msme\'s access to finance framework

$: MSME\'s Access to Finance Framework$
capital business magazine 45

regional business cover story november 09 www.capital-me.com

44 capital business magazine

With the advent of the free flow of“knowledge streams”, the barriers toentry in any MSME business discipline

are eroding dramatically, as most business acu-men or know-how is freely available in digitalform. The global recession is also spawning the“necessity entrepreneur” as job security plum-mets and job losses increase. This is expected tolead to a dramatic increase in the number ofstartups within the MSME arena.In the Middle East, there is growing awareness ofthe importance of MSME enterprises.

GainingAccessA Finance Framework for MSMEs in the Middle East Micro, small and medium enterprises (MSMEs) are the backbone of any economy. MSMEs form the

majority of enterprises in any country and contribute to value addition, employment generation andinnovation. Many of the largest and most successful enterprises in the last two decades have startedas MSME ventures.

By Ahsan Ali

With the advent ofglobal trends inenergy security,renewable energyand depletion of oilreserves, MiddleEasterngovernments arefocused ondiversifying theirreliance on oil-based products.

Economic Importance of MSMEs to the Middle East

Country MSMEs’ estimated MSMEs’ estimated Percentage ofcontribution contribution to total businessto GDP employment entities

Saudi Arabia NA 25% 90%UAE 30% 86% 90%Egypt 80% 75% of 99%

private sector (non-agriculture)Jordan 50% 60% 98% (registered

companies)Lebanon 99% of 82% NA

economic activitySource: Government agencies, SCB Research “Middle East – The RisingImportance of SMEs”

Source: SME Lending in the UAE – 2008, Dunn & Bradstreet

Recently, there has been a shift of focus ontoMSMEs for:

Employment Creation: It is estimated that by 2030,there will be in excess of 100 million youths (age 18to 30) within the wider Arab-speaking world. Unlessnew enterprises mushroom dramatically, countrieswill not have the capacity to absorb this populationin productive employment.Diversification of GDP:With the advent of globaltrends in energy security, renewable energy and de-pletion of oil reserves, Middle Eastern governmentsare focused on diversifying their reliance on oil-basedproducts. Other major concerns are cluster develop-ments around key industries, value-chain linkagesand development of a wide manufacturing base.MSMEs are crucial for the successful execution ofthese strategies.Innovation: The key differentiator for enterprises ofthe future is going to be an innovative product offer-ing. The region is focused on the development of aknowledge-based economy, able to compete globallywith ideas that can be commercialised.Skill set development:With the majority of the edu-cational sector geared towards producing “gradu-ates” versus developing skill sets (vocational orknowledge-based), most of the learning and develop-ment of practical skills is learnt as an entrepreneur.Vocational training initiatives are going to be impor-

tant from a human-development as well as an enter-prise-creation perspective.

Despite the focus on MSMEs, the failure rate for newenterprises in the Middle East remains close to theglobal average (67% fail within the first three years).Amongst the main reasons for failure is access to fi-nance for MSMEs (new startups as well as growingenterprises). A recent Dun & Bradstreet study ofSMEs in the UAE showed that 55% of the respon-dents were unable to get financing.

58% 42%

50% 50%

45%

Satisfied

overall

Satisfied

withinterest

rate

Abletoget

credit 55%

Study on SME Lending in the UAE

yes no




This impacts enterprise creation as well as con-strains growth. The effects of financing constraintshave been documented in various studies and haveconclusively demonstrated that MSME firms’ growthsuffers far more than that of large firms.

The problem of access to finance does not have auniversal solution. The theoretical and practical con-structs of increasing access to financing are im-pacted by geographical peculiarities, state of thefinancial system in the economy, policy support in-frastructure, risk tolerance of financial institutions,private investment and direct intervention by govern-ments.

Building Blocks of an Access to Finance FrameworkWithin the context of Middle East, there is a need todevise a simple framework which can facilitate anincrease in MSMEs’ access to financing.Any framework needs to work on the concept ofpublic-private partnership. This is essential for thefollowing reasons:

• A pure public-driven initiative reduces efficiencies,has restricted scale and ties up precious resources.• Public frameworks tend to create a protected envi-ronment, reducing competitiveness and thus reduc-ing chances of sustainability of the supportedenterprises.• A private endeavour lacks the ability to identify the

right industry segments, devise policies and focus oncluster development.• Private initiatives are rarely altruistic and the profit-seeking motive might deter private entities fromlong-term developmental commitments.

