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Common myths about SME banking - Daily News Egypt

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Common myths about SME banking

In Egypt, like in all other developing and developed countries, small and medium enterprises (SMEs) constitute a large proportion of the nation’s economic activity — contributing to over 50 percent of GDP and almost two-thirds of employment. As such, this sector is increasingly being considered as an attractive commercial opportunity for banks. Some banks have …


In Egypt, like in all other developing and developed countries, small and medium enterprises (SMEs) constitute a large proportion of the nation’s economic activity — contributing to over 50 percent of GDP and almost two-thirds of employment.

As such, this sector is increasingly being considered as an attractive commercial opportunity for banks. Some banks have already started to develop an SME banking strategy. However, since there is relatively little or no experience in this area, banks may not always be pursuing a commercially attractive and well thought out SME strategy.

SMEs encompass a wide range of enterprises operating across sectors such as trade, manufacturing, construction, tourism, health, education, etc. According to a recent World Bank/IFC study, SMEs in Egypt range from small shops operated by five people with annual revenues less than LE 20,000 to larger 100-200 employee set-ups with annual revenues reaching over LE 5 million.

It is therefore essential that before tapping into this segment, banks need to develop a coherent strategy to avoid the common pitfalls of SME banking. Such choices would involve choosing the market segments they wish to pursue, the product portfolio they develop, and the distribution channels they adopt.

In pursuing SME banking, there are some common myths, which need to be understood and avoided.

Myth No. 1: SME banking = SME lending

Many banks think that SME banking means lending to SMEs. It is therefore not considered by banks as a profitable business since it takes more effort and the turnaround time is longer.

The fact is, however, that lending is a very small portion of the profits that can be made from SME banking. A major portion of profits are derived from other areas, such as transactions, O/Ds, etc.

Myth No. 2: It’s expensive to provide banking services to SMEs

There is a myth that it is very expensive to provide banking services to the SME sector. The most common mistake made by banks is that the processing of an SME client should be done in the same manner as that of a corporate client. In such a case, SME banking will not make sense, as the size of the transaction would not justify the effort.

It is therefore essential to have special product programs aimed at certain segments of the SME sector (identified through market research). The processing and delivery of these products to clients must be driven by efficient IT systems, thus enabling a bank to process several loans simultaneously, cutting down on costs and turnaround time.

Banks which develop market driven product programs and have efficient IT systems are very successful in SME banking.

Myth No. 3: SMEs do not borrow from banks because of the high cost of funds

People don’t realize that SMEs have always existed and will continue to do so. These SMEs can be found in almost all sectors of the economy, such as manufacturing, trade, and in the services sector.

Many of these SMEs are also growing and expanding, so they must be investing into their businesses. The fact is that in the absence of formal financing sources (such as banks) they borrow from the informal sector (including relatives and friends) where the cost of borrowing can be as high as 150 percent per annum.

As a matter of fact, SMEs are looking for alternate sources of funds. Although the cost of funds in SME banking is comparatively higher than the market rate for corporate lending, it is significantly lower than what SMEs are currently willing to pay. Bank lending would then replace a very expensive source of funds for SMEs thus enabling them to borrow and grow more efficiently.

Myth No. 4: SME lending requires the same risk assessment as corporate lending

This is also a common mistake that banks make. They either use the same credit underwriting procedures as those for corporate lending, or use the same people to assess the risk of SME clients. Successful SME banks deploy an alternate underwriting process that is in tune with the type of banking necessary for SMEs.

Firstly, the information available from SMEs may not be adequate and hence the bank has to design a risk assessment methodology that is based more on the dynamics of the sector that the SME operates in than on information (including financial statements and business plans) provided by the clients. In essence this means coming up with a robust credit scoring system, which can capture and identify the inherent risks and then coming up with product programs that take account of these risks and factor them into the lending criteria. This enables the bank not to spend time on assessing the risk of individual clients, which would not be a cost efficient way of approaching SME banking.

Conclusion

The above are some of the common myths about SME banking, which prevent banks from entering this market. However, once banks realize that providing banking services to the SME sector can be a profitable and sustainable business if carried out in a proper manner, more and more banks will want to set up such operations.

Kaiser Naseem is Program Manager of IFC’s Bank Advisory Services Program in the Middle East and North Africa. Mr. Naseem has established two financial institutions in Pakistan for a group of investors. He is also the Founder President of Pakistan’s SME Bank, which he helped create, as part of the Government of Pakistan’s financial sector restructuring team during 2000-2002. This article was written exclusively for Daily News Egypt.

The findings, interpretations and conclusions expressed in this article are the authors own and do not necessarily reflect the views of IFC, a member of the World Bank Group.

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