Trading beyond your horizon
SMEs are a key driver for the dynamic UAE economy, which is predicted grow at over 3% this year and beyond. In the growth years, through the global economic crisis and now, UAE SME businesses have sustained an almost consistent growth trajectory. They now constitute around 80% of the non-oil GDP of the UAE (around 30% of the entire GDP), 88% of the employment, and account for at least 90% of all of the UAE’s non-oil exports. The SME sector is the engine for the dynamic re-exports business in the UAE.
The UAE has been ranked by the World Bank and IFC Doing Business survey as in the top three countries in the MENA region to set-up and operate a business in terms of procedures, cost and time taken, and has shown the greatest growth worldwide in start-ups in 2010. With world class logistic hubs at JAFZA and other free zones, there is large facilitation in ensuring the continued performance of the SME sector.
In other economies, where SMEs have driven the overall national economy, access to banking and finance, in addition to efficient logistics and a supportive regulatory and operating environment, has been a critical determinant of success for start-up and newly set up SMEs. On this front, SMEs in the UAE face greater challenges. To quote the WB/IFC survey, access to finance continues to be a leading constraint for SMEs doing business in the UAE.
SMEs often struggle to gain access to basic financing facilities; a report released by the Union of Arab Banks and the World Bank in October 2010 revealed that SMEs in the Middle East receive just 8% of regional bank lending. For GCC-based SMEs the figure was even lower, sitting at 2% of all bank lending.
Although there are several government programmes for start-up funding, such as SME Dubai (formerly named Mohammed bin Rashid Establishment for SME Development), Khalifa Fund, and the ADCED and DED programmes, access is not available to every SME setting up and operating. The disconnect between a bank and a client view could be summarised as follows;
Some of the most important issues relevant to SME financing are;
Financing and the increasing role of trade and supply chain
Of the 52 banks licensed and operating in the UAE, there are ten major players servicing mainstream SME clients, with several others in niche segments. Only now are these banks starting to join up with some of the government programmes to provide analysis and administration facilities to grant SME borrowers banking facilities.
Banks have traditionally used a relationship lending model with SMEs that is based on their knowledge of the promoters and/ or the business of the SME. While a number of banks have indicated intentions of lending more to the SME segment and have enhanced portfolio limits, actual approval and setting of limits is based on an analysis of financial statements and other key risk indicators which limit the eligible SMEs to a much smaller number.
Very few banks have offered scorecard or criteria based lending to SMEs, which has proven to be much more flexible and tolerant of the emerging nature of a majority of SMEs. It is not atypical to see the first two approaches result in rejection rates of 70% of credits examined, and for decisions to take considerably longer than the lead time tolerable to SMEs.
While SMEs withstood the recent economic cycle well and actually increased their share of the economy, many banks have tended to cut back across all their industry segments and portfolios and have not distinguished the SME sector for increased focus. ADCB, which has long had an SME focus, has adopted a tailored model for credit assessment of SMEs using a scorecard-based approach, and has actually increased its focus on lending to the segment.
There is a significant cross- border trade element in the UAE SME supply chain. Within this context, the main SME-focussed banks offer these structures for financing and servicing trade flows increasingly to SME clients;
• Equipment financing (in healthcare, construction, and other industries)
• Trust receipt financing under import local collections (LCs) on an unsecured basis, with a loose linkage to exports
• Financing against export LC either as pre-shipment or post shipment loans
• Back-to-bank financing
Funding and transaction cost
The other major component is the competitiveness of bank pricing of loans and FX for payments in foreign currencies. Apart from international banks that have funding bases in money centres and source deposits in foreign currencies, most local banks in the UAE source foreign currency funding as wholesale funding and not as client deposits, with a higher cost that gets passed onto their clients, either as higher FX margins for payments, or reflected in the margin over benchmark in loans.
Margins tend to be highest for SME clients compared to those for larger corporates as most banks try to expand to a multi- product relationship with the more complex larger corporate, whereas SMEs do not offer other buying opportunities for other value added banking services.
A bank may not wish to finance a transaction itself or do so at a cost unacceptable to the exporter, but could provide an avalisation service (payment undertaking given by a bank in respect of a drawn bill of exchange). Based on the avalised draft, the exporter may obtain financing from another bank that offers lower cost financing. This of course comes with an additional cost for avalisation.
