Module 1: Macro context of SME lending

Money defined: Any object accepted as means of exchange within a society.

Function of Money:

- Medium of exchange: Use of money in exchange for goods. It makes the transaction easier to
complete. In barter it is necessary to find someone that has what you want and who wants to
exchange it for what you have.
- Measure of value (unit of account): Money measures values of goods and services as a unit of
account.
- Store of value: Storage of value in several ways, one of the best is money. If you don’t want to
spend your money now, you can so it later. ( inflation weakens the ability of storing value of
money).
- Standard of deferred payment: Used to buy goods on credit. This often works in the favor of the
purchaser, who buys goods at today’s price, but settles with money later that is worth less
because of inflation.

Classification of money:

- Commodity money: Its value comes from what it is made of, and have value in themselves
like(Gold, Silver, copper, Shells, Cattle)
- Token money: Representative money, its money that doesn’t have real value in itself, and is
accepted as a medium of exchange for services and goods. Its value comes from either the
commodity it stands for or from government regulation or law (paper money, coins...)

Money supply:

Is all the currency and other liquid instruments in a country’s economy on the date measured (all cash
and deposits that can be used almost easily as cash).

Narrow money:

- M0: Is the physical paper and coins in circulation.

- M1: Is the total of M0 plus travelers checks, demand deposits and banks operational balances at
the central bank.

Broad Money:

- M2: All of M1 + Money market shares and savings deposits.

Growth of money supply:

Is an important factor not only for the level of economic development in the country, but also for the
achievement of price stability in the economy.

There must be controlled expansion of money supply if the objective of development with stability is to
be achieved. A healthy growth of an economy requires that there should be neither inflation nor
deflation.

The money supply therefore plays a vital role in the national economy of any society. An increase or
decrease in the amount of money plays a pivotal role on the level of economic activity.
Role of commercial Banks in Money supply:

The money supply of a nation is either controlled by a central bank or similar government entity. In
Egypt, the central bank of Egypt (CBE) is responsible for this process. Commercial banks are one piece of
the process in controlling a nation’s money supply. Commercial banks receive deposits and make
personal and business loans.

CBE can influence the money supply through commercial banks by changing money reserves or
discount rates. Money reserves indicates how much money a commercial bank must retain
rather than disburse as loans. Discount rates work in a similar fashion. Low rates increase the
money supply while high rates decrease the money supply.

The commercial banks can create money or credit against deposits through the bank multiplier. It is true
that “every loan creates a deposit”. Credit creation by commercial banks refers to the multiplication of
loans and advances.

Credit multiplier/Money multiplier (credit creation): Is a model that illustrates how banks can create
money. The rate at which credit is created depends on the reserve ratio.

- Legal reserve (r)= 10%, original deposit = 1000, loans = 90% of deposit

1
∆ M =original deposit ( )
r

∆ M =1000 ( 0.11 )=10,000

Total reserves=10,000∗0.1=1,000
Total Loans=10,000∗0.9=9,000
Functions of commercial banks

They are financial intermediaries, an institution that facilitates the channeling of funds between lenders
and borrower indirectly.
Primary functions of banks

Accepting deposits:

The first important function of a bank is to accept deposits

- Current account: an account for businesses and individuals used for daily operations with no
interest paid on these accounts.
- Saving deposits: this type of deposits encourages saving habit among the public. The rate of
interest tends to be lower than other types of deposits accounts. Withdrawals of deposits are
allowed, usually in demands.
- Fixed deposits: A amount is deposited for a specific period with an interest paid at the maturity,
and not allowed to withdraw before the expiry of the period.
- Recurring Deposits: a certain sum of money is periodically deposited into the bank. Withdrawals
are permitted only after the expiry of certain period. A higher rate of interest is paid.

