complied with Bangladesh Bank’s could entail revamping the SME database that guidelines by opening a MSME Department at was created by the Bangladesh Bank leveraging their Dhaka headquarters, followed by some existing technology solutions. internal and external public relations efforts. Establish a multi-party central coordinating Targets set by the Bangladesh Bank on SME body to promote MSME development and lending appear “indicative”, with no penalties or financing. A pragmatic option would be to assign incentives attached. As such, they would benefit clear responsibilities among the two primary from being more grounded in an analysis of agencies for MSMEs. The SME Foundation under what is achievable. Overall, the banks’ response the Ministry of Industry would focus on research, to the Bangladesh Bank’s efforts may best be overall development policy, and monitoring and characterized as one of passive compliance. evaluation. It will also be important to promote According to industry professionals, the key the formalization of MSMEs, adjust the policy reasons for the underperformance of banks to account for informal MSMEs, and simplify in the MSME market segment include: the business procedures for MSMEs.28 All finance- fear of the unknown (negative perception(s) of related policy and implementation would be under MSME lending, reinforced by an increase in the SME Department of the Bangladesh Bank. A MSME defaults);25 a bank’s desire to be associated coordinating committee/ body would involve other with well-known names in the industry in terms relevant ministries with oversight by the Ministry of their loan portfolios (that is, brand names of Finance or the Prime Minister’s Office. among corporates and institutions); tedious credit Refocus attention on the most constrained among appraisal and operation systems that suit a few big the MSMEs, that is, the ‘missing middle’. Except ticket customers only; collateral-based lending that for the low-end of medium enterprises, most of appears safer than weighing cash flow and business the firms in the medium-size group face a similar II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS 16 Box 3: Lessons of Positive Adaptive Experiences Brac Bank and Industrial Development and Leasing Corporation (IDLC): The two financial institutions are acknowledged leaders in MSME financing. Brac Bank’s MSME asset portfolio reached Tk73 billion (US$873.1 million) and IDLC’s Tk 30 billion (US$358.8 million) by September 2017 (with a non-performing loan [NPL] ratio below 4 percent). They have included MSMEs as a strategic business goal and adjusted their risk functions to the market segment. Each has adopted different structures and processes to suit their competitive advantages in achieving lower costs. IDLC is the largest NBFI in the country. As it cannot offer financial products that larger customers need (such as guarantees, letters of credit, foreign exchange loans, and so forth) due to regulatory constraints, it has invested in the SME and the small enterprise segment. IDLC relies on software. The approval authority lies with the principal branch, whereas the acquisition and other functions are with the local branches (that also have a representative from credit risk management). Expanding geographical coverage is the main challenge for NBFIs serving SMEs, as almost all NBFIs are urban centric whereas the financing gap is higher in rural and semi-urban areas. However, Brac Bank works with hard copies and 60 area credit managers across the country. Its success is attributed to a “go to [the] customer approach”, including agent banking for both secured and unsecured lending to SMEs. Its system is completely decentralized with an equal number of credit document checkers, called hubs or regional operating centers. These centers hold the initial screening process, that is, before a signal is sent for disbursement advice to the principal branch. Both Brac and Brac Bank have developed a very solid reputation in the micro finance space. However, Brac Bank is now contemplating helping micro enterprises to develop into the small (and even into the medium) enterprise space. Although Brac Bank has struggled with this new orientation, they now appear to be experiencing excellent growth in their SME portfolios — with surprisingly low levels of non-performing assets. They are now committed to ensuring that 50 percent of their loan book is focused on SMEs in Bangladesh (presently they are at 41 percent). One issue of concern that remains, however, is the major focus on trading companies rather than manufacturing, industry, and value-added services. Prime Bank: The bank made a strategic shift in 2016 to increase its MSME portfolio share. It adopted policies and guidelines, along with a well-crafted MSME vision, organizational structure, and suitable human resources. The bank established a special unit (the MSME Banking Division), and launched a MSME enabling End2End credit delivery process, standard operating procedures and customized product program guides. It hired MSME banking professionals, relationship managers, credit analysts and collection executives. The MSME relationship managers were deployed in selected business hubs, identified as ‘core MSME markets’. The bank also established ‘Credit Processing Hubs’ in 7-8 key locations across the country. Within a year, the bank’s MSME portfolio grew by Tk 5.2 billion (US$62.2 million). The bank’s vision is to position itself as the ‘Best MSME Bank in Bangladesh’ by 2020. In this context, further investments and changes in the areas of staffing, technology, policy, processes, products, and distribution are in progress. Prime Bank has had a significant demonstration effect, and other leading banks (such as City Bank, UCB and Dutch Bangla) have also started to invest heavily in the MSME segment. Source: PRI (2017) environment to that of the large enterprises. This at the program level, as a re-definition of MSMEs distorts policy efforts, such as the Bangladesh would, once again, disrupt the available information Bank’s financial schemes, thereby reducing their base that should guide decision making. impact. Additionally, safeguards must be put in place Undertake an evaluation of past schemes and to prevent the use of multiple accounts by the same the Bangladesh Bank’s guidelines to inform firm and/or use of accounting techniques by large future MSME finance policies. There is a need firms to access financing facilities targeting MSMEs. to assess these schemes and guidelines, as well as One option is to focus policy on micro and small to draw lessons to better formulate future schemes enterprises, with some adjustment for the low-end of and strategies. The authorities should consider the medium cluster. However, this should be focused FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 17 expanding the use of market-oriented solutions data. The registry’s mandate should include to leverage private sector capital (such as partial movable collateral. In addition, the Secured credit guarantee schemes, see Section F). Transactions Law needs to be enacted. To overcome difficult and costly insolvency and debt resolution Clarify the long-term goals of the government challenges, the authorities should amend the and the mandates and objectives of the state- Small Cause Courts Act, codify and operationalize owned financial institutions. The authorities mediation within the Money Loan Courts and the should consider undertaking an in-depth study general courts, and institutionalize Alternative regarding the role of state intervention in the Dispute Resolution mechanisms. Payment systems financial sector. Irrespectively, policy makers hold promise in expanding MSME financial access should also improve corporate governance through the DFS. To achieve deeper and broader arrangements, strengthen the capacity of the penetration of financial services, the Bangladesh Ministry of Finance’s Bank and Financial Bank needs to review its strategy and policy Institutions Division (BFID) to act as owner, relating to DFS and making the eco-system more focus efforts on development (including MSMEs) supportive of the growth of Fintech. and undertake the necessary restructuring. As state-owned financial institutions strengthen, the Bangladesh Bank should migrate financing Credit Reporting schemes to these institutions, thus avoiding Credit reporting addresses asymmetric any perceived conflicts of interest as regulator, information issues in determining the supervisor and on-lender to financial institutions. borrowers’ repayment capacity, as well as their willingness to repay loans. Information The Financial Infrastructure Gaps asymmetries may lead to adverse selection, credit rationing, and moral hazard problems. Annex Addressing financial infrastructure weaknesses 5 describes the General Principles for Credit is critical. The quality of financial infrastructure Reporting Systems, a core set of general principles determines the efficiency of intermediation, as to guide credit reporting systems developed by well as the ability of lenders to evaluate risk and the World Bank, with support from the Bank for of borrowers to obtain credit, insurance and other International Settlements. financial products at competitive terms. The credit bureau coverage should include all commercial The World Bank Group’s 2018 Doing Business loans, regardless of value, and mine all available Table 10: Efficiency of the Bangladesh Regulatory Regime, 2018 — Getting Credit South Sri Asia Best Getting Credit Bangladesh China India Indonesia Pakistan Lanka Vietnam (average) Performer Strength of legal rights 5 4 8 6 2 2 8 5.3 12 index (0-12) Depth of credit information 0 8 7 6 7 6 7 4 8 index (0-8) Credit registry coverage 0.9 95.3 0 55.3 9.9 0 51 3.8 100 (percent of adults) Credit bureau coverage 0 21.4 43.5 18.3 6.7 35 19.7 14.1 100 (percent of adults) Source: Doing Business 2018, International Finance Corporation. II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS 18 survey ranks Bangladesh at number 159 (of there is no private sector credit information 190 countries) for ‘Getting Credit’ (a measure provider, as in many other countries. The of credit information sharing and legal rights of experience of India is especially useful in this borrowers and lenders). This puts Bangladesh regard. It is a good functional example of a private behind regional comparators, such as India (at 29), sector-led CIB (see box 4). Sri Lanka (at 122) and Bhutan (at 77). The poor The Bangladesh Bank should also work with performance stems from low scores in three key other institutions to help mine all available data indicators (table 10) related to the depth of credit to strengthen credit information relevant to information (with a score of 0 as compared to 8 for MSMEs. MFIs, utility, trade credit data, retailers China),29 credit registry coverage (with 0.9 percent and telecommunications companies are significant of adults versus 95.3 percent for China), and credit sources of data. Such data can be used to assess bureau coverage (with 0 percent of adults versus behavioral patterns for existing MSMEs, as well 21.4 percent for China). as new entrants. Credit bureau coverage should include all Allowing private firms and individuals to access commercial loans, regardless of value, to benefit credit information would also be a positive MSMEs. The Bangladesh Bank established step. Changes in the Banking Act to allow the a Credit Information Bureau (CIB) in 1992, Bangladesh Bank to share credit information which, according to the 2015 policy guidelines, with other/third parties would serve two valuable is responsible for the collection, processing functions. First, retailers would be able to judge and maintenance of an updated database of the creditworthiness of customers based on past credit information supplied by participants and lending history, rather than traditional (and less institutions that extend credit. Nevertheless, while accurate) metrics, such as family connections CIB reports have been particularly helpful for the or previous transactions with that firm. This is relatively larger and corporate enterprises, the particularly important for retailers of high-value majority of MSMEs are still not included in the goods, such as automobiles. Second, individuals CIB list. The thresholds for the loans included in could access their own information. This would a credit bureau’s database are high, and retail and allow borrowers to check and confirm the accuracy small business loans are also excluded.30 Notably, Box 4: India’s Experience with Private Sector-led CIBs The credit information companies in India are led by the private sector. The Credit Information Bureau (India) Limited, commonly