Financial Inclusion

It is expensive to be unbanked in the US

By Bruno Gremez and Samir Kasmi, Fintech entrepreneurs and co-founders of Fincluziv

As Europeans, we started spending time in the US after our fintech startup Fincluziv was selected and invited to take part to the BECU Fintech Incubator in cooperation with the University of Washington earlier this year.

Obviously, we are not unbanked people, but having bank accounts outside of the US does not mean you can easily use them for day-to-day transactions in the US. This is how, in our day-to-day life, whenever paying bills, making payments, etc, we discovered that a number of simple things can get complicated when you do not have any US bank account (yet). We started to talk to Americans, including bankers, and discovered a financial world completely new to us.

As Europeans, we opened our first bank accounts when we were teenagers. It was easy, and more importantly, free. In Europe, anyone has the right to open a bank account. It does not offer any credit facility or credit card, unless you request one and qualify for it, but it is very handy. Through your bank account, you can pay and get paid fast, digitally, online without having to visit any branch, and you can also effect international payments. As there is usually no minimum deposit requirements, it is by no means a luxury.

A bank account becomes even necessary once you start working, since employers typically request you to share your bank account details in order to pay your salary digitally. Employers would usually not accept to pay salaries differently than through straight bank transfers. As more and more European countries want to ban cash in order to promote digital money as a way to combat tax evasion, money laundering and terrorist activities, this is surely not going to change any time soon.

When we arrived in the US, we naively thought that we would wire money from any international account to pay bills, rent, etc. Nothing was less certain. For instance, when you sign your rental contract, you cannot wire money internationally to pay for your accommodation. You also cannot withdraw cash from an ATM and pay your rent in cash. You can only pay from a local bank account, or with so-called money orders.

In the US, around 25% of Americans have either no bank account or use alternative finance channels. That does not mean they are unable to work and collect their wages. To the opposite, if you have no bank account, you can receive your wage through for instance an old-fashioned paper paycheck. There is actually a significant number of US employers that pay their employees by checks.

Once you get you paycheck, you can cash in it. There are several ways to cash in a check if you do not have any US bank account. You can go to the bank where that check was issued, to major retailers or to payday lending stores (see later). For that, you will pay a fee for the service, usually a percentage of the check’s value that you cash in. Fees usually amount from around 1% at banks and retailers up to 5% at payday lending stores.

Once you get your cash in hand, you can use it in stores to buy goods. But there are services you will not be able to pay in cash. For instance, as mentioned above, it was not possible to pay for our accommodation by international wire transfers, nor in cash. You need to turn your cash into so-called “money orders” to pay your rent. Money orders are a kind of check to the order of a third-party, the beneficiary of your payment. You can have money orders issued at some retailer shops or at US post offices. In order to get a money order issued, you will pay yet another fee of around USD 1 for each money order.

So in short: you incur fees in order to cash in your wage check, and you pay yet other fees each time you need money orders to pay your bills. But it does not stop here. If you need money for more important transactions like buying a car, which you may very well need in order to get to work, you may require a loan. If you have no bank account, you have no credit history. The problem is that the US banking industry is based on credit history and the so-called credit scores.

The logic behind a credit score is that it shows your ability and willingness to service your debt based on existing borrowings. In Europe, if you need a mortgage loan or a car loan, you are more likely to get one from your bank at good conditions if you can demonstrate a stable source of income and no debt because it shows you have no financial obligations. Having no financial obligations actually increases your financial flexibility.

In the US, the absence of debt, hence of a credit score, prevents you from accessing any bank loan, irrespective of your proof of income and details of expenses and obligations. Without credit score, you are left only with very expensive options in the market.

There are many expensive borrowing options in the US. To name a few, some car dealership for instance will charge exorbitant monthly installments in order to offer you a car on credit, often charging triple-digit APR. Another form of controversial borrowing option are the so-called pay-day loans, which often end up charging very high triple-digit APR for a loan that is supposed to be extremely short-term, sometimes only 2 weeks.

At the end of the day, from the moment you cash in your wage until you pay your bills and eventually contract some loans in order to afford so major purchases, being unbanked forces you to pay extra fees and bear often exorbitant interest charges. As we found out, it is definitely expensive to be unbanked in the US.

How can FinTechs concretely improve business for small entreprises in Dubai.

