The UAE Government has instituted several initiatives such as the ‘Government Procurement Program’ or ‘Credit Guarantee Program’ to drive development of the SME segment. But are commercial banks aligned to support them? Karthik Kapasi, Senior Engagement Manager at Cedar Management Consulting highlights the risk principles that determine SME credit worthiness.
It’s a well-known fact that only 5% of total advances are being lent to the SME segment in UAE versus 15% in more developed nations, and this is primarily because of the risk perception and challenges that the banks are going through in the region. Having worked and interacted with most of the leading banks in the region across SME and mid-market segments, it’s very evident that most banks are being extremely cautious and selective towards lending to SMEs under the current volatile market scenario. And one common theme that we come across these banks is the level of comfort they draw while lending to SMEs supplying to Government agencies. However, the opportunities have not been explored enough due to a cautious mind-set of bankers with which the SMEs are being perceived these days.
There are 4 key risks principles that determine the credit worthiness of a SME customer. Let’s look at how these risks are typically addressed by banks while lending to SMEs associated with Government agencies.
Most banks would have an Industry strategy which would lay out guidelines for lending covering key sectors where they should focus and the high-risk sectors where lending should be restricted. However, most of them do not take into consideration the industries where Government are highly participative in terms of the SME supply chain. While there are 300 SMEs across 12 sectors and 57 industries; there are at least 18 industries involved in supplying to Government agencies. And, clearly there are at least a dozen of them having a high-concentration of SMEs and a positive or stable industry outlook. There’s a significant opportunity for banks to collaborate with Government and have a specialized value proposition and focused lending strategy for all such SMEs participating in Government supply chain.
2. Management Risk
One of the key challenges most banks typically face with SMEs is to assess the quality of their management teams. SME financing is similar to private equity, and hence the RM should be trained to assess the quality of promoter and his ability to repay. However, the due diligence performed by the banks is mostly considered to be inadequate due to quality or non-availability of information. Since government vendors and suppliers have to go through a rigorous due-diligence process to participate in the supply chain; banks can draw significant comfort to lend to SMEs supplying to Government agencies.
3. Quality of Underwriting and Credit Framework
It’s critical to have a comprehensive underwriting framework aligned to overall credit policy for the SME segment and even while lending to SME suppliers of Government there should be no short-cuts taken for assessment of credit risk. However; what’s more critical is to have a rigorous monitoring framework to manage all exceptions and also identify the early warning triggers leading to credit default.
4. Level of Collateral and Security
More often than not, you’ll find banks having high loss rates in the SME segment due to lack of adequate collateral or security coverage. However, in case of a SME supplier of Government the banks can consider products with relatively lower risk such as invoice discounting, receivable financing, supply chain financing or equipment financing which are adequately backed by government receivables for assignment to bank.
It’s also critical for banks to assess the end-to-end supply chain of all the federal entities to identify potential opportunities. There are a few ministries which would deal with specific industries for products and services aligned to their strategic objectives. For example Ministry of Health would be dealing with Healthcare Products and Equipment suppliers, Pharmaceuticals, Hospitals, Clinics, Laboratories, Engineering and Contracting firms for construction of medical facilities. Similarly, there are a few industries which are critical to functioning of all federal entities such as Business and Professional Services, Property and Facility Services, ICT and Financial Services.
To conclude, if one has to map-out the industry value-chain across all federal entities covering the 11 federal ministries, 19 federal authorities and 25 federal institutions and profile the SMEs participating in their supply-chain across its size and scale, geography, sector/industry traits, financing needs and key risk indicators; there is a significant opportunity for banks to leverage and have a value proposition developed for this segment and play a significant role in supporting the Government in promoting sustainable economic development.