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Gaining Access
A Finance Framework for MSMEs in the Middle East
By Ahsan Ali
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 and
innovation. Many of the largest and most successful enterprises in the last two decades have started
as MSME ventures.

Economic Importance of MSMEs to the Middle East

W
ith the advent of the free flow of
“knowledge streams”, the barriers to
entry in any MSME business discipline Country MSMEs’ estimated MSMEs’ estimated Percentage of
are eroding dramatically, as most business acu- contribution contribution to total business
men or know-how is freely available in digital to GDP employment entities
form. The global recession is also spawning the Saudi Arabia NA 25% 90%
“necessity entrepreneur” as job security plum- UAE 30% 86% 90%
mets and job losses increase. This is expected to Egypt 80% 75% of 99%
lead to a dramatic increase in the number of private sector (non-agriculture)
startups within the MSME arena. Jordan 50% 60% 98% (registered
In the Middle East, there is growing awareness of companies)
the importance of MSME enterprises. Lebanon 99% of 82% NA
economic activity
Source: Government agencies, SCB Research “Middle East – The Rising
Importance of SMEs”

With the advent of

Recently, there has been a shift of focus onto tant from a human-development as well as an enter-

global trends in
MSMEs for: prise-creation perspective.

energy security,
renewable energy
Employment Creation: It is estimated that by 2030, Despite the focus on MSMEs, the failure rate for new

and depletion of oil

there will be in excess of 100 million youths (age 18 enterprises in the Middle East remains close to the

reserves, Middle
to 30) within the wider Arab-speaking world. Unless global average (67% fail within the first three years).

Eastern
new enterprises mushroom dramatically, countries Amongst the main reasons for failure is access to fi-

governments are
will not have the capacity to absorb this population nance for MSMEs (new startups as well as growing

focused on
in productive employment. enterprises). A recent Dun & Bradstreet study of

diversifying their
Diversification of GDP: With the advent of global SMEs in the UAE showed that 55% of the respon-

reliance on oil-
trends in energy security, renewable energy and de- dents were unable to get financing.

based products.
pletion of oil reserves, Middle Eastern governments
are focused on diversifying their reliance on oil-based Study on SME Lending in the UAE
products. Other major concerns are cluster develop-

Able to get
credit
ments around key industries, value-chain linkages 45% 55%
and development of a wide manufacturing base.
MSMEs are crucial for the successful execution of
these strategies.

with interest
Innovation: The key differentiator for enterprises of

Satisfied
the future is going to be an innovative product offer- 50% 50%

rate
ing. The region is focused on the development of a
knowledge-based economy, able to compete globally
with ideas that can be commercialised.
Skill set development: With the majority of the edu-

Satisfied
overall
cational sector geared towards producing “gradu- 58% 42%
ates” versus developing skill sets (vocational or
knowledge-based), most of the learning and develop-
ment of practical skills is learnt as an entrepreneur. yes no
Vocational training initiatives are going to be impor- Source: SME Lending in the UAE – 2008, Dunn & Bradstreet

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

This impacts enterprise creation as well as con- Access to Finance Framework

strains growth. The effects of financing constraints
have been documented in various studies and have Micro Small Medium
conclusively demonstrated that MSME firms’ growth
suffers far more than that of large firms.

Effect of Financing Constraints on Growth

Definition of MSME’s
G
Financing obstacle
O
Collateral requirements V
Microlending Loan Guarantee Based Schemes
Bank paperwork or bureacracy E
R
High interest rates N
Need special connections with banks M
Priority Sector Lending Policy Cluster Based Development Policy
E
Banks lack money to lend N
Access to foreign banks T
Access to financing for leasing equipment Incubators Innovation Strategy
Access to long-term loans