Coverage of supply chain It is typical for banks with global network presence to provide export LC confirmation arrangements and LC/guarantee issuance capabilities across most if not all of a client’s supply chain. However, local banks typically restrict themselves to a region of choice, either where they are present, or in the GCC and MENA/ South Asia region. SME exporters tend to find fewer banks offering them such facilities as these are more focussed on servicing their larger clients.
Banks also tend to cherry pick the countries and risks they wish to confirm, and avoid the rest. As a result, an SME exporter faces a higher cost funding challenge for countries that banks consider “difficult”, as these cannot be covered by supply chain based structures and hence lower cost.
Increasingly though, several defeasance techniques are used commonly by banks, and multilateral agencies such as the IFC, ADB, ICIEC and ECAs play an increasingly important role in bank risk defeasance. In the case of the latter, a few have also been key providers of reinsurance services to enable export credit agency defeasance to banks.
Documentation preparation, presentation and processing
This is typically used by SME exporter clients that either do not wish to have specialist staff focussed on this activity, or are facing a volume growth without any room to face delays in getting paid arising from incomplete or discrepant documents submitted by them. Banks prepare documents on behalf of the SME client and work with counterparties to collect third party documents, to produce document sets compliant at the point of creation Thereafter, this is negotiated.
The benefits an exporter gets from this arrangement are:
• Discrepancies are minimised and turnaround time is reduced
• Effort saved as the manual preparation of documents is minimised
• Banks coordinate with third parties on behalf of the SME Reports and document images are typically provided
• Predictability in getting paid against documents submission, and hence eventually lower cost of transaction or funding
ADCB provides complete services to SME exporters for all bank issuers and countries that they export to, with the exception of sanctioned or otherwise regulatory prohibited environments. In addition to the above, the recently announced strategic alliance with Bank of America Merrill Lynch (BofAML) allows ADCB to offer its SME exporter clients access to the entire global network and services of BofAML.In addition to providing the following trade solutions to SME clients:
Fully electronic single-sign on channel for :
Import LC and guarantee issuance
Viewing and printing of export LCs, and documents
Real time updated view of the progress of issued credits
Payments, collections, account services and liquidity management on
all their accounts
Structuring and approval for trade facilities pertaining to :
Pre-shipment financing against exports
Import LCs and guarantees
TRs under import LCs
Efficient execution and pricing on all trade facilities
ADCB provides SME exporter clients with trade finance solutions that could include the following building blocks:
a) Documentation preparation, presentation and processing
b) Back-to-back LC structuring, with or without financing
c) Supply chain financing – invoice and export credit
Hope for the future
In conclusion, it is fair to say that there is growing focus by banks on longer term relationship building, better analytics, product range expansion, and flexibility for the SME segment. This is likely to most benefit clients that have an established business model and growth strategy, and may still remain a challenge for start-ups and businesses with little disclosed information and track record. Evolution to a model that befits this dynamic economic segment is inevitable on the part of banks.
Murali Subramanian is an Executive Vice President and the Head of Transaction Banking at ADCB. Transaction Banking is a group in the Wholesale Banking Group, offering industry leading cash management and trade solutions and premier client service to over 15,000 multinationals, public sector entities, domestic corporations, government entities, SMEs and financial institutions throughout the UAE. Murali has been in this role since August 2009, when he joined ADCB. Prior to this, he was MD and Head of Global Transaction Services at Citibank N.A. for the MENA region based in Dubai, and has held various senior management roles in GTS in the North African, CIS, and western European business. Murali has had a 22 year banking career of which 20 have been with Citi, and two with ABN Amro Bank in Amsterdam and Kazakstan. Murali holds an MBA from the Indian Institute of Management, and a B.Tech in Mechanical Engineering from the Indian Institute of Technology.
Lloyd Caughey is a Vice President and Head of Trade Finance at ADCB. Trade Finance is part of the Transaction Banking Group, offering industry leading Trade Finance solutions to large corporates, emerging local corporates, SMEs and retail clients throughout the UAE. Lloyd has been in this role since January 2008. Prior to this he was Director and Head of Trade Finance for Barclays Emerging Markets. He has 20 years banking experience of which more than 12 years has been in trade finance product and management. His early career was focused in South Africa where he worked for the major local banks. Thereafter he has spent time managing teams and transacting in many African and Middle East countries. Lloyd holds a Licenciate Diploma in Banking from the Institute of Bankers in South Africa and Bachelor of Commerce Degree from the University of South Africa.