Access to Finance in the MENA Region

– Recent developments and Challenges

Manama, 18 November 2008

Working Group on SME Policy, Entrepreneurship and Human Capital

Development

Contributions by Erin Hengel, Saïd Kechida, Alissa Koldertsova, Sara Sultan

Overview of the Presentation

Part I: Access to Finance in MENA Overview

• Access to Finance: What is the current situation in MENA countries?

• What is the impact of the current financial crisis on the MENA

region?

• What are the implications of the crisis on SME financing?

Part II: How to Respond

• What instruments and approaches have been successfully employed

in OECD and MENA countries to overcome these challenges?

• What options can be considered to maintain financing channels open

to SMEs?

Access to Finance: What is the current

situation in MENA countries?

Access to Finance: What is the current situation in MENA countries

• Banks are the main source of corporate financing in MENA

countries

• Banking sector is conservative in extending loans to private

enterprises, especially in countries with state dominated banking

sectors

High collateral requirements in some MENA countries

Particular difficulties for enterprises with intangible assets

Result: higher reliance on internal funds

High collateral requirements in some MENA countries

Source: World Bank Enterprise Surveys. Data represents approximate value of collateral required as a percentage of the loan value and the loan’s approximate annual cost/rate of interest. Data for MENA countries is for

Algeria (2002), Egypt (2004), Oman (2003) and Syria (2003); data for OECD countries is for Germany (2005), Greece (2005), Ireland (2005), Portugal (2005), South Korea (2005) and Spain (2005). All sources of

finance represented aggregated responses for both new investments and working capital except leasing arrangements (only represents new investments) and trade credit (only represents working capital loans).

112%

131%

133%

185%

217%

0% 50% 100% 150% 200% 250%

Oman

Egypt

OECD

Algeria

Syria

The collateral required as a % of the loan value is high in Syria and Algeria

Structure of sources of finance in MENA and OECD

Source: World Bank Enterprise Surveys. Data represents the percentage difference between MENA and OECD firms’ usage of the sources of finance. Data for MENA countries is for Algeria (2002), Egypt (2004), Oman

(2003) and Syria (2003); data for OECD countries is for Germany (2005), Greece (2005), Ireland (2005), Portugal (2005), South Korea (2005) and Spain (2005). All sources of finance represented aggregated responses

for both new investments and working capital except leasing arrangements (only represents new investments) and trade credit (only represents working capital loans).

Internal funds

Local banks

Foreign banks

Leasing arrangement

Investment funds, etc.

Trade credit

Equity

Family & friends

Internal funds

Local banks

Foreign banks

Leasing arrangement

Investment fund, etc.

Trade credit

Equity

Family & friends

Structure of financing in MENA for new investments

Structure of financing in OECD for new investments

Reliance on other sources of finance in MENA

• Higher reliance on internal funds (including retained earnings) and family

and friends and lower reliance on local commercial banks

• Underuse of leasing arrangements for new investments and trade credit for

working capital loans

255%

-84%

-51% -50% -50%

32%

-150%

-100%

-50%

0%

50%

100%

150%

200%

250%

300%

Family, friends Leasing arrangement

Local commercial banks

Trade credit Equity Internal funds

Sources of finance: % difference from OECD countries

Source: World Bank Enterprise Surveys. Data represents the percentage difference between MENA and OECD firms’ usage of the sources of finance. Data for MENA countries is for Algeria (2002), Egypt (2004), Oman

(2003) and Syria (2003); data for OECD countries is for Germany (2005), Greece (2005), Ireland (2005), Portugal (2005), South Korea (2005) and Spain (2005). All sources of finance represented aggregated responses

for both new investments and working capital except leasing arrangements (only represents new investments) and trade credit (only represents working capital loans).