-12 -8 -4 0 4

% change in firm growth

Score Based Score Based Lending
Lending Models Models
Small firms Large firms
PRIVATE Microfinance
SECTOR Institutions
Source:Beck, Demirgüç-Kunt, and Maksimovic (2005) as reported in World Bank (2008). Equity - Stock
Equity - Angel Investors Equity - Angel Investors
Exchange
The problem of access to finance does not have a right industry segments, devise policies and focus on
universal solution. The theoretical and practical con- cluster development.
structs of increasing access to financing are im- • Private initiatives are rarely altruistic and the profit-
pacted by geographical peculiarities, state of the seeking motive might deter private entities from
financial system in the economy, policy support in- long-term developmental commitments.
frastructure, risk tolerance of financial institutions,
private investment and direct intervention by govern- A basic framework for MSMEs would have the fol- Universal SME Credit Rating / Bureau
ments. lowing three key pillars:

Building Blocks of an Access to Finance Framework 1. Government. Non

Within the context of Middle East, there is a need to 2. Private sector (banks, investors, capital markets, Access to
Governmental Supply Chain Linkages
devise a simple framework which can facilitate an financial institutions). ENABLING Markets
Organization
increase in MSMEs’ access to financing. 3. Enabling environment (initiatives, partnerships
Any framework needs to work on the concept of with global experts, etc.). ENVIRON-
MENT
Improving access
public-private partnership. This is essential for the Skill Development
Partnership with Multilateral Agencies
to finance and
following reasons: 1. Government and Support

investment is
The government in this model plays a central role,

crucial for new-

• A pure public-driven initiative reduces efficiencies, with most of the activities concentrated in strategic

enterprise
has restricted scale and ties up precious resources. planning. Procurement
IP Protection Framework
generation as well
• Public frameworks tend to create a protected envi- Programmes

as sustainable
ronment, reducing competitiveness and thus reduc- Definition of MSMEs

growth for existing

ing chances of sustainability of the supported In order to create a sustainable framework, the start-

entities.
enterprises. ing point is the definition of an MSME. Without a
• A private endeavour lacks the ability to identify the clear-cut definition, it is impossible to align policy

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

The private and the

initiatives, engage the private sector or undertake Microlending

public sector can

performance measurement of key initiatives. Microfinance is a captivating concept, enshrined in

start access to a
The definitions for MSMEs vary across geogra- the community concept of self-help leading to

finance
phies, but usually they are based on a combination poverty alleviation. For microfinancing to be success-

framework;
of: ful, certain key characteristics need to be in place:

however, unless
the environment in
• Assets or investments (capital employed). • Large population base.

sufficiently
• Number of employees (indication of size). • High incidence of population at the subsistence

enabled, the
• Turnover (indication of size). level.

framework cannot
• Nature of entity (complexity). • Absence of or limited social security.

be sustainable over
• Cultural nuances supporting teamwork for survival.

the long term.

The definition of MSMEs in a country is usually un-
dertaken by the relevant ministries or central banks
or recommendations are taken from multilateral
agencies. In certain countries, in the absence of an
“official” definition, banks’ definition of SMEs may
be used. However, this is not a viable approach be-
cause bank definitions are based on profit-based
segmentation versus economic classification, and
in developing economies, the scarcity of credit in-
formation means that banks gravitate towards
larger and organised clients. Thus the bank’s SME
definition is skewed towards medium to large en-
terprises
From these, it is easy to ascertain that the typical
microlending model will not be successful within
most of the Middle Eastern nations (especially the
GCC countries). In countries such as Egypt, Saudi
Arabia and Morocco, traditional microfinance models
are applicable. However, in most of the GCC coun-
tries (with Saudi as a notable exception), the local
population is a minority. The governments have
ample resources available and employment for the
native skilled population outstrips the supply.
Here, the microfinance approach needs to be tar-
geted and packaged with skill development. The ob-

SME Definition by Country

Country Microenterprises Small Medium-sized Defined by

enterprises enterprises

Saudi Arabia NA < 59 employees; 60-99 employees; Government

capital of SAR 1-5mn capital of 5-20mn
UAE N.A. Turnover: < USD Turnover: USD 10- Commercial
10mn 25mn banks
Egypt 1-9 employees; 10-50 employees; 50-100 employees; Government
registered 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 enterprises
total 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 recommended
less than assets of JOD 1mn (USD 1.4mn) definition
JOD 30,000
If sales and total assets both exceed JOD
1mn, a company does not qualify as an
SME
Lebanon Fewer than 5 employees Fewer than 200 employees Ministry of
(88% of total businesses) (99% of total businesses) Economy and
Trade
Source: Government agencies, SCB Research “Middle East – The Rising Importance of SMEs”.