A basic framework for MSMEs would have the fol-lowing three key pillars:

1. Government.2. Private sector (banks, investors, capital markets,financial institutions).3. Enabling environment (initiatives, partnershipswith global experts, etc.).

1. GovernmentThe government in this model plays a central role,with most of the activities concentrated in strategicplanning.

Definition of MSMEsIn order to create a sustainable framework, the start-ing point is the definition of an MSME. Without aclear-cut definition, it is impossible to align policy

Financing obstacle

Collateral requirements

Bank paperwork or bureacracy

High interest rates

Need special connections with banks

Banks lack money to lend

Access to foreign banks

Access to financing for leasing equipment

Access to long-term loans

-12 -8 -4 0

Small firms Large firms

4

% change in firm growth

Effect of Financing Constraints on Growth

Access to Finance Framework

Source:Beck, Demirgüç-Kunt, and Maksimovic (2005) as reported in World Bank (2008).

Improving accessto finance andinvestment iscrucial for new-enterprisegeneration as wellas sustainablegrowth for existingentities.

Micro Small

Definition of MSME’s

Universal SME Credit Rating / Bureau

NonGovernmentalOrganization

Access toMarkets

ProcurementProgrammes

Skill Developmentand Support

Loan Guarantee Based SchemesMicrolending

GOVERNMENT

PRIVATESECTOR

ENABLING

ENVIRON-MENT

Incubators

Score BasedLending Models

Equity - Angel Investors

Score Based LendingModels

Equity - Angel Investors Equity - StockExchange

MicrofinanceInstitutions

Innovation Strategy

Supply Chain Linkages

Priority Sector Lending Policy Cluster Based Development Policy

Partnership with Multilateral Agencies

IP Protection Framework

Medium



initiatives, engage the private sector or undertakeperformance measurement of key initiatives.The definitions for MSMEs vary across geogra-phies, but usually they are based on a combinationof:

• Assets or investments (capital employed).• Number of employees (indication of size).• Turnover (indication of size).• Nature of entity (complexity).

The definition of MSMEs in a country is usually un-dertaken by the relevant ministries or central banksor recommendations are taken from multilateralagencies. In certain countries, in the absence of an“official” definition, banks’ definition of SMEs maybe used. However, this is not a viable approach be-cause bank definitions are based on profit-basedsegmentation versus economic classification, andin developing economies, the scarcity of credit in-formation means that banks gravitate towardslarger and organised clients. Thus the bank’s SMEdefinition is skewed towards medium to large en-terprises

MicrolendingMicrofinance is a captivating concept, enshrined inthe community concept of self-help leading topoverty alleviation. For microfinancing to be success-ful, certain key characteristics need to be in place:

• Large population base.• High incidence of population at the subsistencelevel.• Absence of or limited social security.• Cultural nuances supporting teamwork for survival.

From these, it is easy to ascertain that the typicalmicrolending model will not be successful withinmost of the Middle Eastern nations (especially theGCC countries). In countries such as Egypt, SaudiArabia and Morocco, traditional microfinance modelsare applicable. However, in most of the GCC coun-tries (with Saudi as a notable exception), the localpopulation is a minority. The governments haveample resources available and employment for thenative skilled population outstrips the supply.Here, the microfinance approach needs to be tar-geted and packaged with skill development. The ob-

The private and thepublic sector canstart access to afinanceframework;however, unlessthe environment insufficientlyenabled, theframework cannotbe sustainable overthe long term.

SME Definition by Country

Country Microenterprises Small Medium-sized Defined byenterprises enterprises

Saudi Arabia NA < 59 employees; 60-99 employees; Governmentcapital of SAR 1-5mn capital of 5-20mn

UAE N.A. Turnover: < USD Turnover: USD 10- Commercial10mn 25mn banks

Egypt 1-9 employees; 10-50 employees; 50-100 employees; Governmentregistered capital of registered capital of registered capital of< USD 87,864 USD 87,865-USD USD 878,660-USD(Microenterprises 878,659 (small 1.76mn (medium-make up 71% of enterprises make sized enterprisestotal SMEs) up 19% of total make up 10% of

SMEs) total SMEs)Jordan Up to 10 employees; 10-99 employees; maximum annual sales USAID

registered capital of of JOD 1mn (USD 1.4mn), maximum recommendedless than assets of JOD 1mn (USD 1.4mn) definitionJOD 30,000

If sales and total assets both exceed JOD1mn, a company does not qualify as anSME

Lebanon Fewer than 5 employees Fewer than 200 employees Ministry of(88% of total businesses) (99% of total businesses) Economy and

