The small and medium enterprises (SMEs) sector constitutes an important part of the economic fabric in most Arab countries. Despite its key role in increasing economic growth and providing a large number of employment opportunities, the sector still faces various obstacles, the most important of which being the difficulty of finding funding sources. Although the available data indicates a significant increase in the number of loans granted by banks to the Arab private sector in recent years, it is the large companies that mainly benefit from them.
However, the behavior of banks, which is characterized by strong reservations toward SMEs, is one of the reasons for the current insufficient funding levels. However, careful examination would attribute the inability to find funding resources to the following factors:
- Due to their size and limited potential, SMEs represent a higher risk for banks, as they are less capable of coping with economic shocks than larger corporations are. Many studies prove that the probability of faltering or suffering bankruptcy is higher in SMEs.
- In many cases, SMEs lack accurate and documented financial statements that banks can rely on to assess their financial strength. They also lack the technical and financial qualifications that would allow them to conduct feasibility studies compatible with the required standards. It is through these studies that they need to prove their ability to achieve sufficient financial returns to pay the dues of their desired bank loans.
- There are no incentives for banks to direct their resources toward meeting the funding requests of SMEs, while governments and large corporations still rely mainly on bank financing. Also, the number of big corporations putting their shares on the public markets is still very limited in most Arab countries. This is either due to their unwillingness to reveal their accounts to the public and suffer the consequent tax liability, or the unwillingness of their owners to open their capital to shareholders outside of their families, thus losing full control over the company decisions.
Accordingly, the over-reliance of big companies on bank financing hinders the SMEs’ access to funding and weakens the incentive of banks to develop the capacity to deal with the funding requests submitted by owners of SMEs. Thus, it is necessary that any government policy aimed at addressing this phenomenon be inclusive and consider the objective factors that drive banks to focus on large companies. Also, governments should introduce regulatory reforms and develop incentive packages that would help facilitate the process of financing SMEs. This policy can be summed up in the following seven points:
- The capacity of banks to assess the financial risks of SMEs needs to be developed, along with a way of covering the expenses related to the feasibility studies of submitted projects. Arab countries can also benefit from the experiences of other countries in this area, including the European Union countries, which allocate considerable subsidies to stimulate bank financing of SMEs.
- The owners of SMEs need to be supported in financial management, the management of active capital and liquidity needs. They also need to work on improving the transparency and credibility of their accounts.
- A credit database under the supervision of the Central Bank which covers SMEs needs to be created, and it must be available to all commercial banks to facilitate the process of credit evaluation and risk management.
- A public body which ensures the provision of credit guarantees for loans granted to innovative projects that lack self-sufficient guarantees must be established. This procedure, which was adopted by some Arab countries in the past few years, aims to launch pilot initiatives and creative potential, especially among youths.
- The rules and regulations must be reviewed to promote the rights of creditors and to improve the effectiveness of guarantee laws and the bankruptcy system in a way that helps expand access to credit. The World Bank reports on business environments show that protection of creditors' rights in Arab countries remains weak as compared to international standards.
- Incentives to large companies must be provided to encourage them to put their shares publicly on the financial markets. The performance and transparency level of these financial markets must also be improved, and laws that protect the rights of shareholders should be enacted.
- Alternative methods of funding need to be developed by depending on risky venture-capital companies interested in promising pilot projects that carry a high-risk, or existing troubled projects. Risky venture-capital companies usually take part in projects before providing the needed financial or technical support and sell their share when the projects are able to produce high returns.
The importance for SMEs to obtain funding, in terms of increasing economic growth rates, supporting industrial and service activities and improving productivity via advanced machinery and equipment, and thus increasing competitiveness and the ability to sweep foreign markets, necessitates a vital role by the government in bridging the gap between the high demand of funding and the capabilities of commercial banks.