known as CIBIL, was incorporated in 2000 and launched its operations in 2004. It maintains records submitted by registered member banks and other financial institutions on a periodic (usually monthly) basis. Based on this data, the CIBIL issues credit reports and a credit score. Shareholders in CIBIL include TransUnion International (a global credit bureau provider), the ICICI Bank, the State Bank of India, the Indian Overseas Bank, HSBC, the Union Bank of India, the Bank of India, the Bank of Baroda, and Allahabad Bank. CIBIL has two focus areas, namely a Consumer Bureau that deals with consumer credit records and a Commercial Bureau that deals with the records of companies and institutions. Following the enactment of the Credit Information Companies (Regulation) Act in 2005, three other Credit Information Companies (CICs) were licensed in 2010, namely, Equifax, Experian and CRIF Highmark. There are currently efforts underway to further reform the credit information industry, specifically by increasing the coverage of the credit information business. This would be accomplished by allowing alternate data sources to be collected, establishing a credit registry for supervisory and financial stability purposes, and putting in place best practices for CICs and credit institutions. Source: PRI (2017) FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 19 of the data and, if necessary, to have it corrected. registration system of security interests, require significant improvements. Secured Transactions and Collateral The expansion of the registry’s mandate to Registries include movable collateral could increase Modern secured transactions laws and collateral financing to MSMEs.31 Most small enterprises do registries can increase the availability of credit not have immovable assets to present as collateral.32 and reduce its cost. Collateral provides the basis Challenges related to the development of the for free-flowing credit markets, reducing the movable collateral registry include: (i) the lack of an potential losses lenders face from non-payment. adequate legal and regulatory framework for secured Whereas land and buildings are widely accepted lending against movable collateral;33 (ii) limited as collateral for loans, the use of movable assets availability of movable finance products across the (such as inventory, accounts receivables, livestock, financial sector, as well as in conducive regulation crops, equipment, machinery, and shares) as to support movables-based lending; (iii) a relatively collateral for loans tends to be restricted by the lack limited understanding of secured lending reform of a legal and institutional framework for secured and its importance; and (iv) a credit bureau that still lending and collateral registries. Reforming the needs significant upgradation and capacity building. framework for movable collateral lending would The draft Secured Transaction Law (STR) was allow businesses (particularly SMEs) to leverage presented and accepted in principle in March 2017 their assets into capital for investment and growth by a Monitoring Committee with representatives of (see box 5 for some international examples). BFID and the Bangladesh Bank. There is a consensus and commitment to obtain Cabinet approval of the Loans in Bangladesh are primarily secured STR Law in 2018, and for the Ministry of Finance to through property-based collateral, but face then present the law before Parliament. Furthermore, a challenge regarding property rights — Bangladesh does not have a secured transaction particularly in the lengthy and sometimes non- register, although various development partners transparent process linked to establishing a land have assisted in the drafting of a law to facilitate the title. Discrepancies and uncertainties in the legal formation of such a register. framework governing security rights, as well as shortcomings in the institutional framework of the Box 5: International Examples of Successful Secured Transaction Reforms Colombia: The country enacted a new Secured Lending Law in 2013 and a new centralized collateral registry in 2014. As a result, more loans were registered in six months than in the previous 30 years. More than 58,000 loans were registered with a value of more than US$10 billion. China: The country enacted a legal reform (2007) and a new centralized online registry for accounts receivables and leasing (2008). This resulted in more than US$6 trillion in financing with receivables (mostly to SMEs), as well as the development of the factoring and leasing industries. Vietnam: The country enacted a legal reform and new centralized online registry (2012). As a result, 400,000 loans were granted to more than 215,000 SMEs and 15,000 microenterprises. The total volume of financing through the registry is US$13.7 billion. Mexico: The country enacted a legal reform and a new centralized online registry (2011). Over 150,000 loans were registered for a total secured amount estimated at over US$200 billion. Loans secured with movables multiplied by a factor of four, with 45 percent in the agricultural sector and 95 percent in the SME sector. Businesses have also saved US$4 billion in fees. Source: De la Campa, A. (2015) “Secured Lending and Collateral Registries: A global perspective”, World Bank Group Presentation, Dhaka II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS 20 Insolvency and Debt Resolution of out-of-court mediation settlements that can be handled by an institution such as the BIAC, for Ineffective debt recovery and weak mechanisms example. Only the court enforcement of arbitration for business exits create a higher cost of capital awards is currently regulated. However, arbitration and heightened perception of risk among is often equally lengthy and expensive as in regular investors and financial institutions alike. Well- court proceedings. Therefore, it does not cater to functioning legal, regulatory, and institutional the specific needs of MSMEs. frameworks are crucial for commercial banks and companies. Specifically, they are needed to To settle disputes involving small claims resolve non-performing loans, facilitate business or recover of loans to small enterprises, exits as well as reorganizations, settle commercial Bangladesh has the Small Cause Courts Act, disputes, and collect debts. Legal and regulatory 1887 (Act No. IX of 1887), but there is a need frameworks that inhibit corporate restructuring for amendments. This could be the court system prevent many viable businesses in financial through which smaller denomination defaulting distress from continuing to function as ongoing debts could be adjudicated, if the process is simple concerns when they are in a state of insolvency. and straightforward. As evident from Section 23 of the Act, there are limitations to its ability, if Notwithstanding several legal mechanisms the title of immovable property cannot be proved. currently in place, loan recovery, insolvency Thus, there may be a need for amending the Small resolution and contract enforcements are, Causes Courts Act 1887, particularly to settle in practice, very difficult and involve high commercial disputes and default credit recovery transaction costs in terms of both time and with simpler and least-cost processes. Bangladesh resources. The legal mechanisms include: (i) could also consider the procedures and scope the Artha Rin Adalat (Money Loan Court) Act of what is known as a Small Claims Court (as of 2003;34 (ii) the Arbitration Act of 2001 for found in Australia, Kenya, Singapore, the United out-of-court resolution of commercial disputes Kingdom and the United States, for example), through arbitration; (iii) the privately provided with jurisdiction encompassing private disputes and institutionalized ADR mechanism provided that do not involve large amounts of money. by the independent Bangladesh International Arbitration Center (BIAC); and (iv) the procedure Institutionalizing Alternative Dispute for contract enforcement under the Civil Procedure Resolution mechanisms for commercial Code. Nevertheless, the World Bank Group’s dispute settlement could also help address the Doing Business 2018 report ranks Bangladesh concerns voiced by the private sector regarding at number 189 (out of 190 countries survey) for inadequate, inefficient and lengthy contract enforcing contracts, and number 152 for resolving enforcement processes. An ADR institution insolvency. It also estimates that loan recovery would encourage new investments and help rates are low, at 28.3 cents on the dollar.35 to extricate existing investors from business- hindering litigation. A debt resolution intervention A Small Claims Court could lead to faster could also have a significant impact on improving adjudication with lower costs for cases loan recovery rates. There is an ongoing IFC relating to MSMEs; it is important to codify project on debt resolution in Bangladesh which and operationalize mediation within both assisted with the creation of the first Bangladesh the Money Loan and general courts. Court- ADR Center, the BIAC.36 The next phase of the connected mediation is envisaged as an option project with the BIAC, the Ministry of Law and under both of these procedures, but it has not been other stakeholders aims to incentivize the use operationalized because of lack of implementing of arbitration for bank commercial contracts, rules and capacity within the judiciary. Out-of- including the use of mediation for debt recovery court mediation is virtually nonexistent because actions (before applying to a Money Loan Court). there are no legal provisions for the enforcement FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 21 Payment Systems users of mobile banking accounts as of June 2016, cash remains the predominant form of payment Payment systems form a vital part of used in financial transactions. A 2013 survey on the financial system enabling funds to be “Payment Mechanisms in Bangladesh” indicated transferred between and among people and that there are issues with the EFT and online institutions. Secure, affordable, and accessible banking, including technical glitches, such as payment systems and services promote economic network and server failures and the high volume development, support financial stability, and of fees, especially for those firms that use EFT help expand financial inclusion.37 A transaction frequently for letters of credit. In addition, the account held with banks or other authorized and/ value of transactions through MFS in Bangladesh or regulated payment service providers allows was only 5.6 percent of GDP in 2015, far lower individuals and businesses — in particular, compared to Kenya at 55 percent. BKash, a MSMEs — to perform most, if not all, of their subsidiary of BRAC Bank, has been a pioneer in payment needs (such as making and receiving this area. However, Bangladesh has yet to reach its payments), and to safely store some value. It full potential in implementing an effective digital can also serve as a gateway to other financial financial service (DFS). The legal and regulatory services. Globally, electronic payment solutions structure is restrictive by only allowing a bank- have contributed to expanding MSME access to led model, which has helped BKash innovate and credit because of the creation of a digital footprint grow toward the formation of a virtual monopoly. for MSME transactions. This history can be used to assess MSME creditworthiness. In addition, Small enterprises tend to rely heavily on cash, e-commerce has the potential to help the MSME with cash accounting for 72 percent of all sector grow. payment transactions in a given year. On the other hand, checks only comprise 24 percent of The Bangladesh Bank has made significant all payment transactions, EFT 3 percent, and only advances toward the development of a digitized 1 percent is made through cards, courier, mobile payments system. Importance was given to banking and telephone transfers.38 Business implementing newer payment platforms, that is, payments are typically categorized as either: the National Payment Switch (NPS), an e-Payment (i) Business to Business (B2B), such as for the Gateway and Real Time Gross Settlement purchase of goods and services, sales receipts, (RTGS), while also upgrading the required legal office rent, transportation, utilities costs, security, and regulatory framework befitting the electronic and stationery; (ii) Business to Government (B2G), payment platforms. It currently has in place the such as for fees, value-added tax (VAT) and taxes; Bangladesh Automated Clearing House (BACH), and (iii) Business to Others (B2O), including for the first ever electronic clearing house. The system salaries, services, consultants, and