Growth of SMEs in Islamic Banking and Finance

Muhammad Arif : Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), Former Head of FSCD SBP, Former Head of Research ArifHabib Investments and Member IFSB Task Force for development of Islamic Money Market, Former Member of Access to Justice Fund Supreme Court of Pakistan

The small and medium sized entrepreneurs are the ones who are involved in originating things in order to fulfill the demand of the local market. It also turns out to be a fundamental tool in income generation and creates employment which boosts the economy.

 Mira (2005) states that SMEs proved to be a vital tool for national income at the same time it also generates employment. On the other hand, this sector has proved its potential in the international arena, which creates a roam for the SMEs all over the globe. Lu and Beamish (2001) stressed that SMEs are the key in globalization and their fruitful relation among diverse nations. So, numerous economists, theorists and entrepreneurs have argued the significance in the economic growth.

SMEs have been defined very differently in terms of characteristics across globs which include employment, capital and income of enterprise (Cunningham and Rowley, 2008). Authorities in different countries have defined the SMEs according to the number of persons employed, assets and other related criteria. For instance, the definition of European commission states that a company which employs less than 250 persons can be called SME. There are further categorizations, for example if an organization has less than 10 workers it is called a micro organization. Similarly if the company has 10-49 workers then it is considered to be Small Company whereas the company which has 49-249 workers considered as medium sized company.

 Loecher (2000) adds the condition of annual revenue not more than 40 million euro and 27 million euro of capital at the end of each financial period. Here, it is quite clear that this criterion is different in developing countries than in the developed countries. This sometimes creates the confusion because of the different assessment criteria among the different nations.

The definition of SMEDA for SME in Pakistan is our benchmark for our research and it describes an organization having not more than 250 employees and capital of less than 25 million Pakistani Rupees and the transaction level of 250 million Pakistani Rupees. With respect to the ownership pattern 74% of the total SMEs are sole proprietors, 13% of them are registered partnerships and 2% are societies, where the rest of them fall into other categories. The sole proprietorship is the most preferred form of ownership in Pakistan, because of the minimum regulatory requirements and convenience in forming such business.

By function, the manufacturing units leads the SMEs populace with 49%, followed by the social, personal and community services sector, which accounts for almost 40%. The rest include restaurants and hotels as well as those who are in the wholesale and retail businesses.

Religious belief in the past appears to be one of the main reasons hindering SME financing. This sentiment is has grown sharper in the last five to six years. A huge demand for a finance that is according to their belief is already present in the SME sector; this can result in good funding opportunities. But it is also a fact that the funding to this sector has dropped significantly over the years, because the banks (both conventional and Islamic) prefer to divert their funds to a safer category in this period of uncertainty (KPMG, 2017).

Here we discuss those SMEs who do not opt for formal finance due to religious beliefs of their management. SME entrepreneurs represent a new potential market of around 3.8 billion dollars for the Islamic banking sector in the coming years, so here we present two possibilities (The investment arrangement in the country has significantly increased in the recent times and the Islamic investment is one of the swiftest sub-segments in the financial sector. Islamic deposits have increased of over 42% and the SBP is enhancing the five year design for Islamic investment industry, stressing particularly on the SME sector. The SME sector even with these measures still considerably underfunded as, more than 89% of SMEs are either deprived or totally neglected by the banking sector of Pakistan.

This is mainly due to the extra cautionary behavior of Islamic banks towards the SMEs. The unawareness of Islamic products among the SMEs and the procedure of the Islamic banks are those factors which are responsible for the drop in Islamic SME lending. We have found out while conducting our research that spiritual belief is one of the major reasons preventing the entrepreneurs to opt for a proper finance. There are more than 25% of these entrepreneurs who do not opt any sort of financing, and 20% restrict themselves to a necessary level. Most of the SMEs rely mainly on informal origins for funds.

The tailor made versions of Islamic banks, in order to facilitate the SMEs towards the standard overdraft (which are being offered by the conventional banks) has somehow helped them. But they have to be more innovative. The Islamic banks need to avoid their “one size fits all” approach and offer the SMEs according to their need, like most of the conventional banks are now offering. The Islamic banks need to develop the required competency, where banks secure such expertise which is essential for building and managing an effective “Islamic SME Banking” business. In the end it is estimated that the potential worth for The Islamic Financing market for the SMEs to be over $ 4.0 billion in the coming five years, taking into account those SMEs which are creditworthy but they do not borrow or limit themselves due to the their religious beliefs.


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