Access to Finance: What is the current situation in MENA countries

• High cost of capital relative to OECD countries

High interest rates used to compensate for the lack of credit

related information

Credit bureaus lacking, only recent movement to establish

them

• Low overall pool of credit to the private sector in

comparison with OECD countries

Low credit ratios to GDP in a number of countries

High cost of capital

Source: World Bank Enterprise Surveys. Data represents approximate value of collateral required as a percentage of the loan value and the loan’s approximate annual cost/rate of interest. Data for MENA countries is for

Algeria (2002), Egypt (2004), Oman (2003) and Syria (2003); data for OECD countries is for Germany (2005), Greece (2005), Ireland (2005), Portugal (2005), South Korea (2005) and Spain (2005). All sources of

finance represented aggregated responses for both new investments and working capital except leasing arrangements (only represents new investments) and trade credit (only represents working capital loans).

6.5%

9.2%

11.3%

12.9%

14.3%

0% 2% 4% 6% 8% 10% 12% 14% 16%

OECD

Syria

Algeria

Oman

Egypt

Interest rates are high throughout the region

Low overall pool of credit to the private sector

Source: World Bank, World Development Indicators.

Aggregate data for MENA includes 18 Arab countries plus Israel, Iran and Malta.

Low ratios of credit to GDP in a number of countries

Source: Source: World Bank, World Development Indicators.

Algeria 12

Bahrain 52

Djibouti 20

Egypt, Arab Rep. 57

Iraq ..

Jordan 88

Kuwait 56

Lebanon 78

Libya 14

Morocco 54

Oman 31

Qatar 35

Saudi Arabia 53

Syrian Arab Republic 15

Tunisia 65

United Arab Emirates 61

West Bank and Gaza 8

Yemen, Rep. 7

Domestic Credit to the Private Sector (% of GDP)

• Low ratios of credit to GDP

in : AL, LY, SY, WBG, YE

• Bank credit is distributed

usually to large either state-

owned or private enterprises

(minority beneficiaries)

• Even in cases of high ratios,

SMEs rely mainly on self-

financing (majority

beneficiaries excluded from

credit market)

Access to Finance: What is the current situation in MENA countries

MENA average is calculated on the basis of data available for 14 countries.

• Limited competition in the banking sector : high barriers to

access

Market is highly concentrated by top 3 banks which on average

hold 83 % of all commercial assets

Situation similar in some OECD member countries

• Limited foreign ownership of banks in some countries, while

some countries have opened up banking sector to

competition

• Egypt : OECD’s FDI restrictiveness Index

Bank Concentration

= MENA average (83%)

Source: World Bank Financial Structure Database (2007). Data is from 2006. Data from 2005 is marked with a *.

Calculated as assets of three largest banks as a share of assets of all commercial banks.

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

Three larger banks (% bank assets)

The OECD FDI Restrictiveness Index

Source: OECD (2007)

Non-OECD Average includes data from 14 emerging market economies including : Argentina, Brazil, Chile,

Israel, Egypt, Estonia, Latvia, Lithuania, Romania, Slovenia, China, India, Russia and South Africa.

What is the impact of the current

financial crisis on the MENA region?

Impact of the current financial crisis on the MENA Bank Performance

• Despite positive developments in both conventional and Islamic financeindustries, the impact of financial crisis on MENA is beginning to be felt ;

• Stock market valuations down, putting banks share prices under pressure(Saudi Arabian SE down 42% , Kuwait SE down 30% ); stronger correlationbetween share performance and stock market performance in MENA) ;

• Until the summer, banks’ growth remarkable: reported at 20% annualexpansion – significant slowdown since 2 months (see performance chart);

• Generally, MENA banks are resisting better to stock market downturn (52week change of -32% for Al Rajhi Bank and –15% for Arab Bank versus -72% for Citi Group);

• However, downturn could worsen since some MENA banks and SWFsinvested in toxic financial assets.

Sample of MENA vs. OECD bank’s performance

Bank’s vs. local Stock Index performance

Are there signs of a credit crunch in MENA?

• Project finance drying up, putting a further strain on government purse tofinance infrastructure projects; Calyon is reconsidering Gulf finance dealsand entered talks over escape clauses after underwriting more than $1bnin project financing;

• According to MEED, the value of regional deals so far affected byincreased borrowing costs is estimated to $10.16bn;

• According to Standard and Poor's, growth in the sukuk market has sloweddue to the current tough market conditions ;

• Lloyds TSB Middle East has stopped granting mortgages for UAEresidential properties;

• HSBC is reported to have doubled the salary requirements for customersin the UAE seeking personal loans;

• The expected slowdown in the real economy will increase the riskaversion of banks.

