SMEs are significant wealth creators and sources of innovation and employment, something well-recognized by governments. However, little has been done to increase the flow of debt capital to this sector.
The suppliers of debt are largely just commercial banks – finance companies and/or platforms have not succeeded in any meaningful measure, owing to poor strategies, weak credit processes and a feeble overall credit framework in the country.
That leaves SMES at the mercy of banks. The worst affected are the small companies – those that have annual sales of say less than Dh50 million and desirous of borrowing up to Dh5 million or so. These companies are forced to resort to expensive borrowings from the market or to take business loans from banks, at extremely high interest rates.
While the easiest to obtain, they are almost always the wrong type of financing required – most firms require working capital facilities that can be drawdown and repaid according to need. The business loan market is also restricted to one or two banks. Therefore, even the supply of this type if financing is in severe short supply.
Never a priority on lending
This is unlikely to change due to several reasons. First, lending to this segment is unimportant to banks. Revenues earned from SMEs are small; infrastructure costs are high to solicit business, manage accounts, manage recoveries and so on. To illustrate this further, a relationship manager handling a portfolio of say 30 larger accounts in which average company size could be around Dh100 million can generate 4-5 times the earnings than from a portfolio of smaller companies (average size under Dh50 million).
The management time could be the same, perhaps even more intense in the smaller portfolio, because financial savvy is likely to be wanting.
Second is the problem of short-termism. The SME business is highly profitable if built for the long-term. This business does well on a large, granular, diversified portfolio basis. This takes time to build and nurture.
The SME segment also involves the liability business, in other words, providing services like current accounts, foreign exchange, cash management and so on. A holistic approach involving soliciting accounts that migrate from non-borrowing to borrowing needs to be proactively imagined.
SME support is about the long-term
Banks do not seem to have long-term plans, and hence this approach is missing. Excessive focus on quarterly and annual performance is the norm, since the focus at owners’ level is on annual dividend payouts. Therefore, banks do not have the motivation to build a sustainable SME book.
Third, is the related issue of risk appetite. The SME borrower represents a higher risk profile than larger companies, for a variety of reasons. Annual credit losses are likely to be higher than in other portfolios.
However, with the passage of time, expansion of a bank’s credit portfolio and the institutionalization of SME lending experience will drive credit losses down. Again, this needs time and long-term commitment.
It is for these reasons that bank credit to the SME sector will never improve, unless the government steps in. This is why in numerous countries the SME segment has been deemed a priority sector and lending to it has been made mandatory. Countries have varying approaches and for different reasons, like supporting weaker sections of society, focus on particular credit-starved industries, generation of employment in high unemployment areas and so on.
Some countries that have adopted this approach to boost SME lending are the US, 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 post-pandemic has been spectacular – on visa rules, passport issuance, ease of doing business, some progress in judicial reformation and so on. However, apart from recently reinvigorating the Emirates Development Bank and directing it to support SMEs, little else is evident on the financing front.
Hence the need for the government to declare the SME segment a priority sector and instruct banks to set aside a minimum for SME lending every year. A comprehensive scheme needs to be developed involving lending norms and targets for banks, incentives for them to build the SME portfolio. And preferential terms for SMEs and speedy loan disbursals need to be considered and adopted.
Concurrent with this is the need for government to vastly improve the lending framework. Effective centralized registries, streamlined credit bureaus, information sharing norms, effective oversight of auditors, introduction of ratings etc., are but some of the initiatives requiring adoption.
A comprehensive and wide-ranging approach is required. Even though more banking licenses are being issued, the behaviour of the new digital banks is highly unlikely to differ widely from the extant players. Perhaps, it is time to think of a dedicated SME bank…