casual labor. has two components, namely the Automated In Bangladesh, checks are predominantly used Cheque Processing System (ACPS) and the for all categories of business payments, as well Electronic Funds Transfer (EFT). as for 95 percent of B2G payments. A large share The Bangladesh Bank has also encouraged of B2B payments (32.3 percent) is made through the development of Mobile Financial Services EFT, which typically pay for purchases of goods (MFS), with the objective of expanding access through international Letters of Credit using to banking services and expediting the delivery the Society for Worldwide Interbank Financial of remittances; however, there are challenges. Telecommunication (SWIFT). The current challenge will be to transform this mobile-payments system into a mobile-financial Policy Recommendations system with a broader range of financial services Improve the credit information infrastructure, being offered electronically. Despite 32.2 million expanding the reach of the CIB. Credit bureau II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS 22 coverage should include all commercial loans, key. The Bangladesh Bank has also been ushering regardless of value, to benefit MSMEs. MFIs in regulatory changes, and has issued directives and telecommunications companies could be to the banks for starting e-Commerce activities. significant sources of data to assess behavioral These can be revisited to lower transaction costs. patterns (for both existing MSMEs and new entrants). The Bangladesh Bank should consider Exploring Innovative and allowing credible privately-managed credit Alternative Financing Options reporting systems, while ensuring effective regulation and oversight by the Bangladesh Bank Several innovative and alternative financing or other relevant authorities. options that are currently unexploited hold promise. Appropriately designed and governed Enact a law and establish a secured transaction risk-sharing facilities can help to de-risk MSME register. Pursue efforts to establish a secured lending decisions. As the necessary enabling transaction register, with a legal framework for environment and financial infrastructure improves secured lending addressing the fundamental and digital technology develops, factoring and features and elements for the creation, recognition, warehouse receipt finance are likely to become and enforcement of security rights for all types viable solutions. Public policy can also help to of assets. This would encompass movable and reduce the risks associated with start-up capital. immovable assets and tangible and intangible assets— including inventories, receivables, Risk-sharing Facilities proceeds, and future property. On a global basis, it would also include both possessory and non- A majority of countries around the world have possessory rights. established risk-sharing facilities (RSFs) to partially cover the risks of MSME lending — and Establish a Small Claims Court and help de-risk lending decisions by commercial institutionalize ADR mechanisms. Review banks. A RSF provides third-party credit risk and amend the Small Cause Courts Act 1887, mitigation to lenders through the absorption of a adjudicating for small claims disputes between portion of the lender’s losses on the loans made banks/ financial institutions and micro and small to SMEs in case of default in return for a fee. A enterprise borrowers. Establish a Small Claims well-functioning RSF can contribute to MSME Court with a maximum monetary limit to the finance in a market-friendly way by sharing risks amount of judgments it can award. Institutionalize with financial intermediaries and encouraging ADR mechanisms for commercial dispute the development of appropriate market segment settlement, which will also help with inadequate, lending and risk management technologies. It can inefficient and lengthy contract enforcement also help to alleviate the collateral constraints of processes. MSMEs. Promote an effective payment system and A RSF can also be complex in design and financial infrastructure to support the rollout implementation, as well as subject to moral of DFS. The Bangladesh Bank needs to review hazard if operating in an environment its strategy and policy relating to DFS, including characterized by poor governance.39 There making the eco-system more supportive of Fintech are multiple design options with significant growth. A critical element will be to promote access implementation impacts. These include the to finance through Fintech, as well as having in management structure, the operating rules, and place an effective payment system. The creation guarantee characteristics. Just as with other of a payments and financial infrastructure that will instruments of state intervention, weak governance continuously improve the enabling environment can result in resource misallocation, along with to facilitate lending and uptake of DFS would be market distortions. Critical design choices, FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 23 Box 6: Credit Guarantee Schemes in India and Thailand India: The Government of India instituted “the Credit Guarantee Fund Scheme for Micro and Small Enterprises (CGS)” to provide collateral-free credit to the micro and small enterprise sector. Both existing and new enterprises are eligible. The Ministry of MSMEs, the Indian Government and the Small Industries Development Bank of India (SIDBI), established a Trust to implement the CGS: Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE). It was formally launched in August 2000. The funding is provided by the Government and SIDBI with a financing ratio of 4:1, respectively. The total funding was amounted to Indian Rupees (Rs.) 25 billion (US$358.3 million) until May 2016, with 24,31,490 approved proposals from micro and small enterprises for an aggregate credit amount of Rs.11.35 billion (US$162.7 million). Eligible credits are term loans and/or working capital facilities up to Rs.10 million (US$143.3 thousand) per borrowing unit, extended without collateral and/ or third-party guarantee. The maximum guarantee is 85 percent and varies by size and development considerations. For example, the guarantee is 75 percent for credits up to Rs.5 million (US$71.7 thousand); 85 percent for credits to microenterprises up to Rs.500 thousand (US$7,166) provided; 80 percent for micro and small enterprises owned/operated by women; 80 percent for all loans to the Northeast Region, including Sikkim; and 50 percent if the credit amount is between Rs.5 and 10 million (US$71.7 thousand to 143.3 thousands). The tenure is a block of 5 years, if working capital facility on standalone basis is covered under the Credit Guarantee Scheme. The annual guarantee fee is an all-in of 1.0 percent per year. This is reduced for preferred creditors: 0.75 percent for a credit facility of up to Rs.500 thousand and 0.85 percent for amounts between Rs.500 thousand and 10 million for women, microenterprises and units in the Northeast Region, including Sikkim. To support startups, India is also proposing a scheme that will provide up to 80 percent risk cover for loans of up to Rs.50 million (US$716.6 thousand) without collateral. Thailand: The Small Industry Credit Guarantee Fund (SICGF) was established in 1985 and was renamed the Small Business Credit Guarantee (SBCG) in 2005. It is a state-owned specialized financial institution under the supervision of the Ministry of Finance, and the only credit guarantee institution in Thailand. It has a registered capital of Baht 4.4 billion (US$136 million equivalent). The Shareholding Structure is as follows: the Ministry of Finance holds 93.18 percent; the Private Banks 2.50 percent; the State-owned Banks 1.53 percent; the Government Savings Banks 1.44 percent; The Industrial Finance Corporation of Thailand 1.08 percent; and the Small and Medium Enterprise Development Bank of Thailand 0.27 percent. The Guarantee Fee is 1.75 percent per year of the guaranteed amount, paid in advance, and collected by lenders remitting it to the SBCG. The maximum limit of the outstanding guarantee is five times the capital (that is, Baht 22 billion [US$680.1 million]). Source: PRI (2017) such as the responsibility of loan assessment suffered from severe moral hazard and significant and recovery, the coverage ratio, pricing, claim losses. The Bangladesh Export Credit Guarantee processing, capital relief of the guarantee, and so Scheme (ECGS) presents a more positive on, can influence the developmental impact and experience.40 (See also box 6). Since 1978, this the sustainability of the scheme. These choices government program has been implemented at can potentially have fiscal and financial stability the initiative of the Export Promotion Bureau repercussions as well. and the ministries of commerce, industry and finance. The scheme encourages exporters to Bangladesh had tried to launch guarantee initiate exports of new products and/or to enter schemes through various state-owned banks new markets by covering the risk of insolvency (SOBs), but these have faced significant of buyers — in addition to political risks inherent governance problems. The SOBs did not perform in foreign trade.41 The scheme also provides a the appropriate due diligence, and the schemes SECTION TITLE 24 guarantee for bank loans taken by the exporters Alternative financial instruments for meeting their financial needs during the production time, as well as between the exporting A range of alternative or innovative pre-bank of goods and the receipt of payment from foreign financing options have emerged to support buyers. The Sadharan Bima Corporation, a state- young and dynamic firms reach the bankable owned general insurance enterprise administered stage.42 In factoring, an enterprise receives funds the scheme. However, it is currently inoperative. from a specialized institution (factor) by selling The government is now planning to create another its accounts receivable at a discount. In purchase fund similar to the ECGS, as mentioned in the order finance, an enterprise obtains financing “Export Policy 2015-18”. It is expected to provide for inputs to meet the order against the strength rapid financial compensation for incurred losses of its purchase order against agreed fees and by exporters. service charges. In warehouse receipt finance, the loan is secured by commodities deposited at a With support from IFC in 2017, the Bangladesh certified warehouse, and the commodities cannot Bank agreed to design a targeted RSF to be released until the loan is repaid. In leasing, an address the collateral issues faced by women enterprise secures the right to use machineries entrepreneurs in the SME segment. The and equipment for a specified period by paying scheme design will leverage the WBG’s extensive a rental fee. In securitization, a bank packages experience with public-sector RSFs and ensure MSME loans into a portfolio and sells that the scheme mitigates moral hazard concerns. portfolio to capital market investors (reducing its It will also ensure that it has sufficiently strong risk and increasing liquidity). In crowdfunding, an governance. The Bangladesh Bank will pilot the enterprise raises funding from a large number of RSF with seed funding from the United Nations individuals in the same spirit as social marketing Capital Development Fund. (typically using the Internet to mobilize donations, equity or debt). A mezzanine finance operation At the private sector level, BRAC Bank and the combines two or more financing instruments and Development Credit Authority of the United sells it to an investor as a single entity. A venture States Agency for International Development capital operation involves equity participation (USAID) have been involved in an on-going by wealthy individuals in enterprises regarded as credit guarantee scheme project since 2014. having high potential. Since the investor assumes This is targeted toward 20 underserved districts in a high level of risk, the internal rate of return on the southern part of Bangladesh. For an annual fee investment projects tends to be very high (on the of US$13,000, the agency covers 50 percent of the order of 20-25 percent). Business angels are a BRAC Bank’s agri-business loans. The guarantee variant of venture capital. They typically involve scheme has encouraged BRAC Bank to expand in a high net-worth individual who provides equity areas of perceived high risk. finance to start-up companies (with no family Lessons should be drawn from past and connection) in return for company shares. ongoing experiences with risk-sharing facilities For all such operations, the most important success to design a scheme that responds to market factor is the enabling