Valuable credit: Facilitating a wider choice of financing options for SMEs

With little room for expansion in the public sector, Jordan will depend on the private sector to drive growth in the coming years. Key to this will be enabling businesses to access finance at affordable rates. Although the conventional banking sector is often criticised for not providing enough financing to small and medium-sized enterprises (SMEs), there are fundamental challenges limiting credit availability that need to be addressed before this is likely to change.

CHALLENGES: Banks are not lacking liquidity, so availability of credit is not the issue. The problem lies in finding loan arrangements that meet the business needs of the banks and the borrowers. SMEs commonly cite two main obstacles to accessing credit. First, interest rates on loans are too high, typically between 8-10%, and the low rate of economic growth means businesses are rarely profitable enough to afford repayments demanded of such high interest rates. Second, collateral demands can be as much as 100% of the value of the loan and SMEs can rarely raise the right type of collateral – machinery, for example, does not qualify.

For their part, banks counter that small businesses often do not reach sufficient standards of accounting or company practices to warrant lending to. Indeed, “when negotiating with banks, SMEs often have difficulty providing necessary collateral or detailed financial statements,” Rana Sunna, the deputy general manager of Cairo Amman Bank, told OBG.

Several interventions are under way to overcome the obstacles firms face in accessing credit. While high interest rates offered by banks are not easy to reduce given current levels of inflation and the high rates being offered by government bonds, barriers to reaching collateral requirements are more easily tackled.

INTERNATIONAL SUPPORT: One recent programme intends to overcome collateral issues by establishing a loan guarantee fund for SMEs. In October 2011 the US government-run Overseas Private Investment Corporation agreed to provide a $300m fund to be administered by the Jordan Loan Guarantee Facility. The fund will guarantee up to 60% of a loan made inside Amman and up to 75% of loans made outside the capital to encourage lending in less developed areas. So far a number of local banks have signed up to the scheme and can use the fund to guarantee a proportion of loans to qualifying SMEs. The fund can be applied to loans ranging from $50,000 to $2m, and while interest rates are not set by the fund, the scheme is expected to push down the current rates offered by the market.

LEGAL FRAMEWORK: A long-term and technical approach to alleviating the problem of high collateral requirements for SMEs was provided through assistance from the US. In 2008 the United States Agency for International Development produced a report assessing the legal obstacles to SME lending in Jordan and made a case for introducing a Credit Bureau Law and a Secured Transactions Law for Moveable Property. The report argued the establishment of a credit bureau to keep track of credit history – a task currently undertaken by the Central Bank of Jordan (CBJ) for medium-sized loans – would support creditors to manage risk and thus encourage lending.

Furthermore, a law to secure transactions on moveable property would remove the need for excessive collateral, which often matches or exceeds the size of the loan. The CBJ acted in favour of the recommendation and announced in early 2012 that it is working with the banks to identify a strategic partner to participate in a company to provide credit bureau facilities and handle credit information operations.

The need for a private credit bureau is underlined by the World Bank’s “Doing Business” index, which in 2012 ranked Jordan 150th out of 183 economies for accessing credit, citing the lack of private bureau coverage, public registry coverage and depth of credit information indexing. By providing more systematic recording of individual credit histories, a credit bureau would address a fundamental legislative shortcoming in the sector and offer a long-term and sustainable solution to the problem of accessing credit. As Sunna said, “Moving forward, what the financial sector in Jordan needs most is a robust credit bureau that can assess the risk profile of any potential borrower.”

GOVERNMENT SUPPORT: The Jordanian government is also running various initiatives designed to support SMEs to access finance, most of which are run by the Jordan Enterprise Development Corporation (JEDCO). One key initiative from JEDCO is the Banking Window Programme, which helps SMEs prepare themselves to access credit. This aims to ready businesses when applying for finance by providing accounting and financial planning assistance, as well as direct representation when negotiating with banks. The programme specifically addresses the demand side of the lending equation, in contrast to other interventions that typically target banks. It helps to review and raise existing credit lines, maximise the use of collateral to improve loan conditions and access additional financing against existing guarantees. Eligible businesses are those that are formally registered, employ 5-250 people and have a minimum paid-up capital of JD5000 ($7026), criteria satisfied by more than 95% of all businesses in Jordan.

A related programme, the Loan Guarantee Scheme also offered by JEDCO, supports SMEs applying for finance through the Banking Window Programme. This assists the borrower meet minimum collateral requirements by guaranteeing 70% of the loan value up to JD75,000 ($105,390). The initiative is funded jointly by the government and the European Union. Some lenders are already participating in JEDCO’s programmes, including both Arab Bank and the Cairo Amman Bank.

More direct assistance has also been offered through the Development and Employment Fund, which in 2010 provided 8041 loans valued at JD17.5m ($24.7m) with technical support to empower small business to grow, particularly in areas outside the capital.

MICROFINANCE: The Jordan Human Development Report (JHDR) 2011 titled “Small Business and Human Development” highlights the importance of micro SMEs in the promotion of human development in Jordan. The report analysed the availability and impact of microfinance initiatives in the kingdom. There are 11 microfinance institutions (MFIs) which can be categorised as private MFIs, non-governmental MFIs or governmental MFIs. The report cites the major MFIs as the Jordan Micro Credit Company, Ahli Micro-financing Company, Micro-Fund for Women, National Microfinance Bank, FINCA and the Middle East Micro Credit Company.

The report found that females who made use of microfinance schemes had higher success rates than males. It also found that households with higher incomes have greater access to credit, while those families living further away from microfinance schemes consumed less credit. Households with less land and lower levels of education participate more in such schemes.

The provision of microfinance has grown rapidly in the past decade. A study in 2008 by the Social Solidarity Coordination Commission in Jordan showed that microfinance institutions served almost 116,000 customers with loans amounting to almost JD85m ($119.4m). This is significant growth from 1999 when microfinance loans were offered to around 1000 people, with a total value of just JD4.4m ($6.2m).

Other related services that compliment microfinance are in more formative stages. For instance, micro-insurance is almost non-existent, the deposit-to-loan ratio is extremely low, and most significantly, MFIs still largely depend on external funding.

RATIONALE: There are fundamental reasons why the traditional banking sector does not engage with microfinance. Loan sizes are typically too small to offset the administration costs, and the target customers typically live in rural areas, which are more difficult and costly for banks to operate in. There are also problems of access, as low-income families often cannot afford the interest rates of the MFIs, which can be in the region of 16-20% annually. Other loans for agriculture projects are set at more reasonable rates between 6.5% and 9%. Rates higher than 9% on civil and commercial transactions are technically in violation of the Civil Procedural Law of 1988 and the Usury Regulation of 1926.

The JHDR report states that microfinance credit brings an additional income of 50-90% of beneficiaries engaged in such schemes. Interaction with microfinance institutions also improved other outcomes; for example, recipients were more likely to access public insurance schemes. But while access to credit is one thing, sustaining growth is more difficult to achieve. The report highlights the difficulties of microfinance-supported projects being viable over the long term.

Broadening finance to SMEs in the long-term requires tackling the fundamental frictions currently preventing banks and small enterprises from doing business. Establishing a credit bureau should help banks feel confident to offer more loans, but with the government having little room to manoeuvre to bring down interest rates, there may be little appetite to take up this additional credit. In the meantime, loan guarantee schemes and other initiatives should help to close the gap between supply and demand, providing valuable credit to support the growth of Jordan’s SME sector.