How banks are set to better support SMEs in financing their businesses

We often hear about the data points that highlight the importance of small and medium enterprises to the local economy, among them that they account for 95 per cent of companies in the UAE and employ 86 per cent of the workforce.

These are remarkable numbers that attest to the UAE's achievements in creating a business-friendly hub developed over a long history of mercantile activity, one that has sought to cultivate an environment of entrepreneurship, today a key component of the national agenda. The government recognises the importance of SMEs as a driver of entrepreneurship to help advance economic diversification.

From the launch of Dubai SME in 2002 and the Khalifa Fund in 2007, through to a 2014 SMEs law and the debut of the Emirates Development Bank a year later, many initiatives have been rolled out over the past two decades to support SMEs.

The EBD’s mandate was, and still is, to provide financial support through a variety of credit offerings that conventional banks don't normally extend to small companies. The stimulus measures deployed by the Central Bank of the UAE during Covid-19 to support SME liquidity has also bolstered the sector during the recent macroeconomic challenges.

However, the 2019 annual report by the Central Bank of the UAE acknowledges that almost two-thirds of the SMEs surveyed felt "financially constrained" and unable to access credit at a reasonable cost.

Lenders tend to focus on balance sheet data at the expense of analysing cash flow profiles and, moreover, reportedly underutilise resources such as the Al Etihad Credit Bureau, a points-based credit rating system to help assess creditworthiness.

Enter the pandemic. The government and central bank's stimulus and monetary support response was swift.

A business survey by the central bank found that the underwhelming use of AECB, the Etihad Credit Export Insurance (a government trade credit provider geared towards SMEs) and the Moveable Collateral Registry (a repository on which collateral can be registered and searchable by lenders) "may be testament to the lack of awareness about the importance of these services to help reduce borrowing costs and ease access to credit".

Systemic improvements under the purview of a federal "small business administration" agency that standardises SME borrowing eligibility and provides a level of risk mitigation can help incentivise bank lending and increase financial support for deserving SMEs but with reasonable protections in case plans go wrong and a default looms.

And what do banks do in the face of a default? The options are:

1. Do nothing and hope for the best;
2. Enforce on security and assume the laborious task of monetising assets that lenders would rather not own or manage;
3. Sell the debt (to the extent there is a secondary market);
4. Embark on a consensual restructuring.

Option 1 is too often the reality outside of large-scale distress scenarios when it, of course, is option 4 that best preserves value, avoids uncertainty and preempts insolvency.

But restructurings require a new business plan or a strategic divestiture of assets, all of which demands meaningful stakeholder engagement. SMEs are often inadequately advised on these matters, and thus unable to develop sustainable solutions with stakeholder buy-in.

They may even be unaware of the "business rescue" principles now reflected in the UAE’s insolvency regime, with the federal bankruptcy law allowing distressed companies to pursue court-sanctioned negotiations with creditors to arrive at a financial restructuring.

This system has come a long way with modern insolvency laws, including those of Abu Dhabi Global Market and Dubai International Finance Centre.

No matter the sophistication of the insolvency laws, creditors and borrowers alike will always prefer to avoid the vagaries of a court process and hammer out a deal if there is a deal to be had.

A consensual outcome enhances debt recovery in more cases than not, but requires pragmatism and patience. A cohesive framework for greater risk sharing between banks and government would help SMEs, as would SMEs being wise to the fact that, small though they may be, they have more leverage vis-a-vis their creditors than they think.

Hessam Kalantar and Phumzile Mdakane are managing partner and counsel, respectively, of Kalantar Business Law Group