environment, which is still needs. The current MSME financing landscape under development in Bangladesh. An efficient (and ‘the missing middle’, in particular) lacks regulatory and legal system that preserves the an appropriate incentive mechanism for financial sanctity of a contract by ensuring its enforceability institutions to sustainably scale up their lending is critical. Proper documentation and digitized to this market segment. If appropriately designed, record keeping is also necessary. Without these from specific mandate to independent governance, pre-requisites in place, the risks of fraud are very such a scheme could be a catalyst to expanded high — especially for crowdfunding and angel- MSME financing. funding types of initiatives.43 There are numerous FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 25 examples in Bangladesh of fraudulent practices organized non-bank startup financing options for with high losses for small investor funds. As a small enterprises are very limited. There have result, such efforts are approached with suspicion. been some efforts by private enterprises to develop equity financing options, but these initiatives have As the financial infrastructure improves had limited success (ADB 2014).44 In addition to and digital technology develops, asset-based the absence of an enabling financial infrastructure solutions, such as factoring and warehouse and the lack of regulations for the venture capital receipt finance, are likely to become more (VC) industry, a major problem is the reluctance of attractive. The Bangladesh Bank recently enterprise owners to seek equity financing for the launched an online consultation regarding draft fear of losing control over ownership. Additional guidelines on factoring, which are being discussed challenges include the inability to conduct with legal experts and major stakeholders. proper due diligence, the limited availability of Presently, the guidelines are under finalization for quantitative and qualitative information on SMEs, approval. A feasibility study and other technical and different perceptions of company valuations studies are also planned for warehouse receipt between SMEs and VC firms. financing under the World Bank’s Financial Sector Support Project, which is being implemented by Supporting the start-up space could contribute the Bangladesh Bank. Leasing is in active use, but significantly to supporting new, innovative more it is focused mostly on the upper-end of medium dynamic, and growth-oriented firms. It could and large enterprises. also help the SME sector diversify from “trading” to more value-added activity (such as industry, Start-up capital is much needed, but still manufacturing, and value-added services). New absent. Bangladesh has several large firms in the start-up enterprise finance support could help RMG sector at the top end, but few firms in the in areas such as ICT, mobile-apps/applications, middle range. Microenterprises have benefited tourism, pharmaceuticals, tourism, and so on. from the microfinance revolution. However, Box 7: The United States Small Business Investment Company (SBIC) SBIC is a private company that is licensed by the Small Business Administration (SBA) to provide investment funding to small businesses in the form of debt and equity. SBA supports qualified SBICs by providing funds for approved lines of business. The SBA provides US$2 for each US$1 placed by a SBIC. A typical SBIC loan ranges from US$250,000 to US$10 million and entails interest of 9-16 percent. Equity financing involves joint ownership between the SBIC firm and the business receiving equity financing. Equity participation could range from US$100,000 to US$5 million. A combination of debt and equity financing involves a joint partnership and loan rates of 10-14 percent. The volume of funding is in the range of US$250,000 -US$ 10 million. Part of SBA’s funding relates to the Early Stage Innovation and Social Impact Programs. The former is designed to support companies in the earliest stages (before the company has a significant cash flow or asset base) and financing ranges from US$1-4 million. The latter is designed to provide funding for businesses that have at least 35 percent of employees residing in low- or moderate-income areas, or that operate in the clean-energy or education sector. From 2011 to 2015, SBIC-licensed funds invested US$21 billion in more than 6,400 companies, 20 percent of them located in low- to moderate-income areas. A majority of SBIC-licensed capital went into states other than California, New York or Massachusetts. Evidence also shows that the SBIC program funded more women and minority-led companies than a standard private equity fund. Apple, Intel, FedEx, Costco, Staples, and even Build-a-Bear, are just a few of the companies that received early stage investment from a SBIC license holder. Source: PRI (2017) II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS 26 Public policy can help reduce the risks Several enabling factors are critical to associated with this market segment. Examples the success of Fintech, and the regulatory include the Small Business Investment Company environment is particularly important.46 The (SBIC) supported by the SBA in the United States main regulatory issues center on financial stability, (Box 7) and the Youzma Fund in Israel. Learning prudential regulation, conduct and fairness, and from these experiences, Australia, Canada and competition and development. Ensuring a level countries in Western Europe have also established playing field between market players, banks and similar support institutions. There is already a Fintech remains a key challenge. From a risk good experience in Bangladesh pioneered by the perspective, the traditional risks pertaining to Industrial Development Leasing Company (IDLC), the underlying product remain, whereas some the largest NBFI. The IDLC uses Bangladesh Bank risks have increased, such as money laundering/ refinancing money to finance start-ups and micro financing of terrorism, data privacy and consumer and small enterprises at low interest rates.45 The protection. IDLC could consider establishing similar windows The fact that many of these developments as the SBIC, attracting donor and government are rapidly evolving, coupled with the lack of funding to provide market incentives for financing adequate analysis, raises the question of when NBFIs that are willing to provide start-up financing. and how to regulate. Several central banks and other regulators are establishing regulatory Fintech Solutions sandboxes to encourage experimentation and Technology is transforming the global economy allow regulators to become more familiar with and MSME financing. Fintech companies (a the innovations. With this knowledge, they can short form for the use of technology in financing better assess the risks and calibrate the regulatory solutions, and increasingly used interchangeably frameworks. For example, the People’s Bank of with DFS) hold a promise of providing a new China and Bank Negara Malaysia are establishing set of products tailored to the needs of smaller regulatory sandboxes to encourage and guide businesses. The main use cases of Fintech innovations. Some countries are going further and are provided in annex 7. Fintech companies establishing innovation hubs and accelerators. have emerged with innovative solutions that In this context, the Central Bank of Mexico has can substantially improve efficiencies at each established an innovation hub, and there are also step of the lending process, including loan efforts being made to develop a new legal and origination, underwriting, disbursements and regulatory framework for Fintech companies. collections, along with service and monitoring. Both China and the United Kingdom (UK) have Marketplace (peer-to-peer) lending provides sought ways to preserve financial stability, while credit to MSMEs through online platforms that providing an enabling environment for Fintech match lenders (savers, investors) with borrowers. companies to work in a competitive environment. It has significant advantages in terms of speed, In the UK, the Financial Conduct Authority has convenience, and terms (for example, no collateral established an Innovation Hub. In Singapore, the needs). Technology platforms for invoice and Monetary Authority of Singapore has earmarked value chain finance can streamline processes, S$ 225 million (US$165.2 million equivalent) allowing, for example, small business owners to for research to support the growth of Fintech directly connect their accounting software to the solutions. Also, the Australian Securities and invoice finance platform, apply for a loan, and Investments Commission has created open office receive payment almost instantly. Access to credit hours to support Fintech. Finally, in several can also be expanded using the digital footprint African countries (for example, Kenya presented created by MSME transactions using e-commerce in box 8, or Senegal), the regulators have been or e-payments to assess the borrower’s very supportive, allowing a domestic Fintech creditworthiness. industry to blossom. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 27 The International Monetary Fund and the of electronic money transfer operations (Ahmed World Bank Group launched the Bali Fintech 2017).47 The Bangladesh Bank has also begun Agenda in October 2018. It is a set of 12 policy making regulatory changes and issuing directives elements aimed at helping countries to harness to banks for starting e-Commerce activities. the benefits and opportunities of rapid advances Successful MFS providers include Bkash of in financial technology that are transforming BRAC Bank and Rocket of Dutch Bangla Bank the provision of banking services, while at the Limited, and a number of other new players are same time managing the inherent risks. Agenda emerging.48 These include CloudWell, founded in topics covered relate broadly to enabling Fintech, 2012, which offers several payment solutions under ensuring financial sector resilience, addressing its brand name. PayWell offers prepaid debit cards, risks, and promoting international cooperation payment gateways, and point-of-sale systems. It (see annex 7). has a network of more than 5,000 retail shops, and In Bangladesh, the rapid growth of ICT services its main customers include big enterprises across has led to the growing use of technology for the the financial services, telecommunications, and delivery of financial services. Banks and NBFIs e-commerce industries. SmarTKompare, launched have adopted ICT for a range of services, including in 2015, lets users compare financial products from e-banking. Several NBFIs, such as IDCL, are numerous financial institutions (including loans, using technology to simplify loan applications and insurance, credit cards, and deposits). Projekt. approvals using online transactions. The spread of co, launched in 2015, is a platform that provides mobile phone ownership (and the growing use of innovators, artists, and change-makers with the smart phones) has supported the rapid growth of opportunity to raise funds from their friends, family mobile financial services (MFS). The Bangladesh and the community. SureCash provides mobile Bank defined the regulatory policies for MFS in banking and mobile payment network solutions, 2011, and the response has been positive in terms connecting people, banks, and businesses. It works Box 8: Kenya’s Success with Fintech companies Kenya has emerged as a Fintech hub in emerging markets, with M-Pesa’s success spurring several innovative digital financial products. M-Pesa, led by the telecoms giant Safaricom, revolutionized financial inclusion by offering a broad range of financial services (including deposits, loans, money transfers and e-payments for services). Over 85 percent of the adult population uses such services regularly to pay for products and amenities, such as household bills and school fees — with only 38 percent using a traditional bank account. Spurred by the success of M-Pesa, many Fintech companies have sprung up, including companies that offer MSMEs small loans through mobile phones within a matter in seconds. Others facilitate digital payments and smallholder farmers to purchase insurance for their crops. Several factors explain this success. First, in recent years, there has been an expansion of innovation hubs that are helping new Fintech companies to both start and grow. Incubators such as iHub, the Nairobi Garage, m-lab and Nailab offer low-cost, collaborative opportunities for start-up companies to share and refine their ideas. Second, the financial regulator has played a strong supportive role in providing an enabling