TradeSource: Government agencies, SCB Research “Middle East – The Rising Importance of SMEs”.



jective is not poverty alleviation, but absorption intogainful employment, reducing the burden on the na-tional exchequer (social security, state subsidies,etc). In other words the outcome of microlending istilted more towards human capital developmentrather than poverty alleviation. Some countries arealso coupling this with cultural preservation pro-grams (handicrafts, textiles, etc.) specific to the re-gion. Others are engaging the native populationthrough microfinancing, upgrading their skill setsand either placing them in value-added employmentor upscaling them to sustainable small concerns.Governments need to take the lead in microfinancingto identify needs, decide objectives and develop skillbases. The size of the native population and its rela-tive wealth does not make the Middle East an attrac-tive sector for a private microfinance institution.

Loan Guarantee SchemesMSMEs are viewed as high-risk entities by financialinstitutions. The banking system does not encouragestartup financing. The asymmetry of informationcaused by limited tax regimes (GCC), lax regulatoryoversight, basic credit models and small loan sizesmakes evaluation a costly exercise for banks.Government intervention in the form of institutions orentities that evaluate project financing for SMEs −with a view towards providing risk participation tothe banks in their lending to MSMEs − increases theflow of finance with the following advantages:

• Banks provide financing to feasible projects, reduc-ing paperwork and bureaucracy.• Interest rates charged are substantially lower be-cause of the risk participation of the government.• Tangible collateral is not required from MSMEs.• Risk participation encourages selection of viablestartup projects and once cash-flow generationstarts, the bank transfers these clients to a “regular”relationship.• Banks can develop score-based lending programs;these need a decent portfolio size and loss data overthree years. The government guarantee program caneffectively fund the “development” cost of these pro-grams by underwriting the risk which the bankwould not have taken alone.

Cluster Development and Priority Sector LendingGovernment entities need to formulate economic de-velopment strategy with a focus on industry seg-ments that have a competitive advantage or want todevelop a competitive advantage. For example, ship-ping and logistics can be a focus industry; this wouldrequire developing infrastructure, manpower devel-opment, engineering workshops, etc., to support thisindustry.

The government can prescribe a minimum percent-age of credit extension (as a total lending base) toMSME entities within a particular cluster or MSMEentities across sectors. This approach has been suc-cessfully implemented in Pakistan, India (sectorfocus on agriculture and cottage industries) and thePhilippines (entity focus) within emerging markets.

Incubators and InnovationExperience across the world has shown that innova-tion prospers with the right incubation facilities.Physical proximity to universities, industry focus, in-formation and communication technology infrastruc-ture, and subsidised research facilities are the keycharacteristics for a viable incubator setup. Apartfrom incubators for innovation to thrive, the basicpillars of education, technological capabilities, gov-ernment incentives and development of intellectualproperty protection are essential.Innovation and incubation supports ensure that thequality projects coming up for funding generate therequisite interest within the financial community.Apart from funding, this spawns equity investmentand venture capital industries. The best example ofthis is the US, where the venture capital industry iscredited with major breakthroughs in health care,technology, communications and internet-basedservices.Once the private sector establishes the financial via-bility of incubation and innovation, the transitionfrom a government-sponsored initiative to apublic/private partnership or private-only setups be-comes relatively easier.

2. Private SectorThe role of the private sector in any economy is toefficiently allocate resources and factors of produc-tion to derive the maximum possible gain.

Provision of Loans and Financial ProductsThe private sector should be encouraged to developa suite of financial products covering the needs spec-trum for MSMEs.The challenges arise within microfinancing, wherethe private sector must identify niche opportunitieswith sufficient scale for the model to be commer-cially viable. Usually this can be aided by govern-ment intervention in the form of public-runmicrofinance institutions, subsidising the cost offunds to microfinance institutions and incentives onthe tax or regulatory front. Once suitable scale isachieved, these can be eased out and microfinanceinstitutions can function independently.The two models for regular loan provision for SMEscan be scorecard-based lending and relationshiplending.

Intellectualproperty rights arecrucial formaintaining acompetitive edgeand restrictingunique productsfrom turning intocommodities.




