UAE small businesses can get priority loan support

SMEs are major creators of wealth and sources of innovation and employment, which governments recognize. However, little has been done to increase the flow of loan capital to this sector.

Debt providers are largely commercial banks only – finance companies and/or platforms have failed to achieve anything significant, due to poor strategies, weak credit processes and an overall credit framework weak in the country.

This leaves SMEs at the mercy of the banks. The most affected are small businesses – those with an annual turnover of less than Dh50 million and willing to borrow up to around Dh5 million. These companies are forced to resort to expensive borrowings on the market or take out commercial loans from banks at extremely high interest rates.

Although they are the easiest to obtain, they are almost always the wrong type of financing required – most businesses require working capital which can be drawn down and repaid as needed. The business loan market is also limited to one or two banks. Therefore, even the offer of this type if funding is in serious shortage.

Never a priority on loans

This is unlikely to change for several reasons. First, lending to this segment is not important for banks. Revenues generated by SMEs are low; infrastructure costs are high to solicit business, manage accounts, manage collections, etc. To illustrate this further, a relationship manager managing a portfolio of 30 large accounts, whose average business size might be around MAD 100 million, can generate 4-5 times more revenue than a portfolio of small businesses ( average size less than 50 million MAD).

The management time could be the same, perhaps even more intense in the small portfolio, because the financial know-how is likely to be lacking.

Second, the problem of short-termism. The activity of SMEs is very profitable if it is built for the long term. This business is doing well on a broad, granular and diversified portfolio base. It takes time to build and maintain.

The SME segment also includes the liability business, i.e. the provision of services such as current accounts, foreign exchange, cash management, etc. A holistic approach involving the solicitation of accounts that migrate from non-borrowing to borrowing must be proactively devised.

Support for SMEs is about the long term

Banks do not seem to have long-term plans and so this approach is lacking. Excessive focus on quarterly and annual performance is the norm, as the focus at owner level is on annual dividend payouts. Consequently, banks do not have the necessary motivation to build a sustainable SME portfolio.

Third, there is the related issue of risk appetite. The SME borrower represents a higher risk profile than large companies, for various reasons. Annual credit losses are likely to be higher than in other portfolios.

However, over time, expanding a bank’s credit portfolio and institutionalizing the SME lending experience will lower credit losses. Again, this takes time and a long-term commitment.

It is for these reasons that bank credit to the SME sector will never improve unless the government intervenes. This is why, in many countries, the SME segment has been considered a priority sector and their lending has been made compulsory. Countries have different approaches and for different reasons, such as supporting weaker sections of society, focusing on particular credit-starved industries, creating jobs in areas with high unemployment, etc.

Compulsory push

Some countries that have adopted this approach to boost SME lending are the United States, Denmark, Ireland, Brazil, China, India, Russia, etc. The UAE’s need to alleviate this problem is clearly linked to the government’s strategy to attract entrepreneurs and investors.

The number of initiatives taken after the pandemic has been spectacular – on visa rules, the issuance of passports, the ease of doing business, some progress in judicial reform, etc. However, apart from the recent revitalization of the Emirates Development Bank and its focus on supporting SMEs, nothing else is evident on the funding front.

Hence the need for the government to declare the SME segment a priority sector and to order banks to set aside a minimum for SME lending each year. A comprehensive program needs to be developed involving lending standards and targets for banks, incentives for them to build the SME portfolio. And preferential terms for SMEs and rapid loan disbursements should be considered and adopted.

Along with this, the government needs to significantly improve the lending framework. Effective centralized registries, streamlined credit bureaus, information sharing standards, effective auditor oversight, introduction of ratings, etc. are just some of the initiatives to adopt.

A comprehensive and far-reaching approach is needed. Even if more banking licenses are issued, it is very unlikely that the behavior of new digital banks will differ significantly from that of existing players. Maybe it’s time to think about a bank dedicated to SMEs…

About Wanda Dufresne

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