48 capital business magazine

 regional business cover story november 09 www.capital-me.com
Intellectual
jective is not poverty alleviation, but absorption into
property rights are
gainful employment, reducing the burden on the na-
crucial for
tional exchequer (social security, state subsidies,
maintaining a
etc). In other words the outcome of microlending is
competitive edge
tilted more towards human capital development
and restricting
rather than poverty alleviation. Some countries are
unique products
also coupling this with cultural preservation pro-
from turning into
grams (handicrafts, textiles, etc.) specific to the re-
commodities.
gion. Others are engaging the native population
through microfinancing, upgrading their skill sets
and either placing them in value-added employment
or upscaling them to sustainable small concerns.
Governments need to take the lead in microfinancing
to identify needs, decide objectives and develop skill
bases. 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 Schemes
MSMEs are viewed as high-risk entities by financial
institutions. The banking system does not encourage
startup financing. The asymmetry of information
caused by limited tax regimes (GCC), lax regulatory
oversight, basic credit models and small loan sizes
makes evaluation a costly exercise for banks.
Government intervention in the form of institutions or
entities that evaluate project financing for SMEs −
with a view towards providing risk participation to
the banks in their lending to MSMEs − increases the
flow 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 viable
startup projects and once cash-flow generation
starts, 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 over
three years. The government guarantee program can
effectively fund the “development” cost of these pro-
grams by underwriting the risk which the bank
would not have taken alone.
Cluster Development and Priority Sector Lending
Government entities need to formulate economic de-
velopment strategy with a focus on industry seg-
ments that have a competitive advantage or want to
develop a competitive advantage. For example, ship-
ping and logistics can be a focus industry; this would
require developing infrastructure, manpower devel-
opment, engineering workshops, etc., to support this
industry.
50 capital business magazine
The government can prescribe a minimum percent-
age of credit extension (as a total lending base) to
MSME entities within a particular cluster or MSME
entities across sectors. This approach has been suc-
cessfully implemented in Pakistan, India (sector
focus on agriculture and cottage industries) and the
Philippines (entity focus) within emerging markets.
Incubators and Innovation
Experience 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 key
characteristics for a viable incubator setup. Apart
from incubators for innovation to thrive, the basic
pillars of education, technological capabilities, gov-
ernment incentives and development of intellectual
property protection are essential.
Innovation and incubation supports ensure that the
quality projects coming up for funding generate the
requisite interest within the financial community.
Apart from funding, this spawns equity investment
and venture capital industries. The best example of
this is the US, where the venture capital industry is
credited with major breakthroughs in health care,
technology, communications and internet-based
services.
Once the private sector establishes the financial via-
bility of incubation and innovation, the transition
from a government-sponsored initiative to a
public/private partnership or private-only setups be-
comes relatively easier.
2. Private Sector
The role of the private sector in any economy is to
efficiently allocate resources and factors of produc-
tion to derive the maximum possible gain.
Provision of Loans and Financial Products
The private sector should be encouraged to develop
a suite of financial products covering the needs spec-
trum for MSMEs.
The challenges arise within microfinancing, where
the private sector must identify niche opportunities
with sufficient scale for the model to be commer-
cially viable. Usually this can be aided by govern-
ment intervention in the form of public-run
microfinance institutions, subsidising the cost of
funds to microfinance institutions and incentives on
the tax or regulatory front. Once suitable scale is
achieved, these can be eased out and microfinance
institutions can function independently.
The two models for regular loan provision for SMEs
can be scorecard-based lending and relationship
lending.
 regional business cover story november 09 www.capital-me.com

In most of the Middle East, import-based

The first variant is applicable for smaller size loans. a finance framework; however, unless the environ- The rating process is dependent on accounting regu-

economies with limited protection pit a

In a score-based model, based on actual statistical ment in sufficiently enabled, the framework cannot lations, disclosure laws, industrial data, credit loss,

nascent MSME enterprise against large

data, a scorecard is developed for an applicant for a be sustainable over the long term. The key enablers migration data and peer group analysis. This is a

players from across the globe.