Granting of loans and advances:

The second primary function of a bank is advancing of loans

- Overdraft: this type of advances is given to current account holders. No separate account and all
transactions are made in the current account. A certain amount is sanctioned as overdraft which
can be withdrawn within a certain period, for 3 months. Interest is charged, and sometimes
granted against collateral security.
- Credit cards: Allow their holders to make purchases of goods and services in exchange for the
credit card’s provider. with promising to pay back with promising to pay back over a variable
time-scale. Variable repayments can be made with interest charged on the o/s monthly balance.
 - Short term loans: Granted for short term say a period of 1-3 years. The short term is sometimes
granted against collateral security and / or guarantees.
- Term loans: short term or medium term of 5 years. Repayment of money in the form of
installments spread over a period or in a lump sum amount. Interest is charged on the actual
amount, whether withdrawn or not. Loans are normally secured against tangible assets.
- Mortgages: Specific types of loans used to buy real estate for a period 15,25, or 30 years.
- Discounting of Bills of Exchange: through discounting or purchasing bills of exchange both
domestic and foreign bills. The bank pays the amount to the beneficiary by deducting usual
discount charges.

Secondary functions of banks

Agency Functions:

- Transfer of funds: transfer from 1 branch to another or from 1 place to another.

- Collection of checks: the banks collects the money of the checkes through clearing section.
- Periodic payment: on standing instructions of the client, the bank makes periodic payments in
respect of electricity bills, rent,…
- Portfolio management: To purchase and sell the shares and debentures on behalf of the clients.
- Periodic collections: the bank collects salary, pension, dividend …. On behalf of the clients.
- Other agency functions: Act as trustees, executors, advisers and administrators on behalf of its
clients. They act as representatives of clients to deal with other banks and institutions.

General utility Functions:

- Issue of drafts and letter of credits: issue of drafts for transferring money from 1 place to
another, also issuing of letter of credit, and issues travelers’ cheques.
- Locker facility: Safe custody of valuable documents, gold….
- Underwriting of shares: underwrites shares and debentures through its merchant banking
division.
- Dealing in foreign exchange: banks allowed to deal in foreign exchange.
- Project reports: preparing project reports on behalf of its clients.
- Social welfare programs: such as adult literacy programs, public welfare campaigns..
- Other utility functions: it collects creditworthiness information about clients of its customers.
Provides market information to its customers, etc.
- Modern e-commerce: utilize electronic formats to complete many of their functions include:
o Automated Teller Machines (ATMs) / debit cards / online banking / Automatic clearing
houses (ACHs) / stored value cards.

Main features of the banking system in Egypt

Commercial banks: are commercial enterprises whose purpose is to make profit. Usually in the form of
Joint Stock co. with individuals or institutions.

Overview of the banking subsector

Since 2017, there were 38 banks operating in Egypt that vary in size and in range of products offered.
Central Banks

- Responsible for the issue of banknotes.‫المسئول عن طباعه النقود‬

- The banking service provider for the government.‫مقدم الخدمه المصرفيه للحكومه‬
- Main source of government credit. ‫المصدر الرئيسي لالتمان الحكومي‬
- Managing the public debt.‫يدير الدين العام‬
- Provides the government with technical advice and advice in the affairs of cash and credit. ‫يقدم‬
‫للحكومه المشوره الفنيه و المشوره في شئون النقد و االئتمان‬
- Propose the monetary procedures required by the economic conditions.

‫اقتراح اإلجراءات النقدية التي تقتضيها الظروف االقتصادية‬ -

The government has pledged to the CBE to control the exchange, maintain the

‫ عهدت الحكومة للبنك المركزي بالسيطرة على البورصة‬.state’s of gold and foreign exchange balance

.‫والمحافظة على أرصدة الذهب والعمالت األجنبية‬

 -
- Bank of banks: provides banking services to commercial banks, has control over the volume of
credit it achieves this in 2 ways:
o By obliging commercial banks to retain a certain % of their deposits with the central
bank, thus reducing the money supply.
o Providing loans to commercial banks.

