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MGT604 - Management of Financial Institutions - Lecture Handout 38

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Agriculture Sector and Financial Institutions of Pakistan


What types of securities/collaterals are acceptable to the banks for providing agricultural credit to farmers/growers?

Agricultural land under the pass book system, urban/rural property, commercial property, Defense Saving Certificates, Special Saving Certificates, Gold & Silver Ornaments, personal surety, hypothecation of livestock and other assets e.g. motor boats / fishing trawlers, etc. are generally accepted by banks as collateral.

Is mark-up rate fixed by SBP on agricultural loans?

SBP does not fix any maximum/minimum mark-up rate to be charged on agricultural loans. Banks’ mark-up is based on their cost structure and risk profile of the borrowers and the sector. However, for benchmarking, Karachi inter-bank Offered Rate (KIBOR) is used by banks for the purpose.

Revolving Credit Scheme was introduced in 2003 in consultation with banks. Under the scheme, banks can provide finance for agricultural purposes on the basis of revolving limits for a period of three years with one-time documentation. The borrowers are required to clear the entire loan amount (including mark-up) once in a year at the date of their own choice.

Multiple withdrawals are allowed and the borrowers are also allowed to make partial repayments. Only the amount utilized by the borrower will attract mark-up. This facility can be availed by the farmers just like “running finance”. The limits under this scheme are automatically renewed on annual basis without any request or fresh application.

Is the credit facility under “Revolving Credit Scheme” available only on seasonal basis
i.e. one crop only?

The credit limits under Revolving Credit Scheme are available to the farmers for full one year i.e. covering both the crops in a year. To save the farmers from stress sale of their crops, they are required to clear their account only once in a year at a date indicated by the borrower and mutually agreed with lending bank.

Is there any system/procedure under which farmers can get agricultural loans at their

Mobile Credit Officers (MCOs) and Agricultural Credit Officers of banks are visiting the farmers regularly to ascertain the credit needs of the farmers and ensure its availability at their doorsteps and also provide technical help for different crops.

Whether landless farmers/tenants can avail agricultural credit under Revolving Credit

Yes, agricultural credit under Revolving Credit Scheme can be availed against personal surety, guarantee or any other collateral acceptable to banks.

Are farmers who had availed any concession or remission under Government relief package announced from time to time, eligible for fresh loans?

Yes, borrowers who have availed concession under any scheme notified by the government or concerned bank/DFI in the light of guidelines issued by SBP may be eligible for fresh financing.

What are SMEs?

As defined by State Bank of Pakistan - SME (Small and Medium Enterprise) means an entity, ideally not a public limited company, which does not employee more than 250 persons (if it is manufacturing concern) and 50 persons (if it is trading / service concern) and also fulfills the following criteria of either ‘a’ and ‘c’ or ‘b’ and ‘c’ as relevant:

  • A trading / service concern with total assets at cost excluding land and buildings up to Rs 50 million.
  • A manufacturing concern with total assets at cost excluding land and building up to Rs 100 million
  • Any concern (trading, service or manufacturing) with net sales not exceeding Rs 300 million as per latest financial statements.

SME Financing and Hand-Holding

Research reveals that despite the lack of collateral, SMEs are a better credit risk, as the default rate of this sector is much below that of large enterprises (LEs). Throughout the world, SMEs have provided tremendous opportunities to financial institutions to design various tools for the sector's development (e.g. Program Lending Schemes, Credit Scoring, Venture Capital Financing, etc.). Then there are clusters, technology parks and industrial estates, all being fuelled by the dynamism and vibrancy of small and medium enterprises. Banking institutions, running on Islamic principles, are also experimenting with interest free financial instruments (e.g. Mudarabah, Murabaha, Ijarah etc.) for this sector.

Small and medium enterprises or SMEs, also called small and medium-sized enterprises and small and medium-sized businesses or small and medium businesses or SMBs are companies whose headcount or turnover falls below certain limits.

The abbreviation SME occurs commonly in the European Union and in international organizations, such as the World Bank, the United Nations and the WTO . The term small and medium-sized businesses or SMBs has become more standard in a few other countries.

EU Member States traditionally had their own definition of what constitutes an SME, for example the traditional definition in Germany had a limit of 500 employees , while, for example, in Belgium it could have been 100. But now the EU has started to standardize the concept. Its current definition categorizes companies with fewer than 50 employees as"small", and those with fewer than 250 as "medium". By contrast, in the United States , when small business is defined by the number of employees, it often refers to those with less than 100 employees, while medium-sized business often refers to those with less than 500 employees. However, the most widely used American definition of micro-business by the number of employees is the same of that of European Union less than 10 employees.As of 2005, Germany will use the definition of the European Commission .Business enterprises of fewer than 10 employees often class as SOHO

In most economies, smaller enterprises are much greater in number. In the EU, SMEs comprise approximately 99% of all firms and employ between them about 65 million people. In many sectors, SMEs are also responsible for driving innovation and competition.Providing SME finance and support is thus an important area of economic policy.