particular industry. The scorecard has predictive abil- in such an environment ensure the success of costly and time-consuming process to put in place
ity on the likelihood of default for any applicant MSMEs, promote transparency and develop the skill for MSMEs. What actually makes sense is to develop
based on demographics, industry variables, repay- base of entrepreneurs, thus raising confidence in an MSME rating bureau along the lines of a retail
ment history and other factors. This approach is MSME enterprises. private credit-reporting agency. This would provide
cost-effective, as the disbursement, monitoring and an assessment on the basis of statistical scorecards
collection is done on a portfolio basis with Credit Ratings and Bureaus tailored by industry segments, hence lowering the
economies of scale. However, the downside is that The role of independent credit ratings for MSMEs is cost and the turnaround time substantially. However,
there is no “tangible” relationship with the MSME essential for the flow of financing and equity invest- this requires a concerted effort to invest in collating
enterprise. An example of scorecard-based lending ment to take root. Independent credit ratings usually data at the national level, which in itself is a compli-
would be the credit-card lending model. are the domain of larger corporate concerns. They cated exercise. The global existence of private credit
Relationship-centric lending models usually have a communicate an assessment of the entity’s ex- reporting is mostly limited to the developed markets,
one-on-one relationship with the SME concern pected business performance, financial perform- with some coverage recently in Asia.
through either a relationship manager or branch ance, management effectiveness and, consequently,
manager. This entails a better understanding of the creditworthiness from a going concern perspective. Private Credit Reporting
business and development of customised solutions
for the MSME’s financial needs. Though generally
preferred by MSMEs all over the world, the model Rating Parameters
entails substantial investment in the operating
framework from the bank’s side. Unless a bank has Criteria Parameters
sizeable scale of profitable SME customers, it does
not prefer this approach. Promoter &
Business Financial
Management
Private Credit Registry
Raising Equity Investment • Overall • Gross profit and net • Constitution and Existing
In the developed markets, the private sector is cred- understanding of profit margins shareholding pattern of In Process of Developing
ited with raising a substantial chunk of equity in- business process and • Trend analysis the group companies Does Not Exist
vestment through angel investors, venture capital practices • Gearing • History of the group No Information
firms and stock exchanges. Within the GCC, the • Estimate of the • Return on net worth and its promoter
angel investment network is credited with raising sustainability of the and return on capital • Review of other
only $7 million in 2008, compared with more than business employed companies and
$26.5 billion in the US alone. • Key driving factors • Contingent liabilities investments held by Protected Market Environment spending, and diverting 5% to 10% of this spend-
Investors (both private and institutional) are wary of of the business • Debt service the promoter Sustainable development of MSMEs can be en- ing could support a large number of MSME enter-
equity investments in the Middle East because of a • Important customers coverage ratios • Financing and sured by providing a protected market environ- prises.
lack of transparency stemming from the regulatory and suppliers • Inter-company loans operational ring fencing ment. In most of the Middle East, import-based These types of initiatives are especially appealing
framework, absence of data to make comparative • Sales and purchases with specific attention measures taken by the economies with limited protection pit a nascent to the private sector under the corporate social re-
valuations, missing bankruptcy laws and limited op- fragmentation to the companies management MSME enterprise against large players from across sponsibility (CSR) philosophy.
portunities for exit. • Order book position belonging to same • Professionalism in the globe. A protected environment can be created A key aspect of the protected market is “healthy
Even though stock exchanges exist within the Mid- • Strategic strengths owner but not management by such initiatives as: turnover”. Firm criteria for both eligibility and
dle East, the small cap exchange model (along the and weaknesses consolidated with • Succession plans of “graduation” from the program need to be put in
likes of AIM in the UK) has not been implemented • Diversification plans other companies management including • Creating closed marketplaces (from a competi- place. This ensures that MSMEs continue to drive
yet. Thus the market-making and exit possibilities • Projections and • Monthly cash flows second line of tion perspective) by product category or geography. for self-sufficiency and that the programme does
for equity investors are quite limited in scope and synergies • Other financial management An example could be developing a handicrafts not end up creating inefficient enterprises in the
most of the transactions occur as private place- • Independent factors peculiar to the • Management market with a high concentration of microenter- medium term.
ments. This is one of the most lucrative regions in confirmations from business of the philosophy prises. The fixed and marketing costs of such a
the world to raise equity, but the sad part is that an suppliers and company • Gearing philosophy marketplace can be set up under a public-private Leveraging Partnerships
overwhelming majority of equity investments are customers about the of management partnership. The concept of synergy can be applied to good ef-
routed to developed markets. performance and • Local shareholders • MSMEs can be made a part of the supply chains fect within the framework. Supra nationals, multi-
The three pillars of equity investment (angel, ven- market standing of the interference in the of large corporate concerns. This can be done by lateral donor agencies and nongovernmental aid
ture capital and stock exchanges) need to be re- subject management of the mandating a certain percentage of the supply institutions bring a wealth of experience and re-
vamped within the Middle Eastern markets for • Inherent risk companies chain procurement from MSMEs, with an accept- sources to the game. The important aspect is to
equity investments to start flowing. involved in a similar • Other factors peculiar able variation of cost and quality. identify and align their roles to the central MSME
type of business to the business and • Government procurement programs targeted at development policy and strategy. The role of these
3. Enabling Environment management MSMEs can prove to be very useful. In the Middle partnerships is crucial at the strategy and planning
The private and the public sector can start access to East, government entities control a large portion of phase to ensure seamless execution.

