x Abu Dhabi, UAESaturday 20 January 2018

Credit where credit is due but not for small and medium-sized enterprises

Often the bedrock of developing economies, smaller enterprises generate wealth locally and provide employment. But they also depend on reliable financing.

The World Bank says the Mena region is the place in the world where SMEs are least like to have access to credit lines. Bilal Qabalan / AFP
The World Bank says the Mena region is the place in the world where SMEs are least like to have access to credit lines. Bilal Qabalan / AFP

It is widely acknowledged that on a global scale, commercial bank lending to small and medium-sized enterprises (SMEs) is not sufficient despite rhetoric and various governmental incentives in a number of countries to grow this area.

There are two primary reasons for this: many banks are seeking to rebuild their capital bases to prepare for tighter regulations and also protecting themselves against additional potential write-downs or other unquantifiable adverse effects to their business in the near future.

This rationale is common and is likely to prevail for the short term at least, given the broader unresolved issues in global finance and the finely poised global macroeconomic situation.

Both of these factors foster a cautious approach for commercial bank lending to SMEs. In geographies with more developed capital markets we have consequently seen the development of SME-dedicated funds making direct lending investments and filling the gap in the market left by banks.

With that in mind, what chance do the smaller mid-market borrowers have of raising loans to fund their expansion especially in a region such as the Middle-East and North Africa (Mena)?

According to a World Bank study, the Mena region is ranked as the place in the world where SMEs are the least likely to have access to credit lines from financial institutions. Only 20 per cent of SMEs in Mena have this access, which makes them less likely to have available bank lines than their peers in Africa and half as likely to have bank facilities than their Latin American and Caribbean equivalents.

Within the wealthiest part of Mena - the GCC with some of the highest GDP per capita rates in the world - bank lending to SMEs is almost negligible. In the GCC, only 2 per cent of bank lending is devoted to SMEs.

These numbers are extremely low but are even more surprising when compared to the importance SMEs have in the overall GCC economy, whether that is expressed through a share of employment or of GDP. Even in oil-exporting countries such as the UAE, SMEs account for 60 per cent of nominal GDP and 86 per cent of employment, according to the Ministry of Economy.

SMEs therefore represent an important part of both the regional economy and social fabric because of their ability to rapidly create jobs. This is why governments in the region are increasingly keen to foster the development of bank lending to SMEs. Given this situation, a number of the larger banks in the region have established dedicated SME finance teams.

The typical form of security required by banks is a mortgage over assets as well as personal guarantees from the owners/main shareholders. As such, asset-light SMEs with strong cash generation that require growth capital can often find it difficult to raise flexible debt financing.

Banks in the region are also typically very cautious when it comes to cross-border transactions, with domestic clients the main focus. Acquisition finance is something that in our experience SMEs struggle to raise.

In western Europe, the US and certain parts of the Far East, private equity (PE) investors typically secure debt financing either via banks or via the capital markets.

In some cases, both instruments are combined. In the Mena region, where there are no established sub-investment grade capital markets and only a few examples of institutional credit investors, PE investments are typically fully equitised. We believe that this is holding back the development of PE in Mena.

Why is this the case and why does it matter?

There are some peripheral reasons such as the lack of need for the tax shield that debt provides in countries with higher levels of taxation, which can make debt less attractive in the Mena region.

However, the main constraint on SME corporate and PE-related financing is not because of the lack of demand but rather the limited supply of structured lending. When asset-light borrowers seek growth capital in the form of an acquisition or a capex loan, lenders are often required to take a view on future cash flows rather than relying mostly on the present situation of the borrower. We believe this structured lending approach is not yet widespread enough in the region.

The core of structured lending, we believe, is to analyse and quantify the future financial benefits of a proposed growth plan and carry out detailed due diligence on the borrower's financial and commercial prospects. Structured cash flow lending is required to maximise regional entrepreneurs' growth and PE investments' profitability. For example, a strong corporate with few tangible assets available to mortgage but with high margins and limited debt can struggle to receive bank financing despite potentially being a good investment.

Similarly, a corporate seeking to invest in earnings-enhancing capex that does not involve making assets available to pledge to banks can find limited appetite from lenders. A cash flow investor can look favourably at and analyse the future value of these investments.


Christopher Baines is managing director and co-head of Gulf Credit Partners