A STUDY ON THE MAJOR CHALLENGES FACED BY THE SME BANKING SECTOR IN UNITED ARAB EMIRATES

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A STUDY ON THE MAJOR CHALLENGES FACED BY THE SME

BANKING SECTOR IN UNITED ARAB EMIRATES

Mr. Allen Baby,

Lecturer, (PhD scholar at Karpagam University, Coimbatore) Emirates Institute for Banking & Financial Studies (EIBFS),

Sharjah, UAE.

Dr. Uma Maheshwari. M,

Associate Professor

Dr. SNS College of Arts & Science, Coimbatore, India.

ABSTRACT

Many sectors which were overlooked some time back as being not profitable, has now become

the hotspots. Same is the case with the Banks in United Arab Emirates with respect to the Small

& Medium Enterprises sector. The personal banking sector is overcrowded, while the Corporate

Banking is only evolving. The potential as the Banks and the policymakers realize, now lies in

the SME Banking sector. Though vast majority of business in UAE are SMEs, the Bank lending

to them is just 3.85% of the total Bank exposure. The opportunities definitely galore; but the

challenges are also many. The study tries to analyze the challenges faced by the SME Banking

sector in UAE.

Keywords: SME, Banking, UAE, Competition etc.

Introduction

SME sector is very critical for the economy of UAE, which is a union of seven Emirates namely

Abudhabi, Dubai, Sharjah, Ajman, Ras Al Khaimah, Umm Al Quwain and Fujairah. The country

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registered businesses in UAE are SMEs. Out of this micro firms account for 72% of the total

business count. SMEs also account for 42% of Dubai‟s total work force and contribute nearly

40% to the GDP of Dubai.

However, Bank lending to this very critical sector is abysmally low. Despite having nearly 50

plus Banks serving the market, SME Banking penetration remains minimal. According a World

Bank and Union of Arab Banks study, out of the totalBank lending, the lending to SME sector in

UAE is just 3.85%. The above study finds that the trend is also in line with the overall Gulf

Cooperation Council (GCC) region, where the total lending to SME sector is just 2%.

This study aims to throw insights into the challenges faced by Banks in making major inroads

into this critical sector. The Government of UAE has launched the Khalifa fund to promote

entrepreneurship among the local population and has instructed the Banks to step up the lending

to this sector in the coming years. The Government has also passed the UAE SME law which

aims at strengthening the SME sector through various measures like fixing a percentage of

Government procurement from SMEs.

Now with the thrust given by the UAE policymakers, Central Bank etc, Banks have recently

made significant entry to the bottom of the pyramid where the fortune is expected to be located.

Forty of the fifty three Banks in UAE has products for the SME sector now.

Objectives of the Study

1) To evaluate the importance of the SME lending in UAE.

2) To analyze the major challenges faced by the UAE Banks in lending to SME sector.

Scope and Significance of the Study

UAE being a global trade hub has many SME companies operating in various sectors. While

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The study seeks to find the major issues and challenges faced by the Banks in financing the

sector. Hence it is significant.

Research Methodology

For the study primary and secondary data were used. For the primary data, the respondents

(Relationship Managers & Credit Analysts working in various Banks) were being personally

contacted for collecting the information. The information was entered into a structured

questionnaire which consisted of close and open ended questions, rating questions etc.

Secondary data was collected from published and unpublished financial reports, papers,

journals and websites.

Sample size: 100 respondents were interviewed for the collection of the data. The sampling

method used was convenience sampling.

Limitations of the study

Time limit for the study was not sufficient for conducting an extensive research.

The information collected from the respondents may be biased.

SME Industry in UAE: An Insight

The SME industry in UAE is concentrated mainly on the non-manufacturing sector due to the

prominent status as a regional trading and re-exporting hub. The sector wise classification of

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73% 16%

11%

Total SME in UAE

Trade & Retail

Services

Manufacturing

SERVICE MANF

TRADE &RETAIL

Source: UAE Khalifa Fund White paper on SME sector

Statistical Summary

Analysis of the major factors influencing Bank lending to SMEs in UAE

Factor Number of Respondent Percentage

Evolving nature of policy guidelines 21 21%

Management Risk 19 19%

Quality of Financial Statements 19 19%

Lack of collateral security 17 17%

High chances of diversion of funds 12 12%

High Transaction costs & high interest rates 7 7%

Cyclicality of the industry 5 5%

Total 100 100%

MAJOR CHALLENGES FACED BY BANKS IN LENDING TO THE SECTOR:

KEY FINDINGS

According to a Whitepaper released by the UAE‟s Khalifa Fund on SME financing, the

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According to Dubai SME study only 23% of SMEs have applied for a Bank facility in the

last five years. What are the major risks faced by the Banks which inhibits them from lending

to this sector which is definitely lucrative and has high untapped potential.

1. Policy Initiatives are still at the evolving phase

The respondents found this issue as the most important challenge facing the sector. The

major issues in this regard are as follows

a) No standardized definition of SME across UAE

There is no one standardized definition for SME in UAE. SMEs are defined in different

ways by the governments of various Emirates. The definition of SMEs among the Banks

is also not standardized as there has not been clear Central Bank Guidelines on the area.

