The Saudi Arabian banking sector has a significant growth opportunity in the form of the small and medium-sized enterprise (SME) sector. The nation’s SMEs account for around 90% of registered businesses and 60% of total employment, according to a recent report by Aljazira Capital, and as a result they occupy a central position in the Kingdom’s development strategy.
“With lower oil prices, the importance of growing the private sector’s contribution to GDP has become clear. The best way to do this is by boosting the SME segment,” Ibrahim Al Hunaishel, director-general of Saudi Credit and Savings Bank, told OBG.
Vast Potential
The prospects for an increase in credit extension to this important component of the economy would at first glance appear to be good: unlike the situation in many advanced economies, where banks are retrenching from over-leveraged positions, the Kingdom’s lenders enjoy strong capital adequacy and liquidity ratios which theoretically place them in a good position to lend across the entire spectrum of the private sector without eroding the quality of their balance sheets.
However, despite the promising fundamental aspects of the SME proposition, lending to the segment remains stubbornly muted. Whilst formulating an SME lending map for the MENA region is complicated by varying definitions and reporting standards, the “Flagship Report 2011” by the Union of Arab Banks and World Bank found that in 2011 just 2% of Saudi Arabia’s total lending was directed to SMEs. While this low percentage might be expected in small, corporate-dominated economies such as Qatar (where SMEs account for only 0.5% of the aggregate loan book), the result is a surprising one for a nation such as Saudi Arabia, which has travelled further down the road of economic diversification than some of its hydrocarbons-rich neighbours. While SME lending volumes remain modest across most of the MENA region, according to the report, with even large economies such as Egypt displaying low levels (at just 5%), countries such as Tunisia (15%), Lebanon (16%) and Morocco (24%) show the potential for SME lending in this part of the world.
A Challenging Sector
However, there are hurdles that must be negotiated by banks before there is any likelihood of a significant uptick in SME lending. The Central Department of Statistics and Information (CDSI) defines small enterprises as those with 5-19 employees and an annual turnover of between $1.3m and $6.7m. Companies with more than 20 employees and a turnover of between $6.7m and $33.3m are considered by the CDSI to be medium-sized enterprises.
Much of the financial infrastructure underpinning lending to these businesses is relatively new and only just emerging from a period of inadequacy, so that banks with specialised SME management skills are sometimes scarce and will continue to present a human resources challenge in the short term. This problem is mirrored within the SMEs themselves, where cash management and accounting skills frequently fail to meet the needs of the banks which are assessing them as potential clients. Financial transparency, although improving, is still a concern, and a lack of collateral within the segment threatens to slow loan book growth.
These factors combined help to explain the SME funding gap that has remained a feature of the Saudi banking landscape for decades. For many lenders there has historically been little incentive to invest capital and manpower in pursuit of the relatively modest returns offered by SME facilities when big-ticket deals with corporates have provided easy and consistent revenue. The Kingdom’s banks, therefore, have adopted a conservative stance to SME lending. While it is common for lenders who are financing large contractors to automatically assess their sub-contractors as potential clients, where this linkage does not exist, banks are reluctant to extend credit.
Strategic Imperative
The important role that SMEs are expected to play in the development of the economy has made the problem of funding them a national concern. The principal means by which the government has sought to boost SME lending is the SME Loan Guarantee Programme managed by the Saudi Industrial Development Fund. Better known as the Kafalah programme, it was established by the Ministry of Finance in 2006 in conjunction with local banks to enable SMEs to better participate and provide fresh employment opportunities for the workforce. At its launch, the Kafalah programme defined its goals in more detail: increase the number of SMEs in Saudi Arabia; allow existing SMEs to improve their efficiency and expand their operations; absorb the surplus liquidity of the banking sector and channel it towards the SME sector; and familiarise SME owners with the banking process and the advantages offered by it.
The performance of the scheme to date has been encouraging. By the third quarter of 2014, 10,118 loan guarantees had been made by the programme, for a total value of SR4.9bn ($1.3bn). The growth of the scheme has been consistent year-on-year: having started with assisting 36 enterprises in 2006, by 2013 it was supporting more than 1000 on an annual basis. It has also been successful in securing the cooperation of the banking sector. Out of 12 locally licensed lenders, 10 have made use of the Kafalah guarantee in their extension of credit to SMEs, with National Commercial Bank, Riyad Bank, Arab National Bank and Al Rajhi Bank accounting for around 80% of the total.
Positive Sentiment
The Kafalah programme has clearly played a crucial role in the provision of credit to the SME sector, but in the longer term a more proactive approach by banks remains the more desirable solution to funding the gap. There are, however, clear signs that such a change in attitude is taking place. The success of the SME scheme has allowed the banks to expand their exposure to what is perceived by the industry as an increasingly attractive segment. Rising competition in the banking sector and the altered economic backdrop that prevails in the wake of the global economic crisis have both served to shift sentiment surrounding SME credit into more positive territory.
All of the Kingdom’s lenders now maintain dedicated SME departments, although their strategic approach has varied. Some, such as Saudi Hollandi, have established SME units as part of their retail operations, while others have chosen to place them within their corporate divisions. However, across the industry there is a common acknowledgment that the days of downscaling corporate instruments and applying them to SME lending or simply extending retail-focused products into the SME segment, are over. Banks have begun to deploy SME-specific products and services and, while extending credit to the sector remains problematic, some segments which can be financed on a cash-flow basis – such as the suppliers which serve contractors on large projects – have proved fruitful.
Importantly, banks are also starting to move beyond the Kafalah programme to carry out this business. “We are currently in the midst of an expansion of our SME activity,” Nizar A Al Twaijri, deputy head of corporate banking at Arab National Bank, told OBG. “For the larger SMEs financial model lending is fine. We have developed a scorecard system which we use in our 10 SME units nationwide. We look at the business, how long it has been in the region, we look at the account statement behaviour and the business model, and we look at the product or service they are offering. In this way we can lend totally independently from Kafalah, although we still support the programme.”
This hands-on approach has enabled lenders to extend credit in areas which have been hitherto under-served, and represents a significant step forward from when the Kafalah guarantee was the principal factor in the process. Banque Saudi Fransi, which established its SME unit in late 2013, has seen double-digit growth in its lending to the segment as a result of its more forensic approach to risk evaluation. “For SMEs, 50% of our assessment is on character. This often includes physical visits, which give us an opportunity to assess an applicant on his understanding of the business, the technical aspects and to see his office. The financial question makes up the other 50%. Collateral, even if it is Kafalah, is no good if the other elements are not in place,” Abdulrahman Mutabagani, head of business banking at Banque Saudi Fransi, told OBG.
Going Forward
Given the modest SME lending levels that the banking sector currently exhibits, there is clearly a considerable distance to be travelled before the nation’s smaller businesses could be said to be properly served. Start-ups and firms with rudimentary accounting procedures remain locked out of the market (although a nascent private equity industry is beginning to show interest in the former, see Alternative Investments chapter). There are concerns, too, that a sustained depression of the oil price will have an effect on government payments to contractors over the coming year, leaving banks even less inclined to lend beyond their comfort zone of main contractors and well-established suppliers. However, the green shoots of an SME lending arena are clearly visible, and banks have begun demonstrating their interest in the segment through the development of SME infrastructure and skills.
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