Egypt: From little things, big things grow

Several years ago, an Egyptian mother had a novel idea for a small business in Qalyubia, a governate in the Nile Delta region.

From her humble basement, she would make coat-hangers. The mother’s search for start-up funding brought her into contact with Dr Aliaa Soliman, a partner at Cairo-based AIT Consulting and an expert on small-to-medium enterprise (SME) funding.

“With the assistance of one of the banks, she managed to buy the first plastic moulding machine,” recalled Soliman, “and now she is being contracted by several big producers.”

The entrepreneurial mother gradually expanded her manufacturing repertoire to a whole range of plastic objects, and earned enough money to fund her children’s education. “I remember her because she was somebody very simple, who just had an idea,” Soliman said.

Until recently, Egypt’s bankers had not typically focused on servicing these kinds of grassroots business models. Local SMEs were long starved of credit opportunities, even though the sector employs around 75% of Egypt’s workforce and generates 80% of the country’s GDP, according to CPI Financial.

Addressing this market gap will continue to be an essential part of the banking strategy of Abdel Fattah al-Sisi, who won another four years as President in March’s election.

During Sisi’s first term, in 2o16 the Central Bank of Egypt (CBE) launched its ‘SME initiative’, which compels the banking sector to address this market gap. The programme requires Egyptian banks to provide finance to SMEs (defined as businesses with an annual turnover between EGP1m and 20m [$57,000-$1.13m]) at a fixed interest rate of 5%. By 2020, SMEs must make up at least 20% of each bank’s loan portfolio. Overall, the initiative aims to fund 350,000 SMEs with bank credit totalling EGP200bn over four years.

Some industry experts applaud the project, noting that funding small-scale businesses has driven strong economic growth in countries like China and the US. On the other hand, consultants Oxford Business Group warn that the mandatory SME lending requirements may steer Egyptian banks away from more profitable investments.

Nudge in the
right direction …

Despite the compulsory nature of the ‘SME initiative’, significant banking figures have embraced the change. Hassan Abdalla, CEO of Arab African International Bank, believes that increased funding for SMEs appropriately responds to the youthful demographics of Egypt, where well over half the population is under 30 years old.

“This could be deciphered as a burden of unemployment, but it also points to the way that banks should shift their traditional operations towards micro-finance,” Abdalla told Global Banking and Finance Review.

Soliman, who has advised the government on several initiatives related to SMEs, concurs that many Egyptian banks are eagerly meeting CBE’s 20% quota for SME lending. Indeed, institutions like National Bank of Egypt and QNB Alahli have likely surpassed the target already.

“One of the reasons that this initiative was created was to assist banks in creating a perfect distribution within their portfolio,” Soliman said.

In her view, the project adds balance because Egypt’s millions of SMEs once comprised only a ‘small fraction’ of the banking sector’s clients. This exposed several institutions to a greater concentration of risk, especially if they had loan portfolios heavily weighted towards a few large corporate clients.

Additionally, Soliman believes that SMEs can offer more lucrative opportunities in some respects than heftier clients like large corporations and government. For instance, smaller businesses typically use day-to-day financial services more frequently, leading to higher revenues from commission fees and charges.

Soliman added that SMEs are “not angels” by comparison with larger entities. Both she and Abdalla raised general concerns about Egyptian SMEs’ book-keeping standards, financial structures and quality of training. Yet Soliman argues that other jurisdictions have overcome exactly the same endemic obstacles through professional education programmes, similar to those currently offered by the Egyptian Banking Institute.

“All markets worldwide have encountered the same problems,” she said. “It takes time to upgrade these SMEs.”

… or forcing industry’s hand?

CBE’s mandatory requirements have not met with unqualified approval. In its 2017 country report for Egypt, Oxford Business Group (OBG) referred to concern amongst rating agencies that “Egypt’s new SME lending quota is driven more by a wider economic ambition … than a prudential one.”

The government has championed the initiative as supporting economic growth and employment that includes more Egyptians. But according to OBG, the 20% requirement could erode banking assets if lenders struggle to find suitable SME clients. CBE has compensated for this risk somewhat by allowing banks to meet the quota with their non-interest-bearing regulatory reserves, which allows them to put deadweight assets into play.

Similarly, OBG notes that the 5% interest cap for SMEs could limit profitability when banks might obtain better immediate returns elsewhere, such as from the government’s lucrative Treasury bill programme. Yet Soliman argues that lenders are not fully constrained by the interest rate cap, even before the CBE initiative expires at the end of 2019. This is because plenty of SME clients are already opting for financial products that offer attractive commercial incentives, albeit at a higher interest rate.

Another practical concern is that CBE’s lending quota has placed certain banks at a comparative advantage if they had focused on SME finance before the initiative started. For example, Crédit Agricole Egypt created an SME credit team as early as 2006, while Banque du Caire revealed that
SME lending made up only 6% of its overall portfolio as at April 2017.

Under CBE’s auspices, the Egyptian Banking Institute provides practical training courses on SME lending to address this potential unfairness. Banks can send employees to learn about the specific skills required for handling these transactions. There are separate workshops available for small business owners, many of whom have little experience in dealing with banks.

Soliman endorses CBE’s efforts to level the playing field through education. Yet she does indicate that banks with extra manpower generally have more capacity to handle SME lending, given that small businesses generate a high volume of separate transactions.

Time will tell

Ultimately, the market will determine whether or not Egyptian banks maintain their SME portfolios after the CBE initiative ends. Soliman also points out that small businesses are increasingly attracting funding from alternative sources, including venture capitalists, private equity firms, and leasing and factoring companies. “You have a complete, functional financial ecosystem now,” she said.

Even so, Soliman returns to global market trends in justifying her prediction that SMEs will maintain a strong presence in Egypt’s banking sector for years to come. “You are not re-inventing the wheel [with the SME initiative],” she remarked. “You are just looking at what has been done around the world and fitting it into your [domestic] environment.”