Changing perspectives: As small businesses show increasing potential, lending attitudes are beginning to change

Small and medium-sized enterprises (SMEs) have occupied a prominent place in government policy since 2002, when the Ministry of Finance introduced a more favourable tax regime for the segment. Since then, further government initiatives have sought to diversify the economy and provide employment for a rapidly expanding population by enhancing SMEs’ access to finance, as well as their ability to benefit from non-financial services, such as information and communications technology. Egypt’s banks, however, have traditionally taken a more circumspect approach to SME lending, frequently eschewing what they regarded as a high-risk, low-return segment in favour of the big-ticket corporate deals that have traditionally plumped their balance sheets. “In the small business area the demand for loans is huge but current loans to SMEs in the entire banking sector are almost insignificant. The problem is the grooming process: how do we help bring these SMEs to the mainstream banking sector?” Hisham Ezz Al Arab, the chairman and managing director at Commercial International Bank, said.

More recently, banks have begun to demonstrate an increased willingness to tap into this underserved segment, developing products tailored to SMEs’ needs and including SME portfolio growth in their published strategies. “The response to new products, such as SME lending and Islamic finance, has been good – the potential is excellent and the growth has been noticeable,” Hatem Sadek, the chairman and managing director at Bank Audi, told OBG. As SME financing has become a more prominent issue in the sector, so too have the challenges associated with them, such as the dearth of information regarding SMEs, the large number of informal SMEs and their aversion to taking on debt.

FORMAL SMES: The country’s largest lender has taken a particularly aggressive approach to the segment in recent years. In 2010 the National Bank of Egypt (NBE) in partnership with Cofas, the French consultancy, began mapping the SME market – a sector dominated by informal activity – after first establishing its own definition of SME activity. As far as NBE is concerned, a small enterprise is one which has maintained an average revenue of up to LE20m ($2.8m) over the past three years, while a company that has posted revenue averaging between LE20m ($2.8m) and LE100m ($14.2m) is considered to be a medium-sized enterprise.

The business mapping project concluded that around 2m companies across Egypt meet NBE’s definition of an SME, around 90% of which are informal. Of the 10% of companies that operated within the formal sector, around 40% of them were not served by the banking and finance industries. The reasons for this lack of engagement were also of interest to NBE. “We wanted to explore why this 40% had remained unserved. The results were shocking. Many of the respondents lacked awareness of banking, bank products, the benefits of bank finance, how repayments are collected – some even had a fear of being put in jail for default,” Soha Soliman, head of SMEs at NBE, told OBG.

PLENTY OF OPPORTUNITY: This segment represents a significant opportunity for Egyptian banks, and a number of financial institutions and NGOs have begun awareness campaigns. Topics covered in some of the campaign workshops have included feasibility study methodology, entrepreneurship, constructing business plans, marketing, exporting channels, the value chain, management techniques and human resources.

As a result of these efforts, many believe “that customers and small businesses are making a conscious effort to maintaining and keep a good credit score”, according to Mohamed Kafafi, chairman and CEO at IScore. Donor support from the global finance arena in the form of soft loans from bodies such as the World Bank and the European Bank for Reconstruction and Development have also enabled some banks, including NBE, to decrease the cost of lending and offer SMEs favourable rates on short-term (of up to one year) and medium-term (usually five year) tickets.

Since the CBE introduced regulations that allowed for an exemption to the local currency reserve requirement (which then stood at 14%) equal to the amount that a bank was exposed to SMEs, Egypt’s banks have shown a greater interest in the segment. Most have dedicated SME departments and have established modest SME portfolios by creating new products aimed at this part of the market. Rather than view them as competition, NBE has assumed responsibility for increasing the level of contact between formalised SMEs and the wider banking sector, inviting other banks to work under the umbrella of donors it has established to extend credit to new clients.

GOING INFORMAL: The challenge has been tackling the large number of SMEs in the informal segment. “We need to see transparency in the SME economy, for without this we cannot work and lend effectively. The banking and regulatory infrastructure is there but there is no transparency amongst the SMEs themselves,” Edward Marks, managing director at Barclays Bank Egypt, told OBG. Unlicensed, non-taxpaying, small operations have previously been considered unbankable by most lenders in the market, and to date only non-governmental organisations in the form of microfinance institutions (MFIs) have ventured into the segment.

CBE risk regulations make it difficult for ordinary banks to lend to informal businesses, and in the past most banks have only been able to address the segment by lending to MFIs and allowing them to re-lend small amounts. However, in 2012 NBE began lending directly to the informal SME sector, becoming the first bank in the nation’s modern financial history to do so. It has sidestepped the CBE regulations which require it to report individual loans of LE30,000 ($4269) and above by offering a maximum ticket of LE25,000 ($3558). It has also built upon its existing SME infrastructure, which includes 243 specialist branches and more than 800 SME officers trained in the segment’s peculiarities, in order to roll-out its new offerings.

The bank, once renowned for its centralised approach to business development, has speeded up the process of extending credit by delegating responsibility for loan approvals to both the formal and informal segments to branches and regional offices, only retaining direct control of facilities over LE10m ($1.4m) at its Cairo head office. As a result of its efforts, its SME loan portfolio expanded from around LE4bn ($569.2m) in 2010 to LE10.4bn ($1.5bn) at the close of 2012.

LOOKING AHEAD: Just how successful NBE’s experiment with informal SMEs will be remains unclear. “The medium-term loans that we have extended have terms of five years. We do not think that companies will grow revenue much in the first year or two, but by year three we hope that they will be looking to increase their financing,” Soliman said. For SMEs to receive funds of more than LE25,000 ($3558), they will have to undergo formalisation, with NBE’s assistance. In addition, the bank will offer incentives to formalisation, such as increasing loan terms to seven years and offering softer interest rates, making NBE’s portfolio one to watch.