The first variant is applicable for smaller size loans.In a score-based model, based on actual statisticaldata, a scorecard is developed for an applicant for aparticular industry. The scorecard has predictive abil-ity on the likelihood of default for any applicantbased on demographics, industry variables, repay-ment history and other factors. This approach iscost-effective, as the disbursement, monitoring andcollection is done on a portfolio basis witheconomies of scale. However, the downside is thatthere is no “tangible” relationship with the MSMEenterprise. An example of scorecard-based lendingwould be the credit-card lending model.Relationship-centric lending models usually have aone-on-one relationship with the SME concernthrough either a relationship manager or branchmanager. This entails a better understanding of thebusiness and development of customised solutionsfor the MSME’s financial needs. Though generallypreferred by MSMEs all over the world, the modelentails substantial investment in the operatingframework from the bank’s side. Unless a bank hassizeable scale of profitable SME customers, it doesnot prefer this approach.

Raising Equity InvestmentIn the developed markets, the private sector is cred-ited with raising a substantial chunk of equity in-vestment through angel investors, venture capitalfirms and stock exchanges. Within the GCC, theangel investment network is credited with raisingonly $7 million in 2008, compared with more than$26.5 billion in the US alone.Investors (both private and institutional) are wary ofequity investments in the Middle East because of alack of transparency stemming from the regulatoryframework, absence of data to make comparativevaluations, missing bankruptcy laws and limited op-portunities for exit.Even though stock exchanges exist within the Mid-dle East, the small cap exchange model (along thelikes of AIM in the UK) has not been implementedyet. Thus the market-making and exit possibilitiesfor equity investors are quite limited in scope andmost of the transactions occur as private place-ments. This is one of the most lucrative regions inthe world to raise equity, but the sad part is that anoverwhelming majority of equity investments arerouted to developed markets.The three pillars of equity investment (angel, ven-ture capital and stock exchanges) need to be re-vamped within the Middle Eastern markets forequity investments to start flowing.

3. Enabling EnvironmentThe private and the public sector can start access to

a finance framework; however, unless the environ-ment in sufficiently enabled, the framework cannotbe sustainable over the long term. The key enablersin such an environment ensure the success ofMSMEs, promote transparency and develop the skillbase of entrepreneurs, thus raising confidence inMSME enterprises.

Credit Ratings and BureausThe role of independent credit ratings for MSMEs isessential for the flow of financing and equity invest-ment to take root. Independent credit ratings usuallyare the domain of larger corporate concerns. Theycommunicate an assessment of the entity’s ex-pected business performance, financial perform-ance, management effectiveness and, consequently,creditworthiness from a going concern perspective.

The rating process is dependent on accounting regu-lations, disclosure laws, industrial data, credit loss,migration data and peer group analysis. This is acostly and time-consuming process to put in placefor MSMEs. What actually makes sense is to developan MSME rating bureau along the lines of a retailprivate credit-reporting agency. This would providean assessment on the basis of statistical scorecardstailored by industry segments, hence lowering thecost and the turnaround time substantially. However,this requires a concerted effort to invest in collatingdata at the national level, which in itself is a compli-cated exercise. The global existence of private creditreporting is mostly limited to the developed markets,with some coverage recently in Asia.

Protected Market EnvironmentSustainable development of MSMEs can be en-sured by providing a protected market environ-ment. In most of the Middle East, import-basedeconomies with limited protection pit a nascentMSME enterprise against large players from acrossthe globe. A protected environment can be createdby such initiatives as:

• Creating closed marketplaces (from a competi-tion perspective) by product category or geography.An example could be developing a handicraftsmarket with a high concentration of microenter-prises. The fixed and marketing costs of such amarketplace can be set up under a public-privatepartnership.• MSMEs can be made a part of the supply chainsof large corporate concerns. This can be done bymandating a certain percentage of the supplychain procurement from MSMEs, with an accept-able variation of cost and quality.• Government procurement programs targeted atMSMEs can prove to be very useful. In the MiddleEast, government entities control a large portion of

spending, and diverting 5% to 10% of this spend-ing could support a large number of MSME enter-prises.These types of initiatives are especially appealingto the private sector under the corporate social re-sponsibility (CSR) philosophy.A key aspect of the protected market is “healthyturnover”. Firm criteria for both eligibility and“graduation” from the program need to be put inplace. This ensures that MSMEs continue to drivefor self-sufficiency and that the programme doesnot end up creating inefficient enterprises in themedium term.

Leveraging PartnershipsThe concept of synergy can be applied to good ef-fect within the framework. Supra nationals, multi-lateral donor agencies and nongovernmental aidinstitutions bring a wealth of experience and re-sources to the game. The important aspect is toidentify and align their roles to the central MSMEdevelopment policy and strategy. The role of thesepartnerships is crucial at the strategy and planningphase to ensure seamless execution.

