SME sector problems
The major problem faced by the SME sector is access to capital. A small or medium business can meet its financing needs through a combination of debt, primarily bank loans, and cash investment ( business equity). It is important for a modern business to keep its cost of capital low in the scheme of its overall economics. Pakistani entrepreneurs have no comfort in either of the modes of financing. The banking system is averse to lending to SME's, due to a pedantic risk- averse approach that does not adequately weigh in the talent in an enterprise or viability of the business idea or an entrepreneur's individual credit history.
In Pakistan an estimated 8 million SME's are currently eligible for credit while only 0.5 million of them ( 6 percent) have any credit facility. As a result, despite the SBP's policies' having struggled to assist SME financing since 2002, the bank credit to SME's is only 7- 8 percent of banks' total lending portfolio to private sector against SBP's target of 20 percent, which is the standard in emerging markets. The meager nature of credit by international standards is further explained by the fact that the total share of bank credit in the economy in terms of ' credit to GDP ratio' is 16 in Pakistan ( 2011- 2015), compared to 52 in India and 122 in Singapore. Data suggests that even that paltry SME financing is disproportionately channelled to medium rather than small enterprises.
The obvious inference from these statistics is that the overall environment for private credit is unfavourable and that too goes to medium and large enterprises. The banks in the country are not effectively performing their core function, i. e. channelling depositors' savings into loans for creditworthy businesses and individuals. Despite extracting a widely known boon from the disproportionate banking spreads- the differential between the borrowing and lending rates- Pakistani banks are unwilling to support the very economy that feeds them. The Musharraf government created a SME Bank in 2004 but the bank has been unable to come into proper operation due to meager financial assets, technical capacity, and small loan amounts ( about Rs. 0.8 million on average). During the same period an USAID- supported technical assistance project was launched involving National Bank of Pakistan ( NBP) but did not go far in addressing the problem.
Although the regulatory framework for private equity and venture capital was first introduced by the Securities and Exchange Commission of Pakistan ( SECP) in 1995 and has been revised thrice in 2001, 2008, and most recently in 2015, the industry is yet to make its mark in any significant manner. As of now there is virtually no private equity firm in operation signaling a lack of confidence of investors in regulatory practices and the overall business environment. It is well known that investorsboth local and foreign- take a lead from the bank lending in deciding to invest apart from the financial space that the credit provides in structuring business finance. The aforementioned low share of Pakistan's bank credit in the economy partially explains the reluctance of investors to invest.
A viable way to mitigate SMEs' finance problem would be to form a business partnership which is an excellent mechanism to raise or enhance early and mid- stage capital, distribute failure risk, and add to management capacity when right partnerships are forged. However, there are peculiar inhibiting factors that discourage such alliances in Pakistan, which mostly lead to business failures when forged. The foremost barrier is a high risk of business failure creating a stressful environment in the business operations and cash flows. The other is prohibitive business dispute cost which stems from the absence of viable dispute resolution mechanisms. The third is the lack of an entrepreneurial culture that could promote partnerships through taking risk and entrusting resources.