Bruno Gremez and Samir Kasmi are partners of Smart Fintex and CT&F and ex-ABN AMRO, BNP Paribas, Societe Generale.
Over the last four years, we have noticed increasing difficulties for SMEs in the Gulf region to access financing from local banks.
At first sight, we thought that the main reasons behind this could be company-specific, like their sector of activity or their financial situation in terms of profitability, etc. Over time, we have started to realise that this phenomenon is a structural issue for local SMEs. So much so that we had to approach foreign banks to finance local SMEs that had mandated us to structure financing for their business needs, which we did successfully.
Local banks in the UAE are generally quite proactive in serving retail clients, large corporates and government-related entities, and they do that quite well. However, their exposure to SMEs is still unfortunately very limited.
The Khalifa Fund for Enterprise Development, which was created in Abu Dhabi to support Emirati entrepreneurs, warned already back in 2013 that the SME share of bank lending in the UAE was only 4%, even less than the average of the MENA region, which was around 9%. When we look at the statistics published by the Central Bank of the UAE, we calculated that total loans to SMEs compared to total business loans was around 5,6% in 2013.
We did not find more recent statistics but we believe that the situation has certainly not improved since then, to the contrary. Indeed, the Credit Sentiment Survey from the Central Bank of the UAE for Q2 2017 reported a tightening of credit conditions to SMEs compared to larger corporates.
In a country like the Netherlands, the Nederlandse Vereniging van Banken, the local bank association, published in its last fact sheet that lending to SMEs amounted to EUR 126 billion or 45% of total corporate loans. That is 8 times the level of the UAE.
To add to this figure, one should note that Holland is known to be a country with a relatively high number of large multinationals on which any major Dutch bank will naturally be largely exposed.
The comparison between the UAE and the Netherlands is pertinent, not just because we have worked in both countries. Both countries have relatively limited internal markets compared to larger countries, but compensate that by having built very open economies where a large proportion of SMEs contribute to their GDP.
So, the question is why local banks in the UAE are so reluctant to take risks on SMEs. To put this question into perspective, one should realise that SMEs represent nearly 85% of all establishments in the UAE, but more importantly, they account for 60 to 65% of the workforce and contribute around 50% of the total country’s GDP.
Lending to sovereign entities is, like in any country, the safest risk that a bank can take. Capital requirements from regulators for sovereign types of risks are usually very limited, which also helps banks generate attractive risk / returns.
Retail clients offer banks the advantage of risk diversification: banks spread theirs risks over a large number of small individual clients by lending relatively limited amounts of money to each of them individually. Next to that, lending to retail customers can be largely be collateralised. A significant portion of these loans is usually made of mortgage or car financing. Banks have recourse on fixed assets in case the customer defaults. That protects the bank whenever a customer faces any financial hardship.
Large corporates offer local banks lots of comfort thanks to a combination of elements: their size and strong market position, their financial transparency, the strength of their balance sheet, and their financial flexibility. Local large companies have indeed usually access to a wide variety of financial instruments to fund their corporate developments, which consist of a combination of equity and debt capital markets products on top of bank financing. Large corporates are less dependent on banks and this improves the risk perception of banks.
Most of the time, SMEs we come across have very basic and reasonable needs. They do not require banks to finance complex, long-term investments. They mostly need working capital finance for their next business cycle.
When it comes to banking SMEs, local banks tend to use the same strict criteria that they apply to larger corporates. They typically require from smaller companies audited financials over a minimum period of time, usually three years. Successful start-ups will typically fail to meet such a criteria. They also require companies to meet minimum equity and turnover thresholds. Many profitable companies may fail to comply with these criteria because they have not yet grown enough to meet these hurdles.
Most of the time, local banks impose these strict requirements because they look at the financials of those SMEs as if they were performing the credit assessment of larger corporates. They especially do not look at the underlying business to be financed, since banks are not comfortable or used to collateralise their exposure on SMEs with those current assets that the banks would finance, like inventories and receivables.
Actually, local banks feel comfortable with mortgages on local fixed assets. However, in case of default, converting a fixed asset into cash, in order to repay a loan, may take a long time, sometimes many months, if not years. Converting current assets into cash is normally much easier and quicker. Of course, this assumes that credit facilities are properly structured.
Dubai has very successfully positioned itself over the last two decades as a major trading hub between countries of the Middle East, Asia, Europe and Africa. Trading is a buoyant sector of activity where SMEs are dominant. Given the importance of these SMEs to the local economy, local banks would be wise to look at the example of European banks in general and Dutch banks in particular that have developed for a very long time their technical capabilities to serve SMEs active in trading by securing their exposure with primarily current, liquid, self-liquidating assets.
European banks have proven over many years that such business can be developed responsibly and profitably in a way that enables SMEs to grow their business and banks to earn money. We would welcome discussions with local banks to share with them our experience in putting in place solid financing structures that have proven to fully preserve the interests of banks in the unlikely scenario where a client faces any financial hardship.