Rating Parameters

Criteria Parameters

Business FinancialPromoter &Management

• Overallunderstanding ofbusiness process andpractices• Estimate of thesustainability of thebusiness• Key driving factorsof the business• Important customersand suppliers• Sales and purchasesfragmentation• Order book position• Strategic strengthsand weaknesses• Diversification plans• Projections andsynergies• Independentconfirmations fromsuppliers andcustomers about theperformance andmarket standing of thesubject• Inherent riskinvolved in a similartype of business

• Gross profit and netprofit margins• Trend analysis• Gearing• Return on net worthand return on capitalemployed• Contingent liabilities• Debt servicecoverage ratios• Inter-company loanswith specific attentionto the companiesbelonging to sameowner but notconsolidated withother companies• Monthly cash flows• Other financialfactors peculiar to thebusiness of thecompany

• Constitution andshareholding pattern ofthe group companies• History of the groupand its promoter• Review of othercompanies andinvestments held bythe promoter• Financing andoperational ring fencingmeasures taken by themanagement• Professionalism inmanagement• Succession plans ofmanagement includingsecond line ofmanagement• Managementphilosophy• Gearing philosophyof management• Local shareholdersinterference in themanagement of thecompanies• Other factors peculiarto the business andmanagement

Private Credit RegistryExistingIn Process of DevelopingDoes Not ExistNo Information

Private Credit Reporting

In most of the Middle East, import-basedeconomies with limited protection pit anascent MSME enterprise against largeplayers from across the globe.



Ahsan Ali is the Director Credit for Khalifa Fund for Enterprises Development,a sovereign fund focussed on SME development, in the UAE. His previouswork experience of over 12 years in banking spans across 8 countries andmultiple disciplines. His areas of interest include economic development, riskmanagement, Islamic banking and SME Development. He holds an MBA fromthe Institute of Business Administration, Karachi University, as well an MS inFinancial Economics from the School of Oriental and African Studies, London.Ahsan is a CFA Charter Holder, an FRM certified risk manager and a memberof the Securities and Investment Institute (SII), UK.

About the Author

Skill Development and SupportThe concept of training and development has givenway to skill development in recent years. Class-room sessions on theoretical aspects of running abusiness have given way to peer group experientiallearning sessions. Instead of subject matter ex-perts, these sessions are conducted by facilitatorsaiming to answer problems based on the actual ex-perience of the peer group. This trend has forced arethink of traditional training and delivery chan-nels. With a knowledge focus, professional net-works and context-based solutions to questionsavailable on the internet, the traditional method-ologies have to adapt and evolve.Supporting MSMEs on an ongoing basis in opera-tional aspects, government relations, generation ofbusiness and general counseling has a tangible im-

pact on success rates. Support can come in therole of a “business counselor.” For an MSME, thiscombines a trusted aide, industry expert, bank fin-ancier, psychiatrist, consultant and friend. This in-tervention is crucial in the post-operating stage ofan enterprise. If the right rapport can be estab-lished with the entrepreneur, the failure rate can bereduced.

Regulatory Considerations and Intellectual Prop-erty ProtectionThe regulatory framework, in terms of ease ofdoing business, bankruptcy laws, availability of therequired infrastructure and logistics, commerciallaw and the judicial system, is important for thegeneration of new enterprises and sustainability ofexisting ones.

Intellectual property rights are crucial for main-taining a competitive edge and restricting uniqueproducts from turning into commodities. Establish-ing an intellectual protection environment requirescomprehensive legal challenges as well as align-ment to global standards.

Tailored SolutionsImproving access to finance and investment is cru-cial for new-enterprise generation as well as sus-tainable growth for existing entities. There is noclear-cut formula or model which guarantees suc-cess. Each region requires a tailored solutioncatering to its financial markets, human talentbase, governmental resources and economic prior-ities.For the Middle East, keeping these factors inmind, a basic framework needs to be developed.The core of it has to be a clearly defined public-private partnership backed by key environment en-ablers to help the region’s MSMEs to prosper.

Ease of Doing Business Report 2009 rankings

Country Overall Ease of Starting a Getting credit Enforcing contractsDoing Business ranking business

Egypt 114 41 84 151Jordan 101 131 123 128Lebanon 99 98 84 118Saudi Arabia 16 28 59 137UAE 46 113 68 145Source: Ease of Doing Business Report 2009, World Bank

Experience acrossthe world hasshown thatinnovationprospers with theright incubationfacilities.

msme\'s access to finance framework

Business

medium enterprises msmes

based economy

successful enterprises

cluster development

easternnew enterprises

based products

oilbased study

economic importance