environment for the growth of Fintech companies. This has been done without any restrictions on entry or requirements that these initiatives be led by a bank. Indeed, the traditional financial institutions have taken a back seat in this endeavor. Third, Kenya has undertaken reforms to simplify and deregulate the business environment for the private sector. For example, Doing Business year? ranks Kenya at 80 (of 190 countries), improving rapidly from a rank of 129 in 2014. Finally, the availability of fixed telecommunications infrastructure and the rapid adoption of smart-phone use played a strong enabling role for the users of Fintech services. Source: Blythin and Cooten 2017. II. MSME POLICY, FINANCIAL INFRASTRUCTURE GAPS AND ALTERNATIVE SOLUTIONS 28 with 6 local banks, 350 payment partners and over Pursue the necessary legal and infrastructure 41,000 retail agents. Finally, UCash of the United needs for the introduction or expansion of Commercial Bank Limited is a mobile financial alternative finance. The Bangladesh Bank should service. An increasing number of banks are continue its efforts to promote factoring and providing online Internet banking. E-commerce warehouse receipt financing. The authorities could is also growing with chadal.com, dugdugi.com, also support start-up capital financing and its bikroy. Ride-sharing cabs, such as BD cabs, have ecosystem. Furthermore, the IDLC experience can also emerged. be mainstreamed by establishing a similar window as the SBIC, pooling donor and Government A number of challenges remain. First, there has funding. been only limited penetration and usage of digital payments. Despite the opportunities brought by Support the evolution of Fintech. The Bangladesh some government initiatives (such as “Digital Bank could issue necessary Circulars to support Bangladesh”, “A2I”, digitization of government Fintech and bank/ financial institution partnerships, payments, upgrades of BACH and national switch which is the most pragmatic means in the short [implemented under a World Bank project]), the use term. In the medium term, the Bangladesh Bank of mobile banking and the Internet to pay bills or should consider moving beyond a bank-centric for purchases remains lows. So too, the ownership Fintech model. Instead, it should consider forming of debit and credit cards remain low compared to a dedicated Fintech Support Department that other countries in the region, such as India or Sri could collaborate with the National ID issuing Lanka. Second, there has been limited adoption of authority, the Security Exchange Commission, technology by businesses as measured by the low Prime Minister’s Office, the Bangladesh percentages of firms with their own website (at Telecommunication Regulatory Commission about 25 percent), as well as of firms using email to (BTRC), and the ICT-related regulator. The goals interact with clients/suppliers. Third, there is a lack would be to educate, observe and guide Fintech of capacity, scale and coordination in the digital activities, and encourage experimentation within entrepreneurship ecosystem. a regulatory sandbox, for instance, by better assessing the risks and support for Fintech- Policy Recommendations friendly regulations. The policy and regulatory framework for data aggregators from multiple Introduce a RSF for SMEs. This should sources (MFIs, telecommunications records, incorporate lessons learned from global utility payments, and so on) should be developed experience, as well as any insights from the pilot to allow for full leverage of alternative data for for targeted RSFs for women-led SMEs. The credit decisions, As such, it would help to promote RSF should have an explicit goal of financial the development of the Fintech sector beyond its sustainability, operational transparency, and full current focus on person-to-person transfers and disclosure. Whereas the Bangladesh Bank may retail payments. In addition, encouraging open take the lead in the short run, in the medium- API-based integration with existing financial term, the authorities should consider creating institutions will allow Fintech to offer targeted an independent professional company with an financial products. The suggested Fintech Support appropriate governance structure. This could be Department can take the lead with other relevant funded by the government, participating banks/ Bangladesh Bank counterparts, as well other NBFIs, international development organizations, public-sector counterparts, to operationalize the or other entities. required infrastructure. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 29 SECTION TITLE 30 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL INCLUSION, INFRASTRUCTURE & ACCESS III. CONCLUSIONS T his is an opportune time to reexamine MSME finance policy in Bangladesh. MSMEs are undoubtedly critical for job creation and economic growth, and access to finance has rightly been the focus of policy makers in Bangladesh. However, MSME financing gaps remain very high, even compared with other South Asian economies. Thus, the authorities have focused on this challenge. However, just as with all policies, a frequent reevaluation is warranted. This is an appropriate time, as past approaches can be objectively evaluated, and innovative and alternative instruments are emerging that present a unique opportunity to address remaining challenges. This report presents a desk review of the • Addressing the significant financial infra-- financing gap, constraints and policies related structure weaknesses is fundamental. These to MSME financing, offering recommendations include outstanding policy actions regarding for policy makers to plan for the future. credit reporting, secured transactions and Recommendations are as follows: collateral registries, and insolvency and debt resolution. • Improvements in the strategic vision and policy implementation require institutional • Payment systems, in particular, hold the coordination. Bangladesh would benefit from promise of expanding MSME financial access establishing a central coordinating multi-party through Digital Financial Services (DFS). The body to promote MSME development and Bangladesh Bank has made significant advances financing. toward the development of a digitized payment system. It needs to now review its strategy and • The Bangladesh Bank would benefit from policy in transforming the mobile-financial undertaking an evaluation of past schemes, system to one offering a broader range of services. guidelines and success stories to inform future MSME finance policies. The Bangladesh • The time is ripe to explore and plan for Bank should refocus its attention on the most several innovative and alternative financing constrained among MSMEs and broaden its options. A MSME-focused RSF can learn from policy emphasis beyond the banks. past experiences by addressing governance and design concerns. As financial infrastructure • It is important that the government clarifies improves and digital technology develops, asset- the long-term goals, mandates and objectives based solutions, such as factoring and warehouse of the state-owned financial institutions, and receipt finance, can be promoted. Finally, public undertakes the necessary reforms. policy can help reduce the risks associated with start-up capital. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 31 SECTION TITLE 32 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL INCLUSION, INFRASTRUCTURE & ACCESS ANNEXES Annex 1. Definition and Classification of MSMEs T he following summarizes the various definitions and classifications of MSMEs adopted in Bangladesh: 2003 – Economic Census: The Bangladesh buildings) and the number of employees for the Bureau of Statistics (BBS) used full-time 2010 Industrial Policy (table ). employment as the classification basis for the 2011 – Bangladesh Bank: As a part of its effort to 2003 Economic Census (table 1). promote the financing of MSMEs, the Bangladesh 2010 – Industrial Policy: The Ministry of Industry Bank followed a similar definition to that of the used the value of fixed assets (excluding land and 2010 Industrial Policy. However, it changed the parameters (table ). Table 11: Definition of MSME in the 2003 Economic Census Type of Firms Number of Employees Micro 0-9 Small 10-49 Medium 50-99 Large 100 and above Source: Economic Census 2003, BBS. Table 12: Definition of MSMEs in the Bangladesh 2010 Industrial Policy Total Fixed Assets (Excluding Types of Enterprise Land and Factory Buildings) Total Number of Employees A. Medium Enterprise Service Concern Tk 10 to 150 million 50 to 100 employees Manufacturing Concern Tk 100 to 300 million 100 to 250 employees B. Small Enterprise Service Concern Tk 500,000 to 10 million 10 to 25 employees Manufacturing Concern Tk 5 to 100 million 25 to 99 employees C. Micro Enterprise Service Concern Tk 500,000 or less 10 or less employees Manufacturing Concern Tk 500,000 to Tk 5 million 10 to 24 or less employees Source: Doing Business 2018, International Finance Corporation. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 33 Table 13: Bangladesh Bank Definition of Small Enterprises Sector Fixed Asset (other than Employed Manpower Types of Enterprise Land and Buildings) (Tk) (Not Above) A. Medium Enterprise* Service 5,000,000 – 100,000,000 50 Business 5,000,000 – 100,000,000 50 Industrial 15,000,000 – 200,000,000 150 B. Small Enterprise Service 50,000 – 5,000,000 25 Business 50,000 – 5,000,0000 25 Industrial 50,000 – 15,000,000 50 Source: Bangladesh Bank, 2011. Note: *Bangladesh Bank also defines medium enterprises as those that are not public limited companies. 2013 – Economic Census 2013: BBS adopted 2016 – Updated definition by the Bangladesh the definition of the 2010 Industrial Policy, Bank (see table 14). which introduced consistency for policy- making purposes. However, it made census data Annex 2. MSME Structure and uncompilable across time. Roles (2013 Bangladesh Economic 2013 – WBG Enterprise Survey: The survey uses Census) three levels of stratification: industry, size, and region. Size was defined based on employment: MSME Employment small (5 to 19 employees), medium (20 to 99 employees), and large (more than 99 employees). Since the classification changed from 2003, a strict intertemporal comparison is not possible. Table 14: Updated Definition of MSMEs by the Bangladesh Bank, 2016 Fixed Assets (other than Categories Sectors land and buildings) (Tk) Employed manpower Manufacturing 500,000 – 5,000,000 10-24 Micro Enterprise Business Less than 500,000 Less than 10 Service Less than 500,000 Less than 5 Manufacturing 5,000,000 – 100,000,000 25-99 Small Enterprise Business 500,000 – 10,000,000 6-10 Service 500,000 – 10,000,000 10-49 Manufacturing 100,000,000 – 300,000,000 100-150 Medium Enterprise Business 10,000,000 – 150,000,000 11-50 Service 10,000,000 – 150,000,000 50-100 Source: Credit and Development Forum, 2016. Note: MFIs= Microfinance Institutions. ANNEXES 34 Table 15: Size and Employment of Enterprises in Bangladesh, 2013 Number of Percent Number of persons Percent of Average Enterprise Type Enterprises of total employed Total Employment Cottage and Micro 6,942,891 88.8 13,727,197 56.0 2.0 Small 859,318 11.0 6,600,685 26.9 7.7 Medium 7,106 0.1 706,112 2.9 99.4 Large 5,250 0.1 3,466,856 14.1 660.4 Total 7,818,565 100 24,500,850 100.0 3.1 Source: BBS, Economic Census 2013. Nevertheless, examining aggregates, the total Annex 3. Estimation of the Small number of enterprises more than doubled from Enterprise Financing Gap Using 2003-2013 (from 3.7 million to 7.8 million), suggesting an annualized growth rate of around Bangladesh Bank Loan Data 11.3 percent. Independent data from the number One possibility of estimating the small enterprise of microcredit borrowers suggests that most of the financing gap is to look at the present structure of growth came from the cottage and microenterprise the banking sector loans. segments. Similarly, employment also doubled (from 12.3 to 24.5 million), registering an annual Table 17 presents the total banking sector loan growth rate of 7.1 percent. (See table 15). disbursements to SMEs for FY2016-17. The total number of accounts for medium enterprises MSME Activities Table 16: Distribution of Enterprises by Major Economic Activities, 2013 (numbers in `000) Micro Small Medium Large All # % # % # % # % # % Manufacturing 831.2 12.0 30.9 3.59 3.0 42.1 3.12 59.4 868.2 11.1 Other industrial activities 26.1 0.4 7.8 0.91 0.3 4.6 0.17 3.2 34.3 0.4 Trading and related 3,057.7 44.0 531.0 61.80 0.6 8.9 0.08 1.5 3,589.5 45.9 activities Transport and storage 1,265.9 18.2 37.7 4.39 0.2 2.3 0.04 0.8 1,303.8 16.7 Other services 1,766.0 25.4 251.9 29.32 3.0 42.2 1.84 35.0 2,022.7 25.9 Total 6,946.9 100.0 859.3 100.0 7.1 100.0 5.25 100.0 7,818.6 100.0 Source: BBS, Economic Census 2013. Table 17: Banking Sector Loan Disbursements to SMEs Average per Average per Total Amount Number of Account Number of Enterprise (Tk billion) Accounts (Tk million) Enterprises (Tk million) Small 328.31 163,482 2.01 859,318 0.4 Medium 392.1 49,881 7.86 7,106 55.2 SME 720.41 213,363 3.38 866,424 0.8 Source: Bangladesh Bank and BBS 2013 Economic Census. