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29 March 2024

Call to set up specialised banking units to help SMEs

Call to set up specialised banking units to help SMEs. (EB FILE)

Published
By Nadim Kawach

The UAE needs banking units which are specialised in providing funding for small- and medium-sized enterprises (SMEs) as they face obstacles in getting financing on the grounds that they are a high-risk sector, according to an official study.

Given their significant role in domestic development because of their large number, the country should facilitate the creation of more SMEs, mainly those which are export-oriented and less-reliant on labour, said the study by the government-controlled Emirates Industrial Bank (EIB).

It estimated that the UAE has about 208,000 SMEs, accounting for nearly 80 per cent of the country's total companies of about 260,000.

EIB said SMEs form the backbone of any economy and this makes them critical for the process of development and growth.

While there are several issues regarding fostering SMEs, their financing is foremost as they usually do not have access to organised capital markets.

"Bank financing is usually their only option, and is the predominant source of external financing for most SMEs. However, banks consider SMEs to be relatively high risk, which on the one hand impedes their ability to obtain funding, and on the other leads to the charging of higher interest rates," it said.

"Commercial banks are keen on business which meets the working capital needs of businesses, but less on business to finance SME start-ups. Thus, there is a need for dedicated banks, working on commercial principles but devoted to financing of the setting up of SMEs. Currently, not only the UAE but the entire GCC region lack institutions which specialise in funding SMEs."

The study said such institutions exist in Western countries and even China, adding that the larger demand for SME funds in the region can be expected not from setting up new enterprises, but from existing ones.

"There is a need for the establishment of dedicated/specialised banks and the concept of 'house bank' …. this is where the concept of a 'house bank' as popular in Germany for SMEs can come very handy," it said.

"Here, bank lending is exercised through close, long-term relationships between an SME and one particular bank – and not deal with several banks, unlike large enterprises which could be dealing with upwards of 10 banks at any time."

According to the study, this puts the house bank in a position to reduce risk and charge a lower interest rate, at least compared to another bank which does not have the same amount and quality of information on the SME and will therefore charge the debtor a risk premium to make up for this lack of information.

"The house bank is entirely a commercial entity and run on market principles without any subsidy element," EIB said.

"SMEs certainly need to be fostered and encouraged. A blanket policy to encourage them is not appropriate. In some economies, they have been seen as too many and too small and focused on small-scale trade. This could also be the case in some sectors in the UAE. For example, SMEs are known to be more labour intensive and given the labour shortage in the UAE, capital intensive SMEs employing less labour and supporting growth should be fostered."

Besides funding and other facilities, an index needs to be set up to serve as a benchmark for SMEs in the country, the study said.

"Some benchmarks should be established, not for the entire population of SMEs, but SMEs by each individual business sector. There is a need to create a sector-wise 'SME Index' to establish the role of SME enterprises. This index could even be based on different definitions," it said.

"Currently, there are several definitions of SMEs used worldwide which vary considerably, not only by threshold but also by the criterion. The SME Index can be simply calculated as the number of SMEs in proportion to total enterprises."

EIB cited a study by the Dubai Chamber of Commerce and Industry showing that bank credit represented a major source of funding for SMEs in the UAE.

It also found SME companies faced difficulties in obtaining the needed liquidity as the country's commercial banks classify SMEs as high-risk categories because they view SMEs financial structures as weak.

In addition, banks maintain that some of these projects lack feasibility studies, which forces them to classify them as high risk.

At the same time, banking regulations instruct banks to finance SMEs up to 10 per cent of the total banking portfolio.

"A study released earlier this year by a private consultancy firm found that more than half of the SMEs in the UAE were unable to get the finance they required and the same proportion of SMEs surveyed were unhappy with the interest rates they were paying. This survey also showed that overdraft and letters of credit facility were the chief requirements of SMEs in the country," EIB said.

"According to the same survey, more than half of SMEs in the country were facing difficulties in accessing credit. The report also mentions that interest rates for unsecured lending to SMEs [reportedly as high as 15 per cent] are much higher in the UAE compared to those in Western markets."

It said the high rate is the result of a risk premium, as the perceived risk of SME lending in the UAE is high. Typical interest rates in the UAE for secured lending for overdrafts were four and 10 per cent respectively which are close to international norms, according to EIB.

"The risk premium that drives up interest rates is primarily the result of an informational asymmetry between lender and borrower," it said.

"This situation arises largely because the lending bank does not have adequate information about the borrower. It can be asserted that this is largely a procedural and standardisation problem.It can be corrected by establishing standards of information revelation to which the borrowers must adhere with discipline with accompanying documented proof."

EIB said the survey had also found that the loan rejection rates for those applied by SMEs to be rather high. "If so, it suggests this is partly due to the potential borrowers' failure to comply with banks' requirements.

"Some banks are of the view that accurate financial statements were difficult to get from SMEs and in rare cases, recovering money/assets was a complex and time consuming process. This needs to be corrected and should not be difficult if the pre-conditions of funding are amply made clear to SME borrowers. A survey on the causes of rejection would provide valuable insights into the problem and lead to the appropriate remedy."

The EIB study followed a decision by the UAE early this year to abolish a requirement for a minimum Dh150,000 capital to start small companies.

Under a decree by the President His Hignness Sheikh Khalifa bin Zayed Al Nahyan, Ruler of Abu Dhabi, founders of limited-liability companies (LLCs) are allowed to decide capital that will be sufficient to achieve its objectives

"This decree illustrates the insight and strategy of our leadership to develop the investment environment in the country and support diversification plans to ensure economic prosperity for all citizens and residents," said Minister of Economy Sultan bin Saeed Al Mansouri.

"Our leadership is committed to strengthening the performance of SMEs, which are a major contributor to the UAE's GDP."

Ministry figures showed SMEs contribute 46 per cent of the GDP and form around 80 per cent of the total projects worldwide.

"There are many challenges facing SMEs in the UAE, including lack of training, financing, high operation costs, expatriate labour, absence of marketing network to promote national products and procedural obstacles," Mansouri said. "We should exert efforts to tackle these challenges, by developing SMEs across the UAE. We will also work to facilitate procedures of registrations and financing and to conduct training programmes."

There has been no official data on the size of credit to SEMs in the UAE but Central Bank figures showed the country's 24 national banks and 28 foreign units have extended a total Dh172 billion in personal loans for business purposes. The loans accounted for around 18 per cent of the total credits of Dh949bn provided by the banks by the end of July.

Experts said the UAE had the second highest number of SMEs in the six-nation Gulf Co-operation Council (GCC) after Saudi Arabia at the end of 2008.

They have mushroomed over the past two decades within the country's long-term strategy to diversify its oil-reliant economy. The focus has been on the industrial sector, which has received in excess of Dh77bn. Nearly 75 per cent of those investments have been pumped by Abu Dhabi and Dubai.


What are SMEs?

There is no standard global definition of small -or medium-sized enterprises (SMEs). In the UAE, SMEs are classified according to the number of employees and the level of investment.

A firm is considered large if it has more than 100 workers and investment worth more than Dh5 million.

A company with 10-100 employees and an investment of Dh2-5 million is considered medium-sized, and a firm with 3-10 workers with an investment ranging between Dh200,000 to two million is considered small.

There are 260,000 companies in the UAE according to estimates by Ruwad Establishment, and 208,000 of them are SMEs, roughly accounting for 80 per cent of the economy.

Data on SMEs is largely available from private sources, is not official but adequate as an indicator.

 

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