What instruments and approaches

have been successfully employed in

OECD and MENA countries to

overcome these challenges?

How to respond

• Micro Finance

• Credit Guarantee Schemes

• Alternative Financing : Equity Capital/VC/Angels

• Legislative Framework

• Financial Education

How to respond: Micro Finance

Overview of Instrument/Approach:

• Refers to the provision of financial services to low-income clients

• Is becoming an increasingly popular financing method in rural areas,

with little access to conventional banking services

• Key example of success of the approach - the Grameen bank

Case Study: Morocco

Ten years in the making, run by NGOs, over wide range of products

Provide loans up to 4 500 €

Boast 1 million beneficiaries (more than 60% are women)

99% repayment rate

How to respond : Credit Guarantee Schemes

Overview of Instrument/Approach:

• Commitment by an export credit agency to reimburse a lender if the

borrower fails to repay a loan. The lender pays a guarantee fee.

• To mitigate risk-averse attitude of commercial banks

Case Study: Jordan Loan Guarantee Corporation

Facilitates borrowing from participating banks at prevailing interest

rates guarantees up to 75% of amount

Guarantee granted based on feasibility of project and cash flows, not

conventional collateral

How to respond: Legislative Framework

Improving creditor protection laws:

• Certain countries have weak property rights, making it difficult for

firms to claim property as collateral

• Bankruptcy laws can be very onerous and favour the creditor, and can

make it difficult to obtain delinquent payments

• These situations make lenders reluctant to loan funds to businesses

Case Study: Jordanian Insolvency System

• Initiated a public-private sector initiative to assess the insolvency legislation

• Assessment found, inter alia, that there is a need for developing rescue and restructuring proceedings

How to respond: Alternative Financing

Overview of Instrument/Approach:

• Play role in financing high-growth and innovative enterprises, which

may have difficulty accessing capital markets (size) or banks (lack of

collateral)

• Channel funds from international investors

Case Study: Tunisia

• Established two types of equity funds since 1o years ago

• SICAR: provide minority equity contributions in projects finance by

publicly funded schemes, 277 approved projects of which 70%

produced innovations

• FCPR: a mutual equity fund

How to respond: Financial Education

Increase SME awareness:

• SMEs are not aware of financial products offered by banks and other

lending organisations

• Many SMEs are also unversed in developing business plans, which is

key for expressing business objectives and growth to lending agents

Case Study: Citigroup Financial Education Programme

• Created the Citibank Small Business Guide entitled “Becoming an Entrepreneur”.

• Provides clear information on developing a business idea, writing business proposals, approaching financial agents, maintaining sound financial management skills, etc.

• Explains financing options available to SMEs.

What options can be considered to

maintain financial instruments and

approaches have been successfully

employed in existing channels open

to SMEs?

Increasing liquidity to SMEs in MENA: measures taken and options to consider

Existing mechanisms to improve financing

Options to consider

• Facilitate access to capital marketsby establishing secondary tiers witheasier access restrictions

• Use existing state lending facilities(Bahrain Development Bank in Bahrain, Kafalat in Lebanon, etc.)

• Consider providing fiscal or otherincentives to financial institutions lending to SMEs (strategic sectors to consider)

• Consider providing credit guaranteeschemes to reduce risk aversion by banks

• Morocco: second tier capital market, SME agency, venture capital law to stimulate finance to SMEs

• Tunisia: state owned SME bank (BFPME), alternative market

• Lebanon: loan guarantee programme (Kafalat)

• Palestinian Authority: various donor programmes on SME financing

• Egypt: SME unit in the Ministry of Finance

Contact Information

Anthony O’Sullivan

Head of Division

Private Sector Development

Organisation for Economic Cooperation and

Development

Anthony.osullivan@oecd.org