Significance of SMEs

SMEs are considered the engine of economic growth in both developed and developing countries, as they: Provide low cost employment since the unit cost of persons employed is lower for SMEs than for large-size units.

  • Assist in regional and local development since SMEs accelerate rural industrialization by linking it with the more organized urban sector.
  • Help achieve fair and equitable distribution of wealth by regional dispersion of economic activities.
  • Contribute significantly to export revenues because of the low-cost labour intensive nature of its products.
  • Have a positive effect on the trade balance since SMEs generally use indigenous raw materials.
  • Assist in fostering a self-help and entrepreneurial culture by bringing together skills and capital through various lending and skill enhancement schemes.
  • Impart the resilience to withstand economic upheavals and maintain a reasonable growth rate since being indigenous is the key to sustainability and self-sufficiency.

Problems Faced by Pakistan’s SME Sector?

Pakistan’s economy has amazing potential for development but sadly, we haven't been able to derive optimal benefits despite a series of efforts launched by various policy makers at different times. The impetus of all these endeavors was on the large scale industries and manufacturing concerns. High rate of failures, owing to economic slumps, institutional
malpractices, political motives and damaging activities of labour unions in that sector, left the formal lending institutions with huge infected portfolios, in addition to adverse effects on the entire economy e.g. insufficient and low quality production to meet the demands of local and international markets, deficit in balance of payments and ever rising
unemployment, etc.

Pakistan’s SMEs are still unable to achieve their maximum potential and are in dire need of ‘hand-holding' and business support services.

A major challenge to economic policy in Pakistan at this time is to energize the private SME sector of the economy. This follows in part from the fact that other sectors are unlikely, under present circumstances, to provide the needed growth either of output or of reasonably remunerative employment; in fact, there will be a major employment challenge
over the coming years as labour supply continues to expand rapidly and as neither the largescale private sector nor the public sector are poised to create significant numbers of jobs, and though agriculture and the non-agricultural micro enterprise sector can and probably will do so the levels of productivity and hence of remuneration are likely to be
unattractively low. By contrast, the SME sector does have substantial untapped potential to contribute to those objectives; both economic logic and the experiences of other developing countries point to that potential, as well as providing evidence on how it may be achieved. A dynamic SME sector is an important complement to a more open economy; in most of the countries which appear to have reaped major benefits from export orientation the SME
sector has been importantly involved in that process. Achieving the maximum contribution from SME, however, will require significant improvements in the support system. If achieved it will not only constitute an important source of dynamism in and of itself, but will also complement efficient large enterprise, strengthen the demand for agricultural
products, and make it easier for micro enterprise to graduate into the SME size range.

Promotion of Small and Medium Enterprises (SMEs) entails enhancement of the competitiveness of the economy and generation of additional employment. A thriving Small and Medium Enterprise (SME) sector has long been recognized as one of the key characteristics of any prosperous and growing economy.

Pakistan is an economy comprising mainly of SMEs. The significance of their role is clearly indicated by various statistics. According to more recent estimates there are approximately 3.2 million business enterprises in Pakistan. Enterprises employing up to 99 persons constitute over 95% of all private enterprises in the industrial sector and employ nearly 78% of the non-agriculture labour force. They contribute over 30% to the GDP, Rs.140 billion to
exports, and account 25% of exports of manufactured goods besides sharing 35% in manufacturing value added.

However, there has been concern that in Pakistan the SME sector has not been able to realize its full potential. The SMEs continue to suffer from a number of weaknesses, which hamper their ability to take full advantage of the opening of economy and the increasingly accessible world markets. The areas of constraints are normally identified as labour, taxation, trade capacity, and finance and credit availability.

It is understood that despite previous efforts the SME sector has not received due priority on account of segregated efforts and non-consolidation of programs to achieve well targeted results. In order to move forward, we need to develop a common vision for SMEs to be the real engine of growth. Our vision also needs to be achievable so we may find motivation in implementing phase.

Implementing change requires the formulation of a Policy for SME development and assigning specific responsibilities for its implementation and continuous improvement. The Government of Pakistan has thus constituted the SME Task Force, by Notification No.1 (68)/2003-Inv-III of 29 January 2004 of the Ministry of Industries and Production, which is to define the basic elements of our SME policy.

As there are many cross-cutting issues to be addressed, the SME Task Force is composed of diverse sectors and levels of Government and includes major stakeholders of the private sector, and SME in particular. Where the SME Task Force deems it necessary or useful, it may invite specific organizations or individuals to assist its work. It may also co-opt further members.