UAE SME law passed recently proposes to soon introduce a uniform definition for SME

in the country.

b) Absence of proper legal and regulatory framework

The absence of a proper bankruptcy law makes the job of Banks tougher. The absence of

a detailed Credit bureau for SMEs, which has adequate information about the borrower

and the credit history, complicates the scenario. Al Ithihad Credit bureau, launched

recently is an effort to overcome this challenge.

c) Delay in reporting of loan exposures in Central Bank Risk Bureau can be

misused by the borrowers.

The Central Bank Risk Bureau, a platform for reporting the loan exposures of the Banks,

is not updated real time. Banks are given 60 days‟ time to report loan exposures. Loan

exposures below 0.25million AED need not be reported in the platform. At times, Banks

take more than two months to do the reporting due to the volumes involved.

This delay opens a window for fraudulent activities for the unscrupulous borrowers. A

customer can submit the financial statements to as many Banks as he needs at the same

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take loans from many Banks using the same Balance sheet before it gets reported in the

Central Bank Credit Bureau after a period of sixty days. If the exposure taken per Bank is

less than 0.25M, it goes unreported.

2) Management Risks

This is an inherent risk in the Banking sector in UAE as majority of the SME companies

operating in UAE are owned by expatriates. The Government of UAE doesn‟t grant

permanent residency to the expats, instead gives it for very short duration. Therefore the

Banks which lend to unscrupulous businessmen can be taken for a ride they decide to

leave the business and the country. Thus Banks prefer to lend only to those businessmen

who have an established track record, leaving the large chunk unbanked.

Also most of the SMEs are not professionally managed and is driven by a single person

or a family. Corporate governance practices are very minimal in the SME sector when

compared to the corporate sector. This puts the Banks at risk and inhibits them from

taking major exposure to the sector.

3) Absence of adequate quality financial information for Credit Risk Assessment.

As UAE is a tax free country, filing of annual Balance sheets for SMEs are not mandatory in most of the cases .Many of the Micro SMEs, don‟t even prepare audited balance sheets.

According to the study conducted by the Dubai SME, a Govt of Dubai initiative, only 50% of

the SMEs prepare audited financial statements. So in many of the cases, the Banks are forced

to restrict their financial statement analysis to just Bank statement analysis.

Now Banks are insisting the SMEs to prepare audited Balance sheets for seeking Bank

finance. However majority of the respondents have concerns on the quality of the financial

statements including the Income statement and the Balance sheet. Given the absence of taxes,

artificial inflation of turnover and profits are a common sight even in audited Balance sheets.

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SME lending in UAE is largely unsecured lending. Even if it is secured, there is hardly

any collateral security apart from the primary security (stocks and receivables). This is

because since most firms are in the trading or services sector (89% of total SMEs), they generally don‟t have any major fixed assets like Land, Building, Machinery unlike the

manufacturing sector.

This risk is accentuated through loan products like Business loans, which are given as

unsecured loans for „expansion of facilities‟. The end use of the funds is not tracked by

the Banks. It is probable that these funds could have made way to the Real Estate and

stock markets for arbitrage opportunity. The returns in the last few years in Real estate

and stock markets were significant when compared to the interest rates on these loans.

5) High chances of Diversion of Bank Finance

This according to the respondents is a very critical challenge before the Banks. Working

Capital finance is often diverted out of the business and goes to other unrelated areas like

Real estate, stock markets etc. Since the loan amounts are low when compared to

corporate lending and the number of clients are large, banks are not able to always

effectively monitor the end use of funds.

Another area of diversion of funding is through the associate companies. The Bank

finance given to a particular company is often transferred to associate or sister company

to manage their cash flow issues. These loans given to associates often take long time to come back and many a times don‟t come back creating financial problems to the

borrower and renders the Bank loan bad.

6) High transaction cost percolates to high interest rates.

Banks face the challenge of high cost of lending for SMEs. All the Banks which are in the

sector have to setup the complete organizational system and framework for the SME lending.

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and legal teams etc. While the Bank invests so many resources, the lending size is small and

the risks are high. This results in higher cost of lending for the Banks after covering the credit

risk spread. This in turn creates a vicious cycle, where higher cost of borrowing prevents

SMEs from seeking Bank finance.

7) SME’s in cyclical industries

Due to the structure of the economy of UAE, which is anchored in trade and commerce,

cyclicality affects the economy. So is the situation with many of the SMEs in the sector.

Since the majority of them are in trade related areas, a downturn in the global economy

can significantly affect their operations and profitability.

Since majority of the SMEs are in these industries, Banks are not able to significantly

diversify their portfolio to prevent major cyclical risks. As a result, major cyclical events

can significantly affect the loan quality of the Banks.

References

1. Roberto Rocha, Subika Farazi, Rania Khouri, Douglas Pearce, 2010, “ The status of Bank lending to SMEs in Middle East and North Africa”, Working paper, World

Bank & The Union of Arab Banks, 2010 June.

2. “SME Financing in UAE”, Khalifa Fund SME Financing Whitepaper, Abudhabi,

2013

3. “Report of state of SMEs in Dubai”, Dubai SME (An agency of Department of