The small and medium enterprises (SME) of Pakistan are the backbone of our economy. With more than 5.2 million companies distributed between manufacturing, services and commerce, SMEs contribute almost 40 percent to GDP and use more than 80 percent of the non -agricultural workforce. From Gujrat furniture manufacturers to the new Karachi technology companies, these businesses reflect the diversity and potential of Pakistan’s economic panorama.
However, despite their significant contribution, many SMEs cannot reach their maximum potential. The trip from the potential to performance is still difficult for many, mainly due to structural and systemic barriers. Although public and private sectors have been positive efforts to support SMEs, including the initiatives of the State Bank of Pakistan (SBP) and the SME Development Authority (Smeda), many small businesses continue to face considerable challenges.
After reviewing hundreds of SME financing proposals over the years, a subject is constantly highlighted: the potential is not the problem, access is. Many companies fight to climb due to obstacles such as limited access to credit, weak legal frameworks and insufficient enabling infrastructure.
Small businesses represent the majority of private sector activity, but receive less than 7PC credit from the private sector, one of the lowest proportions in southern Asia
Access to capital remains a persistent barrier to the sector. SMEs represent the majority of private sector activity in Pakistan, but receive less than 7pc credit from the private sector, one of the lowest relations in southern Asia. The central problem lies in how “financing” companies are defined.
Traditional loan models in Pakistan are based on collateral, which means that banks prefer assets, such as titled Earth or Property. However, most SMEs operate from leased facilities, household configurations or shared spaces, which means that their largest assets, such as inventory, accounts receivable and talent, do not qualify as acceptable guarantees.
Take the example of Ali, a Gujarat furniture exporter, which obtained a considerable export order from an EAU client, with a partial payment in advance and healthy benefit margins. However, when he requested a loan of RS10M to comply with the order, he was denied since he did not have a property in the main cities such as Lahore or Karachi. Despite a solid commercial case and a verified buyer, the exporter could not meet the rigid requirements based on the guarantee of a traditional loan system. The story of Ali, however, is not unique. Many companies with real potential are not detained for the lack of demand, but by standards of outdated loans.
Banks are awakening the reality that SMEs need much greater support, and that their financing struggles have not been addressed for too long. What is needed now is a broader change in the way we evaluate solvency. It is time for the entire industry to move to expand loans based on cash flow, where financing is linked to the income flow of a company instead of physical assets alone.
In addition, the expansion of the credit guarantee schemes, where the risk between the bank and the SME is shared, can encourage more loans to this vital sector. Institutions such as the Pakistan credit guarantee company continue to play a key role in this area, but a broader adoption of these models is crucial for SME growth.
Another challenge facing the SME sector in Pakistan is the weak legal framework for application and recovery. Even when banks are willing to lend, recovering loans from SME is often a painful process. One of the central problems is the weak mortgage execution framework of Pakistan, which allows the delinquent to delay or avoid reimbursement, discouraging banks to increase their exposure to SMEs.
A key element in this history is section 15 of the Ordinance of Financial Institutions (Finance Recovery), introduced in 2001 to allow banks to recover the guarantee without going through prolonged judicial procedures. Its objective was to accelerate loan recovery and reduce loan risks. However, in 2013, the Supreme Court demolished it, stating that mortgage execution without judicial supervision violated article 10-A of the Constitution, the right to a fair trial. For the next three years, banks operated without a clear legal way to recover the guarantee. This legal vacuum severely impacted SME financing, as the lenders captivated at risk.
In 2016, the Government recreated section 15, with some amendments that provide the right to a fair trial to customers, according to the spirit of article 10-A; However, the same was immediately challenged before the higher courts. The Superior Court of Lahore confirmed it in March 2020, and in October of the same year, the Supreme Court dismissed the appeals against him. This reaffirmed the rights of banks to mortgage execution in guarantee.
However, in practice, recovery remains slow and uncertain due to delays in court, frivolous litigation and lack of application. Legal ambiguity continues to paralyze the purpose that section 15 was destined to serve.
An example of real life illustrates the problem clearly. A textile SME in Faisalabad breached a loan of RS50m. The loan bank initiated the recovery under section 15, but the borrower filed a false reimbursement claim and obtained a suspension order. For the next four years, the case remained caught in court while the borrower moved active and continued operations with a different name. The bank finally absorbed the financial loss and, as expected, reduced its future SME loans. This is not an isolated case: it reflects a broader pattern throughout the financial sector.
To address this problem and unlock the financing of SMEs, specific legal reforms are essential. First, suspension orders must be linked to time, limited to two or three months unless there is a convincing reason to extend. Second, the courts must ensure that both parties are heard before granting a stay, to avoid misuse. Third, fast track procedures must be introduced with fixed deadlines for collateral auctions. Finally, tax incentives must be offered to auction buyers eliminating or reducing the seller’s tax obligation, increasing participation and accelerating assets.
Unless these reforms are implemented, banks will continue to avoid SME loans, depriving the economy of their most dynamic growth engine. Fixing the mortgage execution frame is not just about protecting lenders, but it is about creating a healthier and more inclusive financial system for Pakistan.
The future of Pakistan’s economy will have no form not in joint rooms but in workshops, warehouses and small offices throughout the country. If we want truly inclusive and sustainable growth, SME empowerment is not optional, it is essential.
The writer is the president and CEO of JS Bank and a member of the Steering Committee of the Banking Summit of Pakistan, an initiative of the Pakistan Banks Association
Published in Dawn, The Business and Finance Weekly, August 18, 2025