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 regional business cover story november 09 www.capital-me.com
Skill Development and Support
The concept of training and development has given
way to skill development in recent years. Class-
room sessions on theoretical aspects of running a
business have given way to peer group experiential
learning sessions. Instead of subject matter ex-
perts, these sessions are conducted by facilitators
aiming to answer problems based on the actual ex-
perience of the peer group. This trend has forced a
rethink of traditional training and delivery chan-
nels. With a knowledge focus, professional net-
works and context-based solutions to questions
available 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 of
business and general counseling has a tangible im-
Ease of Doing Business Report 2009 rankings
Country Overall Ease of Starting a
Doing Business ranking business
Egypt 114 41
Jordan 101 131
Lebanon 99 98
Saudi Arabia 16 28
UAE 46 113
Source: Ease of Doing Business Report 2009, World Bank
Experience across
the world has
shown that
innovation
prospers with the
right incubation
facilities.
About the Author
Ahsan Ali is the Director Credit for Khalifa Fund for Enterprises Development,
a sovereign fund focussed on SME development, in the UAE. His previous
work experience of over 12 years in banking spans across 8 countries and
multiple disciplines. His areas of interest include economic development, risk
management, Islamic banking and SME Development. He holds an MBA from
the Institute of Business Administration, Karachi University, as well an MS in
Financial Economics from the School of Oriental and African Studies, London.
Ahsan is a CFA Charter Holder, an FRM certified risk manager and a member
of the Securities and Investment Institute (SII), UK.
54 capital business magazine
pact on success rates. Support can come in the
role of a “business counselor.” For an MSME, this
combines a trusted aide, industry expert, bank fin-
ancier, psychiatrist, consultant and friend. This in-
tervention is crucial in the post-operating stage of
an enterprise. If the right rapport can be estab-
lished with the entrepreneur, the failure rate can be
reduced.
Regulatory Considerations and Intellectual Prop-
erty Protection
The regulatory framework, in terms of ease of
doing business, bankruptcy laws, availability of the
required infrastructure and logistics, commercial
law and the judicial system, is important for the
generation of new enterprises and sustainability of
existing ones.
Getting credit Enforcing contracts
84 151
123 128
84 118
59 137
68 145
Intellectual property rights are crucial for main-
taining a competitive edge and restricting unique
products from turning into commodities. Establish-
ing an intellectual protection environment requires
comprehensive legal challenges as well as align-
ment to global standards.
Tailored Solutions
Improving access to finance and investment is cru-
cial for new-enterprise generation as well as sus-
tainable growth for existing entities. There is no
clear-cut formula or model which guarantees suc-
cess. Each region requires a tailored solution
catering to its financial markets, human talent
base, governmental resources and economic prior-
ities.
For the Middle East, keeping these factors in
mind, 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.