Stark SME stats don’t tell the full story

Banks need to be smarter in their dealings with small businesses

Mubarak Al Mansoori, governor of the Central Bank of the UAE projects the country's economy will grow faster than IMF forecasts in 2019. Antonie Robertson / The National

The issue of lending to SMEs in the UAE was discussed at the Middle East Banking Forum in Abu Dhabi on Wednesday, where a number of solutions were raised to tackle a perceived dearth in funding for the country’s small businesses.

Mubarak Rashed Al Mansoori, the governor of the Central Bank of the UAE, said the Bank was working on a multi-pronged solution to the conundrum, one of which is to encourage private equity (PE) investors to take up some of the slack left by the banks.

Important as it is for PE players to participate in the SME sector, it’s worth remembering that their contribution forms a different part of the capital structure for businesses of all sizes. There’s undoubtedly a place for equity investment in SMEs, but that doesn’t mean they won’t need debt as well.

That’s not to say that the Central Bank is looking for solutions in the wrong place. But it’s worth noting that the bank has already done everything in its power to support the SME segment. The banking sector and the SMEs themselves, however, deserve a little more scrutiny.

Speaking on behalf of the banking sector at the same forum, Abdulaziz Al Ghurair, the chief executive of Mashreq Bank and head of the UAE Banks Federation, noted that SME loss rates for Mashreq stood at around 20 per cent, a pretty stark figure. But it’s worth remembering that such a headline number does not mean that distribution is uniform across the bank’s small business clients.

For example, consider the scenario of every bank experiencing 20 per cent loss rates, versus the scenario of banks representing half of SME lending experiencing 35 per cent loss rates and the other half experiencing 5 per cent loss rates, which gives an average 20 per cent loss rate. The first example might indicate that the issue is with the SMEs, whilst the second scenario definitely indicates an issue with some of the banks.

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In either case there is another important issue to look at, and that is the assumption that the SMEs who take loans represent the whole SME sector. This is not necessarily true. Consider the following hypothetical example.

Imagine two SMEs, one which is doing well and is cash flow positive. It considers expanding by taking on debt but the owner-manager is required by the bank to provide personal security cheques to the bank in order to receive the loan. If you were in his place, i.e. your company is doing well, would you risk going jail on the chance that your company faces financial difficulties? I know that I wouldn’t, and would look at other funding sources.

On the other hand, consider an SME that is in financial difficulty, to the extent that the owner-manager is about to lose everything, and he and his family face living on the streets. In such a case, the business owner might decide to risk taking on a risky loan – and the prospect of a jail term – to ensure the security of his family, let alone his business.

In other words, it’s the SMEs that are acting on a shakier financial footing that are more likely to take out loans from a bank in the first place. This phenomenon is called the self-selection bias, and may be skewing some of the figures put out by the banks.

The 20 per cent loss rate figure cited by Mr Al Ghurair, while accurate, may therefore be missing the bigger picture. Within the wider banking sector, such figures may also mask the fact that some banks might be terrible at lending to SMEs, or that there is a self-selection phenomenon whereby bank demands for security cheques that can lead to jail time is scaring away the stronger SMEs.

So what else can be done to help small businesses? One big step forward has already been taken by Dubai, which this month announced a partial dismantling of the jail-time framework for bounced cheques. Here’s another idea. According to the Central Bank’s monthly statistical bulletin, resident government and government related entities’ deposits with banks stood at Dh384 billion at the end of September, representing 24 per cent of total deposits in the country. That’s a lot of deposits.

If the government wants to spur SME lending, then the Central Bank can easily provide a report on which banks are effectively lending to the SME sector, and these substantial deposits can then be shifted in part to support these banks. Even better, perhaps other conditions could be added to receive those deposits, such as requiring collateral other than personal security cheques.

Or, indeed, enterprising banks that are competent in lending to the SME sector can come up with their own innovative proposals about how to lend to small businesses, taking into account the specific requirements that such businesses have. Banks can complain about SME losses as much as they like, but it’s their responsibility to invest in their competency and really learn how to properly work with the sector.