Why UAE banks shun lending to SMEs

Changes in operating structure will help unlock more credit, says executive.

Banks have abundant liquidity and can overcome financial woes of small and medium enterprises (SMEs) provided the sector incorporates fundamental changes in its day-to-day operations, according to a senior banker.
Mahdi Kilani, head of SMEs committee at the UAE Banks Federation, said the SME sector's true potential could not be tapped despite the best incentives and support given by the federal and local governments.
Elaborating, he said the government ensures availability of generous credit facilities, necessary training and technical assistance to SMEs, which is considered the backbone of the economy. However, banks and financial institutions are not happy with the SME working environment and have proposed a plan to revitalise the sector.
"SMEs neither have assets to pledge with banks nor do they maintain proper accounts to show their financial history and health. So, many banks have to do unsecured lending, which is expensive and one of the main challenges in promoting this sector," Kilani told Khaleej Times in an interview.
He said SMEs lack proper books and a management structure in most cases. It is one of the main challenges for banks to ascertain the financial worthiness of small companies.
"So, banks have to set up an early warning mechanism to keep an eye on their borrowers' business before they default on loan servicing or when they get into financial troubles and leave the country to avoid paying debt," he said.
Addressing challenges
The UAE Banks Federation (UBF), which represents 43 banks in the country, has constituted a committee on SMEs to look into the challenges faced by the sector.
The UBF has identified five key areas where banking and corporate regulators can take steps to encourage more documentation, he said.
In the absence of a taxation system, a big majority of small enterprises neither maintain account books nor have bank accounts. However, mid-sized companies operate in a better environment as most of them audit accounts and have a corporate structure.
The UBF is working with the Central Bank of the UAE, the Ministry of Economy (MoE) and Ministry of Finance (MoF) on several initiatives to bring changes.
"A new definition of SMEs; introduction of a mandatory corporate governance code; law on bankruptcy; and a law on asset registry, if implemented, will change the situation and banks will be encouraged to give higher loan limits to SMEs," Kilani added.
Kilani said the banking industry wants a definition of SMEs based on annual sales turnover rather than workforce or capital. The definition will allow for specific rules and regulations to better regulate the sector, he said.
Corporate governance
The Federation is also advocating for the introduction of a code of corporate governance at the national level, whereby SMEs would be required to maintain accounts and adopt a corporate structure depending on their size and sales turnover.
"If we have a code of corporate governance at the national level and every single company - small, medium or large - is obliged to enforce it, then things will be different," Kilani said.
The UBF is also working with the authorities on a law allowing SMEs to declare insolvency.
"At present, SMEs can be liquidated within a week," he said. Its owners are mostly expatriates who can leave the country when they get into financial trouble to avoid a possible arrest.
The bankruptcy law would allow them to stay in the country and work with banks to settle loan default and other financial matters with creditors and trade partners, he said.
There are an estimated 300,000 SMEs registered in the UAE, said Kilani, out of which 200,000 are actively engaged in business. Small firms with a sales turnover of over Dh15 million are estimated to be around 150,000.
Unsecured lending
Around 90 per cent of such firms neither employ accountants nor maintain account books. So, any lending to them is unsecured and expensive for lenders.
Around 50 to 60 per cent of medium-sized firms employ accountants and audit accounts, which makes it easier for financial institutions to lend based on financial history, Kilani said.
Lending to SMEs is growing by 10 to 15 per cent year-on-year, he said.
The UBF is also offering its input on the Asset Registry Law, which is in the pipeline. It would allow for pledging immovable assets such as plants, machinery and equipment with banks. This will help small manufacturing companies and service providers in a big way.
The law will allow banks to buy immoveable assets for clients in their names after registering a lease contract with the MoE or MoF. Once the debt is paid off, the asset can be transferred to the client.
At the moment, banks cannot finance immovable assets for SMEs until they have substantial collateral to pledge. Under the proposed law, a mechanism would be introduced on the lines of motor vehicle registration, where the plant and machinery would be registered in the name of banks. It cannot be sold without getting a no-objection certificate.
- haseeb@khaleejtimes.com