Sailing the Seven “Cs:” Unlocking bank financing for SMEs in the Middle East
By Arun Hsu, Chief of Party, Jordan Loan Guarantee Facility
In this guest post, an OPIC partner outlines a system for determining creditworthiness of potential borrowers that lack collateral and a track record of working with banks.
Small and medium enterprises (SMEs) are the key to innovation and an engine of economic growth and job creation in the Middle East and North Africa (MENA) region. Despite the crucial role SMEs play in the region’s economies, they have great difficulty accessing financing needed for start-up and/or growth. The financing gap for SMEs in the MENA region is estimated to be between $110 billion and $140 billion.
SMEs are frequently unable to obtain financing from the banks, as the banks consider the risk of lending to SMEs too high. Prospective borrowers state that the banks impose excessive collateral requirements and demand too much information. SME’s find themselves in the position of being too big to qualify for loans from microfinance institutions and too small and risky for the commercial banks.
While cash flow is normally considered the primary source of repayment when evaluating loan proposals, many banks in the MENA region rely primarily on collateral when making lending decisions, especially when lending to SMEs. Banks say the main reason for this is the prospective borrowers’ inability to provide adequate business plans with cash flow projections.
OPIC, in partnership with USAID and Global Communities, has established Loan Guarantee Facilities (LGFs) in Egypt and Jordan to address the SME financing gap. The LGFs facilitate SME lending by providing partial loan guarantees for SMEs that are creditworthy, but cannot provide the collateral and/or information required by the banks.
The Jordan Loan Guarantee Facility (JLGF) is working closely with its partner banks to strengthen SME credit underwriting. This involves applying the traditional five “Cs” of credit to which we added a further two – Concept and Competency:
- Capacity. Will the business generate sufficient cash flow to pay back the loan?
- Character. How willing and committed is the borrower to repaying the loan, even if the business faces hardship?
- Collateral. What assets is the borrower willing to pledge as secondary sources of repayment?
- Capital. How much money is the borrower willing to invest in the transaction along with the bank financing and how much capital has the owner contributed to the overall business?
- Conditions. What outside factors can potentially affect the borrower’s ability to repay the loan?
And the two additional “Cs”
- Concept. Does the loan purpose logically support a clear business opportunity?
- Competency. Does the management have relevant experience, expertise, and track record?
In our work in the Middle East, we are also placing a special focus on “Capacity” and are working with our partner banks to overcome the obstacles to underwriting loans based on cash flow as the primary source of repayment. This involves developing efficient ways of obtaining financial information from borrowers, developing cash flow projections, and validating assumptions upon which those projections are based.
As long as lending remains predominantly collateral-based, the financing gap for SMEs will remain large. Our aim over the longer term is to use the LGFs to demonstrate to the banks that SMEs are a viable market whose credit needs can be profitably served, without the need for a guarantee program.