By Bruno Gremez, Co-Founder of Fincluziv, Smartfintex and CT&F, ex-ABN AMRO and BNP Paribas.

I read recently a very interesting article published in Business Matters, a UK publication for SMEs. The article described a number of transformations experienced by the financial sector in recent years with the so-called FinTechs and explained that these changes were gradually translating into a number of advancements that are improving the way small entreprises can conduct their business and get access to financing.

I will summarise below these main changes and insist on one particular improvement that can, and should, revolutionise the way small businesses fund their growth.

The first of these improvements is the increased transparency of small businesses. With the help of digitised payment recors and supply chains, SMEs can more easily document and maintain their financial books. That only improves their transparency and eventually reduces the asymmetry of information between potential lenders and SMEs.

A second improvement is derived from the ease and cost of effecting and receiving payments. The likes of PayPal have in recent years brought to the market affordable and convenient payment solutions. These solutions can help SMEs save time and a lot of money when dealings with payment flows.

FinTechs translate into a third improvement. The digitisation of lending through online platforms means that the customer experience greatly improves at every stage from the loan application, through the loan processing and the loan approval and disbursement. This reduces the time and the complexity of applying for any loan.

A fourth improvement is derived from lower international transfer costs. Any small entreprise doing business overseas, which is the case of a vast majority of companies in an open economy like Dubai, incurs huge costs due to transfer charges. Next to transfer charges, conversion rates often translate into huge costs for the business.

The last, and to my view, most important improvement brought by FinTechs for small businesses is what Business Matters calls the shift towards cash-flow based lending. Traditional banks rely on collateral in order to grant credit. The problem is that many banks around the world have a narrow definition of what they consider as acceptable collateral. Traditional banks often prefer to get security over immovable assets. The problem is that start-ups usually have working capital, i.e. short-term liquid assets used in their business, and no fixed assets.

I have met countless SMEs in Dubai that experienced that issue when they approached traditional banks. While most SMEs need credit in order to fund part of their inventories and receivables before those are converted into cash a few weeks later when they are sold to customers and when cash is eventually collected from customers, banks require mortgages on some fixed assets, or worse, cash collateral in order to open a credit line.

FinTechs are gradually bringing improvements on that field too by carefully granting collateral value to some short-term liquid assets in order to enable SMEs to get access to short-term finance, meet their immediate funding needs, and grow their business. That may be the most needed (r)evolution expected by the SME community in thriving economies like Dubai, where they contribute close to 50% of the GDP but represent less than 5% of the balance sheet of traditional banks.

SME Dubai opens the door to 100% ownership of onshore companies with a view to boost innovation.

By Bruno Gremez, Co-founder FincluzivSmart Fintex and CT&F.

The above title may sound bizarre for foreigners who are less familiar with the UAE or the Gulf region. All the more since the UAE are known as a hub for business in the MENA region and have built up a strong reputation as a business-friendly country in the world.

One has to realise though that while foreigners can have 100% ownership of their business if their company is established in so-called free zones, companies established “onshore”, i.e. outside any free zone, must be owned for 51% by a local partner, leaving the foreign shareholders with a minority stake of maximum 49%. Why bother? Because onshore companies can do things that offshore companies cannot. For instance, doing business inside the UAE and domestic transactions falls in principle outside the scope of any free zone company.

This is the reason why this new initiative by Dubai SME, an agency of DED (Dubai Economic Development), may be very significant. It could unlock initiatives and investments by enabling entrepreneurs and startups to enter the UAE as full-fledged local, onshore companies with new and innovative ideas and giving them the opportunity to rapidly scale up their business in the UAE.

Dubai SME has offered 100% ownership to small and medium entrepreneurs if they are able to demonstrates that they have completely new and innovative business ideas and the ability to execute them.

This step shows that the government of Dubai is not only taking measures to attract big businesses, but also and even small and medium entrepreneurs, which will be provided with incentives to grow and contribute to the diversified local economy. Currently, SMEs contribute 40% in the GDP of the Emirate of Dubai and the government has the ambition to increase this share up to 45% by 2021 (in less than 4 years time!).

This step is especially important for entrepreneurs who have bright ideas and less capital, and especially the ambition to conquer parts of the local market with their ventures.

The difficulty for SMEs in the UAE to access financing, by Bruno Gremez and Samir Kasmi.

Bruno Gremez and Samir Kasmi are partners of FincluzivSmart 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.