Financing of new enterprises

Surveys of small and medium scale rural enterprises in Bangladesh (Ahmed 1984, for example), other South Asian countries, and Africa frequently reveal that financing constraints are binding. But closer examination of the findings uncovers equivocation, both with respect to need, as well as local availability (Aryeetey, et al 1995). Proposals about remedying the situation have become more hedged as experience has accumulated. Cross-country evidence suggests that entrepreneurs draw personal savings and, if possible, the resources of the extended family to set up an enterprise. Thereafter, profits are the main source of funds for expansion. Small firms in Africa and Bangladesh do obtain some working capital from informal sources, credit cooperatives, and banks. They also receive credit in the form of raw material advances from suppliers and advances from their customers (Islam and others 1994). Because most borrowers cannot supply collateral and banks have difficulty ensuring repayment, banks rarely extend term financing for equipment and structures. Likewise, although rotating savings and credit associations (ROSCAS) are widespread in Asian and African countries, they rarely contribute directly 36 to the development of small-scale industry. They do not contribute mainly because the amounts involved are fairly small (Jaffee 1994) and because the loans are mainly used for consumption purposes. But if these associations are able to spread and strengthen the ethic of disciplined saving, as in Taiwan (China) (Besley and Levenson 1993), then they can indirectly encourage rural industrialization by increasing household demand for durables. The message is that very small pools of institutional finance do not have a discernible effect on rural industrialization. Only when the pools expand do they enter the picture, either through market demand or, as in China, by enabling community-managed rural cooperatives to finance industry.

In Africa low rates of rural household savings have rendered ROSCAS ineffectual for industrial purposes. Household savings are higher in Bangladesh, in areas where the Grameen Bank, which requires that borrowers save, is active. But these efforts will be a slow process, and will probably work through the demand side rather through direct industrial financing. Does that mean that financial instruments are ineffectual or irrelevant? The Bank's record of lending to small and medium-sized enterprises shows that the cost per job created was US $4,000 in Asia and nearly US $10,000 in Africa (Webster 1994). Programs involving development banks were ineffectual, and lending for technical assistance yielded slim returns. But if the local business environment was buoyant and a base of supportive institutions was functional, financing through competent banks or NGOs produced good results.

Continuing to improve savings, investment, and exports would spur the rural industrialization in Bangladesh. Institutions such as Grameen Bank, BRAC, and BSCIC can serve as conduits for financing and extension, with commercial banks also playing a larger role. A deliberate attempt to stimulating rural industry around a small number of strategically located growth poles can ensure the needed supply of services. Lending by the World Bank and other donors, which gave rise to an interlinked cluster of rural enterprises, could start a virtuous circle if early success generated a strong demonstration effect.