Saturday, November 30, 2013

SME financing is much more than money

I have not published anything here for quite a while, because all my effort is working in the Thomson Reuters Islamic Finance Gateway community and it will continue, so you should sign up for the newsletter at  This is just as a teaser since I am just returned from Dubai and got the week off from the Weekly Briefing, so be sure to sign up there for when I return to my writing there. 

One of the key areas in the Global Islamic Economy Summit was the SME sector (it was one of the 7 pillars established for the Islamic Economy).  There is significant potential in that sector that has not been developed, particularly in the GCC, but also in the wider OIC (and there are some gaps too beyond the OIC in the developed world as well).  The UAE central bank governor speaking earlier this week mentioned the sector with an interesting comment:

"We are looking at various options to provide credit to this key segment of the economy outside the banking system. SME financing is very important in job creation and we need to pay special attention to this segment"

This is a clear indication that the banking system has failed to manage the SME sector's demands and it is understandable given their focus on size to mobilize the deposits they attract.  Ever growing deposits have to find a home and it is more cost-effective to put them to work in larger projects.  However, as the analysis I did in the Weekly a couple weeks ago showed, the conventional side of the banking system in the UAE is now dangerously over leveraged to the government-related entities and the new UAE central bank directive will force them to divest in GREs for risk purposes.  The Islamic banks face less of an overconcentration, but are still quite leveraged towards the GREs.

This deleveraging is likely to not be accompanied by growth in financing for SMEs on either the conventional or Islamic sides, or else the governor could have pointed to one or the other as a source of financing for SMEs.

So, with the banking sector unable to service this sector, where should we look?  If you asked me a week ago, I would probably not had a good answer, but I was reminded of one source of services that does serve the SME sector well: payment processing.

I was not honestly rushing to see the country representative of Mastercard at the event, but he was one of the more illuminating as he explained the role that they play beyond debit and credit cards in small business development.  In an ever globalizing world, there is a lot more market there for small businesses besides the 10 miles around their shop, but if they can't get paid, there is not likely to be much development.  But it also doesn't necessarily provide much financing; it is much more payment processing activity.

For these companies to really provide a good boost to entrepreneurship in the UAE (or elsewhere) there will need to be a better bankruptcy law and more acceptance of business failure regionally to encourage more people to try it.  This was a consistent theme of this panel, but there is more.  The person (who I assume was not speaking on behalf of his employer at this point) explained that his wife was interested in starting a cupcake business.  He asked her "What's the PnL?" and got a blank stare back.

This is probably not an uncommon response for small business owners (if I weren't a finance guy, I would have probably given the same look when I started my business).  Banks always ask for the PnL and most small businesses can't provide it because they don't know how to make a business plan, let alone the pro forma financials that a bank would require.  There will be some leeway on this type of information (or at least more hand holding) from non-bank institutions, but the key for opening up finance for SMEs is helping on this aspect.

And that gets to the real issue: an SME is not a small business, nor an entrepreneur. SMEs have over a million dollars of turnover annually.  And they still cannot get bank financing.  What is needed is something outside the banking system that gives them financing and is available for the sub-SME level too.  And that will come with education needs that probably will also apply for SMEs.  It is much more than just finding money, it is about SME development.  If you can crack that nut, you will be much better than I at solving the issue of 60 million new jobs that the Arab world will need created by 2030.  The important thing now is that there are policymakers listening, waiting for help finding the answer, as fast as possible please.

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