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 35 Table 18: Small Enterprise Financing Gap Demand-Supply Average Demand Number of Total Demand (Tk Balance (Tk million) Enterprises billion) (Tk billion) Demand 2.01 859,318 1,727.2 1,727.2 Supply 328.3 Financing Gap 1,398.9 Source: Bangladesh Bank and BBS 2013 Economic Census. exceeds the total number of medium enterprises Table 18 provides an estimate of the small in the 2013 Economic Census by a factor of enterprise financing gap. If the average loan 7, suggesting multiple accounts by medium disbursed in FY2016-17 is a fair representation of enterprises — and/ or access to the facility by the average loan demand (from small enterprises large enterprises using smaller accounting units. that have access to banking credit), multiplying The average loan disbursement per enterprise is this with the total number of small enterprises Tk 55 million (US$657.8 thousand equivalent), yields an estimate of Tk 1,727.2 billion (US$20.7 which implies the absence of a credit constraint for billion equivalent) (or 10 percent of GDP) as the medium enterprises (on average).49 However, the potential credit demand. In turn, the financing total loan accounts for small enterprises amount gap stands at Tk 1,398.9 billion (US$16.7 billion to a mere 19 percent of the enumerated small equivalent) (or 8.5 percent of GDP). enterprises in the 2013 Economic Census, which suggests that there are many financially unserved small enterprises. ANNEXES 36 Annex 4. Roles and Activities of Agencies Supporting MSMEs Agencies Activities and Services Ministry of Industry • Formulates National Industrial Policy, including definitions of Cottage, Micro, Small and Medium size industries. • Handles matters related to micro, cottage industries and SMEs. • Supervises the functioning of the Bangladesh Small and Cottage Industries Corporation (BSCIC) and the Bangladesh Industrial Technical Assistance Centre; and also has the SME foundation under its authority (see below) SME Foundation • Helps implementation of SME policy strategies adopted by the Government. (under the Ministry • Provides collateral-free loans to the targeted entrepreneurs of selected clusters and of Industry) segments through partner financial institutions. • Organizes national and regional SME product fairs. • Conducts initiatives to create and develop women ICT entrepreneurs/freelancers/ workforce in collaboration with the Access to Information (a2i) Program and the Bangladesh Women in Technology (BWIT). Provides various support and capacity building to women entrepreneurs. • Conducts studies on various SME sectors in line with the Industrial Policy, including a needs assessment program to design and implement a cluster development action plan. • Supports the SMEs with various kinds of services, including helping SMEs identify and address the challenges in legal and administrative regimes, such as regulatory barriers on trade licenses, patents and trademarks, product certification, environmental issues, and so on; Supports technology up-grading, adaptation of advanced/appropriate technologies, and compliances and certification. Bangladesh Small • Helps entrepreneurship development through counseling and training. and Cottage • Provides infrastructure facilities by establishing industrial estates. Industries • Extends credit facilities to entrepreneurs, prepares project profiles and project appraisal Corporation proposals. (BSCIC) • Innovates and adapts appropriate technology in the small and cottage industry (SCI) sector, and develops and distributes new designs and prototypes. • Conducts research, studies and surveys in the SCI sector; collects, compiles and disseminates technical and other information leading to investments, production and marketing of SCIs. • Provides technical and consultancy services for establishing new industrial units and quality improvements in SCI products. • Provides registration services for small and cottage industrial units. Bangladesh • Upgrading the skills of the industrial personnel in technical fields (light engineering sector). Industrial Technical • Disseminates modern technical know-how among industrial personnel. Assistance Centre • Collects and circulates information relating to industrial productivity. • Provides consulting services to industrial organizations and industries, mainly in the private sector. • Organizes capacity-building programs in the SME sector. Ministry of • Supervises the functioning of the Business Promotion Council (BPC) and the Export Commerce Promotion Bureau (EPB). Business • Supports the growth of potential industrial sectors that have yet to take off. Promotion Council • Facilitates capacity building among the industries involved in BPC. • Facilitates market research. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 37 MSME Department • Formulates and implements policies for the development of the SME sector including of Bangladesh through SME financing policies and women entrepreneurship development polices. Bank Issues guidelines for financing of the SME sector through the banks and NBFIs.Monitors SME loan disbursements, recovery, and so on. Operates various refinancing windows supported by multilateral donors (such as by ADB, the International Development Association [IDA]) as well as from its own sources for small entrepreneurs, for example, implementation of the Financial Sector Project for the Development of SME with the assistance of the JICA TSL Fund.Promotes financial facilities through banks and financial institutions for SMEs, women entrepreneurs, and new entrepreneurs. Extends support for entrepreneur development. Small and Cottage • Provides training on various topics related to entrepreneurship and Small and Cottage Industries Training Industries. Institute (SCITI) Palli Karma • Provides financial assistance and institutional development support to appropriate Sahayak organizations for implementing sustainable, inclusive financial programs for reduction Foundation of poverty for the moderate and ultra-poor, small and marginal farmers and micro- (PKSF): APEX entrepreneurs. organization • Builds and strengthens the institutional capacity of partner organizations. established by the • Programs include: the Enterprise Development Program; the Finance for Enterprise Government of Development and Employment Creation (FEDEC) Project, and the Promoting Bangladesh Agricultural Commercialization and Enterprises (PACE) Project. Bangladesh • Issues, develops and guides science, industry and technology research to solve the Council of issues related to the establishment and development of industries. Scientific and • Conducts research and development of laboratories, institutes and organizations for the Industrial Research management of science and industry research activities. • Takes steps to commercialize the discovery and innovation arising from research conducted by the University or any other research institute. • Takes necessary actions to use newly invented methods in the industrial establishment. Department of • Arranges skills development training programs for various vocational activities. Youth Development • Supports self-employment and entrepreneurship development. under the Ministry of Youth and Sports Other agencies focusing on specific sectors: Jute Diversification • Arranges various training programs for upgrading of skills. Promotion Centre • Organizes fairs and exhibitions, buyer-seller meetings, exposure trips, workshops, seminars, exchanges of ideas, and so on. • Provides technical information, technology and know-how, design and product development services, and raw materials through the Raw Materials Bank (RMB), and so on. • Helps entrepreneurs in selecting the right type of machinery and adopting the appropriate technology. Bangladesh • Supports and formulates plans for development of sericulture and the silk industry. Sericulture • Supports improved methods of mulberry cultivation, castor cultivation and other related Development plants, and provides technical advice to the entrepreneurs. Board • Provides training facilities to silk spinners, weavers and printers, and promotes and supports facilities for the standardization of silk products for exportProvides arrangements of credit facilities for Seri culturists. ANNEXES 38 Annex 5. General Principles for Settlements constituted “the Credit Reporting Credit Reporting Systems Standards Setting Task Force”. Box 9 lists the World Bank recommended five General Principles To provide a core set of general principles to for a Credit Reporting System and Box 10 contains guide credit reporting systems, the World Bank the recommendations for their effective oversight. with support from the Bank for International Box 9: General Principles for Credit Reporting Systems (CRS) The General Principles seek to ensure that CRS effectively support the sound and fair extension of credit. As such, they should also be safe, efficient, and supportive of data provider and consumer rights. Data General Principle 1: CRS should have relevant, accurate, timely and sufficient data collected on a systematic basis from all reliable, appropriate and available sources, and should retain this information for a sufficient time. Data Processing: Security and Efficiency General Principle 2: CRS should be efficient and have rigorous standards of security and reliability. Governance and Risk Management General Principle 3: The governance arrangements of credit reporting service providers and data providers should ensure accountability, transparency and effectiveness in managing the risks associated with the business, as well as fair access to the information by users. Legal and Regulatory Environment General Principle 4: The overall legal and regulatory framework for credit reporting should be clear, predictable, non- discriminatory, proportionate and supportive of the data subject and consumer rights. The legal and regulatory framework should include effective judicial and/or? extrajudicial dispute resolution mechanisms. Cross-Border Data Flows General Principle 5: Where appropriate, cross-border credit data transfers should be facilitated, provided that adequate requirements are in place. Roles of Key Players Role A: Data providers should report accurate, timely and complete data to credit reporting service providers on an equitable basis. Role B: Other data sources, particularly public records agencies, should facilitate access to their databases by credit reporting service providers. Role C: Credit reporting service providers should ensure that data processing is secure and that is provides high quality and efficient services. All users having either a lending function or a supervisory role should be able to access these services under equitable conditions. Role D: Users should make proper use of the information available from credit reporting service providers. Role E: Data subjects should provide truthful and accurate information to data providers and other data sources. Role F: Authorities should promote a credit reporting system that is efficient and effective in satisfying the needs of the various participants. They should also be supportive of data subject/consumer rights, as well as the development of a fair and competitive credit market. Source: World Bank. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 39 Box 10: Recommendations for Effective Oversight Recommendation A: Credit reporting systems should be subject to appropriate and effective regulation and oversight by a central bank, a financial supervisor, or other relevant authorities. It is important that one or more authorities exercise the function as primary overseer. Recommendation B: Central banks, financial supervisors, and other relevant authorities should have the powers and resources necessary to effectively carry out their responsibilities in regulating and overseeing credit reporting systems. Recommendation C: Central banks, financial supervisors, and other relevant authorities should clearly define and disclose their regulatory and oversight objectives, roles, and major regulations and policies with respect to credit reporting systems. Recommendation D: Central banks, financial supervisors, and other relevant authorities should adopt, where relevant, the general principles for credit reporting systems and related roles, and it should apply them consistently. Recommendation E: Central banks, financial supervisors, and other relevant authorities, both domestic and international, should cooperate with each other, as appropriate, in promoting the safety and efficiency of credit reporting systems. Source: World Bank 2011. Annex 6. Principles for Credit 6. Set a sound corporate governance structure Guarantee Schemes for SMEs with an independent board of directors. 