The art and science of SME

Regional banks are waking up to the growing need to offer tailor-made services to cater to the growing number of start-up enterprises.

Statistics released by the International Finance Corporation and World Bank Group in January 2007, show that on average 80% of the total regional business and employment market is made up of Small and Medium Enterprises (SMEs), and this figure is as high as 86% in the UAE.

SMEs, from a 2 person operation to a 50 strong business, are considered the backbone of a country's economy. In the Middle East alone SMEs make up a sizeable portion of all the businesses incorporated on an almost daily basis. Yet most financial institutions and banks have only recently created specific banking products targeted to the SME sector.

Most entrepreneurs face a Catch-22 situation of having to be credit worthy in order to get funding from financial institutions. On the flip side SMEs have to be in business for 1 year or upward to be credit worthy.

Even if financing is available, the products available are ‘collateral based lending' usually offered by traditional banks and finance companies, made up of a combination of asset-based finance, contribution-based finance, financial statement lending, credit scoring and relationship lending.

Fully secured lending is still the most prevalent form of financing available for SMEs. Most banks still believe that SME financing is riskier than financing large corporate businesses.

The main reason behind this thinking is the higher rate of default amongst SMEs. For this reason, banks are more inclined to fund SMEs with a track record of at least three years. This is because traditionally and it has been proved that if a start up can survive its first three years then the chances of that business being a success increases tremendously.

In some instances Viability based finance is offered in the form of venture capital, but again the business has to project sizeable returns over a relatively short span for 3 years to 5 years. But it is not all doom and gloom for entrepreneurs as this phenomenon is common in most emerging economies.

Bridging the SME Finance Gap

Most SMEs find themselves in the proverbial ‘chicken and egg' situation as they do not have sufficient collateral required for collateral-based lending, and cannot show high returns to justify that risks be taken by venture capitalists. In addition, the Middle East markets have little, or unreliable, information, limiting the effectiveness of financial statement lending and credit scoring.

However, there have been significant changes in the attitudes of banks towards entrepreneurs and SMEs in the Middle East, particularly in the UAE. At present there are few avenues of borrowings, on an unsecured basis, available to SME. However, some banks have now started lending on an unsecured basis.

There are also facilities available for loans against collateral and some loans on an unsecured basis. Banks also see this segment as a potential for cross sell opportunities, to personal wealth management and other related products.

Additionally, financial institutions are broadening the viability based approach. This approach focuses on the type of business and offers more than just monetary support. With the added emphasis on business development there is a clear reduction in risk and the opportunity for the financial institutions to benefit from the increase in returns.

It must be stated that the rate of return or value of returns will not be attractive to venture capitalists, however this mode of financing does reduce the risk profile of the business.

Financial Options Available

In any economy SMEs play an important role in providing the necessary impetus for overall growth. They provide the continuous churn required to enhance and grow any economy. The economic expansion of the UAE has also led the banks to offer efficient, cost effective and comprehensive solutions for SME financing.

Every bank has its own lending criteria. However, at the minimum level every bank looks for three years of audited accounts from the SME. Based on the products available with a particular bank, additional requirements, like gearing ratios, profitability and management stature, are then taken into consideration.

For SMEs that meet the criteria set out by the banks and financial institution there are a range of banking products and services on offer. Based on numerous factors the principal of which is time; banks are providing products and services that help SMEs become more efficient and effective.

To help SMEs manage their business cash flow better, some banking products and financial services offered are; Current Accounts, Fixed Deposit, International Trade Account, FX & Treasury and Cash Management Facilities. Additional products that help keep costs low and generate significant savings are free electronic funds transfer, free cheque collections, free demand drafts and free inter-branch banking.

SMEs can also benefit from some of the add-ons offered with these products including sweep-in facility linked to fixed deposits, local cheque book, personalised payable at par cheque book, monthly statements by courier and e-mail, phone banking, third party transfers through internet banking - usually at no additional cost.

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