Law no. 88 of 2003of the “Central Bank, Banking sector and Monetary System” entrusts the Central Bank
of Egypt (CBE) with the formulation and implementation of monetary policy, with price stability being
the primary and overriding objective. The CBE is committed to achieving, over the medium term, low
rates of inflation which it believes are essential for maintaining and sustaining high rates of investment
and economic growth.

SWOT Analysis

Internal:

Internal factors are the strengths and weaknesses of the company. Strengths are the characteristics
that give the business its competitive advantage, while weaknesses are characteristics that a company
needs to overcome in order to improve its performance.

External:

External factors are the opportunities and threats to the company. Opportunities are elements that the
company sees in the external environment that it could pursue in the future to generate value. Threats
are elements in the external environment that could prevent the company from achieving its goal or its
mission or creating value.

Importance of SME definition:

- Necessary to help with the segmentation of the sector (i.e. business size, type, income
generated, services needed and borrowing requirement).
 - To set the general rules and initiatives to such segment of business.
- To build a database to help in analysis and assess the economy.

SMEs Definition:

IFC definition

Enterprises must meet at least 2 of the following criteria, or if the loan falls within the relevant MSME
loan size proxy.

The Role of SMEs in the international Economy

Egypt’s SMEs faces many challenges

- Legal and regulatory issues.

- Slow technology adoption.
- An insufficiently skilled workforce.
- Poor financing options.
- The lack of access to suitable financial products hampers SME growth.
- Lack of experience.

Importance of access to finance

SMEs and other businesses have different life stages and each stage usually needs a different level of
funding.

Key principles to SME Banking and the integrated Approach to SME Banking

In order to make SME banking a profitable and sustainable business activity, banks need to be able to:

- Perform high volume lending.

- Lower the average transaction cost.
- Maintain a healthy portfolio.
- Promote cross selling, lending on its own is not enough.

To be successful at SME banking a bank must (banks plan):

- Possess a clear, well defined strategy that is supported by key members of the institution.
- Understand the SME market in which the bank plans to operate.
- Develop, offer, an effectively sell appropriate products.
- Manage risk effectively.
- Hire, train and motivates staff.
- Maximize effectiveness of IT and MIS.

Ways to characterize SME businesses

- Micro: Informal business, operated by low income people and have a few barriers to entry.
- Small: Usually registered, operated by a family or close group, business owner is the day to day
decision maker, financials may not be accurate and rarely audited.
- Medium: business is large enough that decision making must be delegated, financial record
keeping is more transparent and accurate.

Reason to enter the SME banking

- Diversification of revenue.
- Diversification of credit risk.
- Opportunity to cross-sell a range of products.
- Good for the economic growth of the community.
- Good alternative to corporate lending.

Constraints to SME lending include.-‫العوائق‬

- Cost to serve: the cost of analyzing SME loan is the same as analyzing a large loan. This can be
addressed through changing analyzing procedures and expense control.
- Lack of information: the lack of having audited statements. The information may be often in the
owner’s head. This addressed by using substitutes for formal financial statements.
- Higher failure rate: failure are more common at start-up, the bank can avoid this problem by
not lending to start-up businesses.
- Higher interest rates: SMEs are willing to pay higher interest rates to cover additional costs,
however, higher interest rates may let the SME unable to repay and put the portfolio into risk.

Benefits of SME lending.

 - Less price sensitivity: The owner is able to pay high interest rate, opposite to have good service
and flexibility are much more important.
- Customer loyalty: the bank gets to know the business better over time, which mitigates the
problem of lack of information, thus loans become less risky.
- Cross-selling opportunities: lending can lead to the use of other services, including deposits and
fee-based services.

What do SMEs want?

- Relationship with bank: Good relationship, the bank and the banker can be sources for advice
and education on financial matters for the SME.
- Reliable and consistent availability of credit: Well trained credit officers and on the same level
of knowledge.
- Rapidity and proximity of decisions: Quick access to fund.
- One size does not fit all: Different products to fit his needs.