7. Design a sound internal control framework to The World Bank Group and its Financial Sector safeguard operational integrity. Reform and Strengthening Initiative (FIRST) have launched a new tool to help governments implement 8. Adopt an effective and comprehensive public credit guarantee schemes. The tool is enterprise risk management framework. intended to become the standard for effectively and efficiently establishing and running public Credit Operational framework Guarantee Schemes (CGSs) for SMEs around the 9. Clearly define eligibility and qualification world. The 16 principles cover four key areas that criteria for MSMEs, lenders, and credit are critical for the success of CGSs. instruments. 10. Ensure the guarantee delivery approach Legal and regulatory framework balances outreach, additionality and financial 1. Establish the CGS as an independent legal sustainability. entity. 11. Issue partial guarantees that comply with 2. Provide adequate funding and keep sources prudential regulations and provide capital transparent. relief to lenders. 3. Promote mixed ownership and treat minority 12. Set a transparent and consistent risk-based shareholders fairly. pricing policy. 4. Supervise the CGS independently and 13. Design an efficient, clearly documented, and effectively. transparent claims management process. Corporate governance and risk Monitoring and evaluation management 14. Set rigorous financial reporting requirements 5. Clearly define the CGS mandate. and externally audit the financial statements. ANNEXES 40 15. Publicly disclose non-financial information Service and monitoring. Early warning systems periodically. that use multiple structured and unstructured 16. Systematically evaluate CGS performance data points assist financial institutions in loan and publicly disclose the findings. monitoring by assessing the potential to default. Fintech models can also provide end-to-end Annex 7. Fintech Solutions solutions for the lending value chain or “full Fintech companies have emerged with stack lending models”. innovative solutions that can substantially Marketplace (peer-to-peer) lending. This is a full improve efficiencies at each step of the lending stack disruptor across the lending value chain. process. It provides credit to MSMEs (and individuals) Loan origination. Fintech can reduce the costs through online platforms that match lenders for banks to originate loans. For instance, an (savers, investors) with borrowers. The speed and aggregator’s platform or an online loan comparison convenience of such loans, as well as the absence platform can be used as alternate channels for of a need for collateral, are important advantages. customer origination. Sophisticated e-Know Your They can also result in lower interest rates if the Customer (KYC) solutions can be embedded for low cost of structures is passed on because they are digital on-boarding and verification of customers, technology based. As such, the need for physical and chatbots can improve customer experience. facilities and staffing is much more limited. Moreover, the regulatory environment is also far- Underwriting. Fintech can leverage alternative data less expensive in terms of capital adequacy, reserve (such as utility bill payments, social data, mobile requirements, and so on. Marketplace lending to phone data [such as call records], text messages, MSMEs has taken off (World Economic Forum psychometric data, and so on) to determine the 2015). In 2016, the peer-to-peer (P2P) lending creditworthiness of potential borrowers through market in China, the United Kingdom and the alternate credit scoring solutions. Manual intensive United States was estimated to be around US$89 tasks such as an analysis of a borrower’s bank billion, with China alone accounting for US$66 statement, or a company’s financial statements billion. It is estimated that 60-80 countries now and tax documents can now be automated through have marketplace lending for MSMEs. In Africa, Fintech solutions, thereby drastically reducing the marketplace lending is increasing, particularly in credit assessment time. Other solutions such as Kenya, Ghana, Tanzania and Zambia. geo-tagging can provide additional information about the existence of the borrower’s property. Technology platforms for invoice and value These can help financiers access additional chain finance. Platforms can streamline factoring information about small businesses, make more solutions, allowing MSMEs to sell accounts informed credit decisions, and potentially reduce receivable to third-party financial institutions collateral requirements. more efficiently. Small business owners can directly connect their accounting software to the Disbursements and collections. For instance, invoice finance platform, apply for a loan, and the National Payments Corporation of India receive payment almost instantly as the application has developed innovative products that can be is processed mostly automatically. Fintech leveraged to automate installment collection. companies such as MarketInvoice (based in the E-mandate and pull payment facilities are helping UK), Fundbox (United States), NoviCap (Spain) financial institutions to collect payments on time and Finexkap (France) have grown significantly in with minimal manual intervention. Aadhar e-sign recent years. Receivable exchanges using digital can facilitate loan disbursements. platforms such as NAFIN in Mexico, TREFI in Peru and TREDS in India are also on the rise. FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 41 Furthermore, useful information is generated The Bali Fintech Agenda: A Blueprint for about the MSMEs that can benefit lenders, for Successfully Harnessing Fintech’s Opportunities. instance the value and frequency of purchases, The Bali Fintech Agenda, developed jointly by which is also a proxy for sales; the number of the International Monetary Fund and the World years in business; the location of the business, and Bank Group, proposes a framework of high-level so on. issues that countries should consider in their own domestic policy discussions with regard to Fintech. Access to credit can also be expanded using It is a set of 12 policy elements (listed below) the digital footprint created by MSME aimed at helping countries to harness the benefits transactions. Leading e-commerce enterprises and opportunities of rapid advances in financial such as Amazon, Alibaba and e-Bay have entered technology that are transforming the provision of the lending market by offering lines of credit to banking services, while at the same time managing MSME vendors. Payment processors such as the inherent risks. PayPal and telecommunications companies are also engaged in this segment. As transactions • Embrace the promise of Fintech. are online and customers are well-known to the • Enable new technologies to enhance financial creditors through their transaction data, working service provision. capital and expansion programs can be supplied at a relatively low cost. The acceptance of electronic • Reinforce competition and commitment to open, payments, such as M-Pesa, enables merchants free, and contestable markets. to leverage data to obtain access to finance. All • Foster Fintech to promote financial inclusion and digital transactions of merchants can be tracked develop financial markets. and provide information about the merchants’ • Monitor developments closely to deepen the operations and creditworthiness. This source understanding of evolving financial systems. is utilized, among others, by Amazon (USA); Alibaba (China); Rakuten (Japan); PayPal (USA); • Adapt the regulatory framework and supervisory Square Capital (USA); iZettle (Sweden); and practices for orderly development and stability of Telemex (Mexico). The market is very lightly the financial system. regulated, which also lowers the transaction costs. • Safeguard the integrity of financial systems. Technology can also help to improve • Modernize legal frameworks to provide an MSME operational efficiency and become enabling legal landscape. more competitive, consequently improving • Ensure the stability of the domestic monetary and opportunities to acquire external financing. financial systems. This includes virtual support in the preparation • Develop robust financial and data infrastructure of business plans, the running of their to sustain Fintech benefits. businesses, improvements in business processes, inventory management controls, and so forth. • Encourage international cooperation and Complementary analytical applications can information-sharing. process the data generated by firms’ transactions • Enhance collective surveillance of the in order to provide valuable insights for financial international monetary and financial systems. planning, inventory management, and sales strategy purposes. ANNEXES 42 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL INCLUSION, INFRASTRUCTURE & ACCESS REFERENCES Acharya, V. V., Agarwal, A. & Kulkarni, N. (2010). State Ownership and Systemic Risk: Evidence from the Indian financial sector during 2007–09. Unpublished paper, NYU–Stern, New York. Barth, J., Caprio, G., & Levine, R. (2006). Rethinking bank supervision and regulation: until angels govern. New York: Cambridge University Press. Bertay, A., Demirgüç-Kunt, A., & Huizinga, H. (2015). Bank ownership and credit over the business cycle: Is lending by state banks less procyclical? Journal of Banking & Finance, 50, 326-339. Brei, M., & Schclarek, A. (2013). Public bank lending in times of crisis. Journal of Financial Stability, 9(4), 820-830. Coleman, N., & Feler, L. (2015). Bank ownership, lending, and local economic performance during the 2008–2009 financial crisis. Journal of Monetary Economics, 71, 50-66. Choi, M. J., Gutierrez, E., & Martinez Peria, M. S. (2016). 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Washington, DC, USA: World Bank Policy Research Working Paper 5141. Shleifer, A., & Vishny, R. (1998). The grabbing hand: Government pathologies and their cures. Cambridge, MA: Harvard University Press. The World Bank (2012). Global Financial Development Report 2013: Rethinking the Role of the State in Finance. Washington, DC. doi: 10.1596/978-0-8213-9503-5. REFERENCES 44 FINANCE, COMPETITIVENESS & INNOVATION INSIGHT | FINANCIAL INCLUSION, INFRASTRUCTURE & ACCESS ENDNOTES 1. Throughout this document, all amounts have liquidity in the banking sector, resulting in been converted from and to US$, using the competitive yet short-term funding, which effective exchange rate as of December 31, leads to restrictions in other forms of corporate 2018. fundraising; and, (iii) cultural constraints, whereby family-centric ownership structures 2. Given resource limitations, it consolidates raise obstacles to equity stake dilution; (iv) background literature research, and relies on court system strengthening, and removal of tax available data and focused interviews with distortions and legal impediments; and (v) the government officials and stakeholders. The existence of very few institutional investors, interpretation of quoted data varies based on with the market dominated by merchant banks. the MSME definition deployed by each source. Conclusions are feasible from drawing on 7. Depending on their sizes, loans can be overall trends, and should be approached with considered microloans or microenterprise caution. Recommendations draw on global loans. experience, adjusting for Bangladesh’s present 8. It is understood, for example, that 80 percent of socio-economic context, policy and regulatory BRAC Bank’s loan book to SMEs is currently environment, as well as an assessment of provided to the “trading” sector. reform feasibility in the short to medium term. 9. Firms with higher employment are likely to 3. Knowledge gaps include the number and type of have higher capital intensity of production per MSMEs, value added and growth, employment worker, as well as higher production volume size and growth, and so on. per worker to benefit from economies of scale. 