When the current panic in the SME (small and medium enterprise) market dies down, when banks begin to recover somewhat from the shocks created by a tidal wave of “skips”, the worst I have seen in 22 years here, they will, hopefully, put on their thinking caps to analyse what went wrong and how it could have been avoided.
It is quite clear that a mini sub-prime crisis has been created as a result of profligate lending to undeserving clients over the past five years. If indiscriminately throwing money at sub-prime clients caused the global crisis, both corporate and individual, then exactly the same has happened in the UAE.
The same causes shine through — ambitious growth targets, post global crisis exuberance, focus on assets to drive revenues, bonuses based on revenue rather than its quality, easy lending and tolerance of inefficiencies. Yes, plenty to think about.
I will focus on the “easy lending” part, as it is clear there has been a relaxation in underwriting and customer due diligence standards over the years. Given the peculiarities of the UAE market, it is perhaps time for banks to question underwriting processes and examine whether they have suitably evolved with business practices and an environment that has so drastically changed over the past five years or so. I reckon they have not.
With easy credit availability for reasons mentioned above, business practices have become far too sharp, requiring considerably more vigilance and an extremely “market focused” approach in lending. Banks, in my view, maintain too much of an inward looking and analytical approach in assessing SME risk, bar perhaps a couple of local banks which truly have an ear to the ground.
SMEs need to be treated differently and risks assessed differently as well. They retain the characteristics of SMEs even when they grow reasonably large. Which is why the description of the larger SME segment as ‘emerging corporates’ by some banks is more amusing than accurate. After all, they are called thus judging by only one criterion — the size of the company’s turnover, nothing else.
Without labouring the point, it is plain to see that before a company is termed a “corporate” it will have to have evolved beyond size — it must have good corporate governance, professional and deep management strength, well-documented business continuity processes and so on. However, it appears that only size, nothing else, matters.
There are numerous areas to be addressed in banks being more “market focused”, but I will focus on one major one. And that is the engagement of key stakeholders by banks. There are several stakeholders in every business apart from the owners and employees — other banks, service providers, auditors, etc — basically the ecosystem which enables a SME to grow in.
This ecosystem not only provides invaluable information to banks to assess risk, but through it, lenders can actually play a more aggressive role in managing and reducing risk. Let us go through a few key stakeholders and how and why banks should engage them more.
First, audit firms are key. They not only can be a source of invaluable information but as an unregulated service industry, need to be monitored closely as well. There is no shortage of dubious audit firms churning out falsified accounts of companies.
Banks need to come together among themselves and with the audit industry association to create a common rating system and a blacklist of dodgy auditors. They also need to engage more closely and formally with audit companies to discuss industry trends, clients and changing practices.
Second, industry associations need to be partnered with banks to give the former more teeth to name and shame defaulters, to learn of new trends and practices, and of key risks and opportunities faced by businesses.
I have rarely seen a true engagement of trade associations — either individually or collectively — by banks. It is when there is a crisis that associations spring into action and banks engage with them reactively.
Third, the logistics service providers — freight forwarding, transport and warehouse companies, etc, - are vital stakeholders. These vendors have a finger on the pulse of the physical movement of goods and are therefore an excellent store of information. The industry is ready to engage with banks and is well represented by the well run National Association of Freight & Logistics.
Fourth, financial consultants/advisers are key to SMEs here and play a vital role in bridging the knowledge gap that exists among entrepreneurs. Advisers are a mine of information and can be crucial to banks in assessing risk. There is no trade association that brings advisers under one umbrella, but surely banks can apply the same principle as suggested for auditors — rate and evaluate consultants and advisers and engage closely with them.
Bankers need to shake off certain preconceived notions about consultants — that only SMEs that are not creditworthy use them, or that they are a conduit for bribes to be paid and so on. Consultants thrive the world over and would not exist if a real need for advice and guidance did not exist in the SME world.
Fifth, industry brokers — these are a much ignored bunch. Brokers create platforms for businesses and are present across the board — especially in the commodities trade but also in segments such as textiles, building materials and so on. Nobody can be closer to the goings on in trade than specialist brokers — they know who has surplus stock, liquidity issues, bad credit history, profligate spending habits and so on.
I think the drift is clear. Banks need to widen the net of engagement — and create real-time sources of information that is not report-based to assess risk. They need to get out there more, and rely less on paper.
This market is such, as I have said before — it is a giant bazaar and has to be treated as such.
The writer is the Managing Director of Vianta, which works with SMEs in raising bank finance.