4. There is a wide literature about the broader Microenterprises in urban areas are likely to MSME financing challenges. For example, have higher production costs per worker —and Beck and Demirguc-Kunt (2005) provide a larger scale of production per worker to offset evidence from a study of 70 countries that the cost effects. small firms face larger growth constraints and 10. The total loans disbursed in Table 5 includes have less access to institutional finance. loans for all purposes (that is, personal loans, 5. This is a program funded by the Government of home loans, education loans, agriculture loans, Bangladesh and the European Union. and so on). They are not just direct support to microenterprises. However, these loan 6. Long-term finance and capital markets disbursements can be regarded as beneficial development are the subject of an ongoing support to cottage and microenterprises. World Bank-IFC exercise called the Joint Capital Markets Initiative (JCAP). 11. Some 87 percent of the credit comes from Fundamental impediments to development MFIs, charging an average interest rate of 23- include: (i) the distortionary effects of National 24 percent. The prevailing market interest rate Saving Certificates on government security from the commercial banks is in the 10-12 issuance (and the establishment of a risk-free percent range. yield benchmark) and on the distribution of 12. Annex 3 describes an estimation of the small long-term savings (excluding institutional enterprise finance gap using BB loan data. investors); (ii) the high dominance of and FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 45 13. It estimated how much credit-constrained firms 18. Currently, most credit rating agencies are would borrow to define the counterfactual under providing rating services for SMEs. which the gap exists, as well as the bankability 19. Accordingly, all banks/financial institutions of those currently un-/under-served, that is, have established a dedicated desk for women how much financial institutions would want to entrepreneurs. finance to define the gap on the supply side. 20. Bangladesh Bank offers several refinancing 14. The NSDC was established in 2004. Its main schemes for women entrepreneurs in cottage, goal is to ensure the comprehensive and micro and small enterprises, as well as agro- coordinated development of SMEs across all businesses. Under these refinancing schemes, sectors. Among its key achievements are the loans for women can be taken at 4 percent following: (i) setting a common definition interest, including a 5 percent bank rate, that is, for SME (2004) and redefinition (2014); (ii) 9 percent in total. establishing a periodic census for statistical updates; (iii) crafting the SME Development 21. An amount of Tk 8.2 billion (US$98 million Framework, the SME Master Plan and the SME equivalent) had been refinanced to women Act Framework; and (iv) establishing a Central entrepreneurs until mid-2014 for a total of Coordinating Agency (CCA) as a platform to 10,214 enterprises. gather the latest information and monitor the SME programs by the Ministries and Agencies. 22. Aziz and Siddique, “The role of Bangladesh Bank in promoting SMEs’ access to finance 15. Several articles, including Aziz and Siddique, in Bangladesh.” International Journal of SME “The role of Bangladesh Bank in promoting Development, Issue 2, 2016, reviews the role SMEs’ access to finance in Bangladesh”, of the Bangladesh Bank in promoting SME International Journal of SME Development Issue financing and development. It also summarizes 2, 2016, review the role of the Bangladesh Bank the various financing support provided by the in promoting SME financing and development. Bangladesh Bank. 16. The Bangladesh Bank recently updated its 23. Their capital shortage has significantly definition of micro, cottage, and small and increased since 2016, with negative capital medium enterprises in line with the National to risk weighted assets in three cases. Non- Industrial Policy 2016 (see annex 1), including performing loans vary from 20 to 55 percent, an update of the lending targets for MSMEs. including a failure to keep the required loan- loss provisions in three cases. 17. In each rating scale, the risk weights vary for MSMEs and large firms. Rating 1 is for the best 24. United Kingdom Department for International client and Rating 6 is for the riskiest client, that Development (DFID) Bangladesh, “Research is, the one with the lowest rating. It is observed study on review of SME credit-related that the risk weight is always higher for large policies of Bangladesh Bank: Areas of further firms compared to MSMEs under similar ratings improvement with a focus on micro and small with two exceptions (firms under Rating 1 and enterprises”, 2016, and World Bank, “The Rating 6 have similar risk weights regardless of impact study on financial sector project for size). Computing ratings for firms is not always the development of small, medium enterprises feasible since it is a very costly process, even for (FSPDSME)”, 2018. large firms. Even if a rating is not determined, the capital gains of lending to even an unrated 25. According to a 2017 Bangladesh Institute of MSME are significantly higher than lending to Bank Management report, default loans in an unrated large firm. Additionally, large firms the SME sector have increased by more than under Rating 1 and Rating 2 are hard to find. eight times in the last seven years. Notably, in ENDNOTES 46 line with the performance of their overall loan secure loans. However, a bank lending against operations, the rate of SME non-performing the personal guarantee of a borrower or a third loans (NPLs) in the case of state-owned banks person or cash flow is not regarded as a secured is very high. This has given rise to views that creditor. the main culprit is SME loan disbursement 33. From the most recent Doing Business 2018 targets in the presence of unmitigated adverse rankings for Getting Credit, Bangladesh scored selection. 5 out of 12 points on the strength of its legal 26. According to the Bangladesh Bank guidelines, rights index, which measures the effectiveness unsecured lending is permitted for loans smaller of regulations on non-possessory security than Tk 1 million (US$12 thousand) (and interests in movable property (see table 10). smaller than Tk 2.5 million [US$29 thousand] 34. Bangladesh has long had in place laws related for loans to women entrepreneurs). to insolvency, such as the Insolvency (Dacca) 27. A recent IFC study focused on the issue of Act of 1909, the Insolvency Act of 1920, and increasing financing for women entrepreneurs the Bankruptcy Act of 1997. in Bangladesh (IFC 2016). The study was 35. The survey indicates that the enforcement of a entitled: “Mapping the market potential and secured claim can take an average of four years, accelerating finance for women entrepreneurs cost eight percent of the value of the collateral, in Bangladesh”. Notably, non-direct-finance and return no more than 28 cents on the dollar activities could be important in yielding results, to the secured creditor. By comparison, the such as business development services, or South Asian average is a duration of 2.6 years, a the establishment of the secured transactions cost of nine percent of the collateral value, and registry (as women are more likely to hold a return of 32.7 cents on the dollar. No direct moveable property). evidence is available as to the enforcement 28. An expert team comprised of representatives of unsecured claims, but in the comparable from the National Board of Revenues (NBR), process of contract enforcement, the Doing the Ministry of Finance and the Bangladesh Business 2018 report indicates that the process Bank could be established to look specifically at can, on average, take 1,442 days, and cost 66.8 formalization solutions to the MSME segment. percent of the value at issue. This would place Bangladesh as the second worst country in the 29. The score is zero because the coverage of the world in terms of enforcing a contract in a civil credit registry is less than 5 percent of the court. Again, by comparison, the South Asian population. average is 1,101 days, and 29.6 percent of the 30. The current regulation of the CIB in Bangladesh claim value. takes stock of loans over Tk 50,000 (US$598 36. The ground work for establishing ADR was equivalent) and credit cards over Tk 10,000 completed; important changes in the three major (US$120). tax laws to include alternative dispute resolution 31. There is an ongoing IFC project regarding of tax appeals were enacted (unlocking movable collateral registry reform. It aims to US$ 289 million in government revenues); establish the requisite legal and institutional amendments to the Civil Procedure Code to frameworks, as well as raise awareness and include mandatory mediation of commercial capacity to promote the use of the registry disputes were passed; and awareness about the among stakeholders. impact of an effective out-of-court workout framework for distressed debtors was raised. 32. Banks do use other personal guarantees, hypothecation of goods, and cash flows to FINANCING SOLUTIONS FOR MICRO, SMALL AND MEDIUM ENTERPRISES IN BANGLADESH 47 37. Improving the safety and efficiency of, as well is also some crowd funding. A crowd-funded as access to, electronic retail payment services documentary titled ‘Startup Dhaka’ inspired a can bring important benefits to commerce lot of youth to engage in entrepreneurship. The and overall business activity. Specifically, it documentary, produced by SD Asia, creates can achieve this through the distribution and content about startups, entrepreneurs, and collection of payments made by/to government businesses. It raised over US$9000 from 56 agencies, and to payments between individuals, backers from around the world. among other possibilities. 44. Examples include the Frontier Private Equity 38. Bangladesh Investment Climate Fund, Fund; Tindercapital; SEAF; Bangladesh “Payment Mechanisms in Bangladesh: A Venture Capital Limited; Venture Investment Baseline Study”. World Bank, 2013 Partners Bangladesh; and BD Ventures (ADB 2014; Challenges Consulting 2012). 39. Annex 6 summarizes the “Principles for Credit Guarantee Schemes for SMEs”, a tool 45. The main features include loan limits of up to developed jointly by the World Bank and the 2.5 million (US$29.9 thousand); loan tenures Financial Sector Reform and Strengthening of up to 5 years; grace periods of 3 to 6 months; Initiative (FIRST) initiative to help governments and repayment methods equal to monthly implement public credit guarantee schemes. installments or structured payments. 40. The scheme, nevertheless, can be improved 46. These include the availability of data; a by upgrading management and staff skills, supportive regulatory environment; the providing a better orientation for the exporters availability of sufficient investor capital; and and commercial banks, and introducing the spread of financial education to the relevant operational improvements to product quality stakeholders. The data requirements are and improving service delivery promptness. becoming simplified through technology that has developed user-friendly online application 41. Both pre-shipment and post-shipment forms and computer-based risk assessment guarantees are made. Risk coverage varies from models. There is also a growing source of 75 to 80 percent in the case of commercial risks private capital based on the willingness to take and 95 percent in the case of political risks. some risks for higher returns, as compared with Guarantees issued during 1978-1995 numbered low returns from deposits and other financial 5,223, covering an amount of Tk 64.23 billion instruments. (US$268.2 million equivalent). The premium income was Tk 2.28 billion (US$27.3 million), 47. In this first phase, the Bangladesh Bank took a claims paid amounted to Tk 1.18 billion cautious stand regarding the eligibility of MFS (US$14.1 million) and claims outstanding service providers. As a result, competition has amounted to Tk1.64 billion (US$19.6 million). been inadequate, and the range of services offered by MFS is very limited (Ahmed 2017). 42. These options include debt, equity or a hybrid of debt and equity financing packages. A 48. See: https://www.techbullion.com/popular- detailed review of these financing options in fintech-companies-bangladesh/ Organisation for Economic Co-operation and 49. This is corroborated by other studies (for Development (OECD) countries can be found example, Khalily and Khaleque 2013), in OECD (2015). suggesting that there is little meaningful 43. There have been reports of some angel funding. distinction between medium and large For example, angel investors are reported to enterprises, other than that the former are not have funded Chaldal.com, a Bangladeshi startup, likely registered with the stock exchange as which was launched three years ago. There public limited corporations. ENDNOTES 48