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Only with transparency can SMEs secure trusting commercial partnerships with lenders

Frederic Paquay

Published: Updated:

Like the rest of the global economy, COVID-19 has landed a heavy blow on the SMEs in the UAE, with different effects across sectors.

It needed government action to mitigate the effects on this vulnerable segment of the country through relaxed economic, regulatory and taxation policies.

The Emirates Development Bank Strategy was announced in April, providing a 30 billion dirham support package for start-ups and SMEs to rebuild businesses while navigating challenges.

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According to the State of SMEs Study survey by Dubai SME, the lack of tailored, affordable financing solutions remains one of the greatest challenges for small companies needing funding to grow and prosper.

Interest rates charged by banks to SMEs remain extremely high — typically ranging from 14 percent to 24 percent. Up to 65 percent of businesses are rejected from borrowing, five times higher than the median rate of OECD countries.

So, what makes it so difficult for SMEs to access bank financing in the UAE? There are multiple factors and one of the primary reasons is banks and financial institutions do not trust small companies.

The lack of transparency and unavailability of validated information with little or no business data, no official records, no credit history, and a higher risk of default constitute major barriers for banks to come forth to offer financial support. Financial institutions encounter greater hurdles in assessing and monitoring SMEs relative to large firms, and constraints are particularly severe on companies relying on intangibles such as goodwill, brand recognition and intellectual property, like patents, trademarks, and copyrights.

The UAE was ranked the 16th best economy by The World Bank’s Doing Business report in 2020. But, access to credit and resolving insolvency still remain key difficulties for private organizations in the country. Yes, the depth of credit information is one of the best worldwide, but the coverage of UAE firms in Al Etihad Credit Bureau registry is relatively low when compared to the total number of companies in the country.

It means financial institutions must find alternatives to assess the financial strength and credit risk of private businesses.

The iconic Gate Building in Dubai International Financial Centre (DIFC). (File photo)
The iconic Gate Building in Dubai International Financial Centre (DIFC). (File photo)

The risks are considered too high to lend money in the UAE because if that company defaults on its loan or credit line, it may take too long to recoup the money, and is often expensive for the lender.

Asymmetric information is a serious problem with SMEs as these have no obligation to make public disclosure of their financial reports. The line of demarcation between the finances of the owner and those of the business is sometimes blurred making it possible that once financing is received: the entrepreneur may use funds in ways other than those for which it was intended. Also, there is wider variance of profitability and growth than larger enterprises and greater year-to-year volatility in earnings.

Taking into account the specific challenges that limit banks from lending to SMEs in the UAE, it is crucial for these companies to proactively improve corporate and financial transparency in their business relationships, including those with banks and financial institutions.

To prove their willingness to work in full transparency and increase their creditworthiness, SMEs must prepare and regularly update necessary information on the company and its shareholders ranging from corporate and ID documentation to UBOs (Ultimate Beneficiary Owners), financials, and audits, more so if it is a sole proprietorship.

There are 39 different commercial registries operating across the seven Emirates and the Federal State. It becomes difficult (and time-consuming) for financial institutions and other private companies to search, check and monitor basic corporate information on their future creditors.

SMEs can also mitigate their credit risk by implementing and following strict standards of corporate governance and providing financial institutions and business partners’ access to detailed information concerning the company’s financials, operations and future projects.

Getting accredited from independent and recognized credit risk institutions will build the confidence of third parties. It will fulfil the regulatory and compliance requirement, and also prove their credit worthiness.

SMEs are the backbone of any economy, making up for the bulk of economic activity and employment. In Dubai alone SMEs make up about 99.2% of companies and contribute to 46% of the Emirate’s GDP. The need for financial support in this sector is greater than ever and vital for future success. No doubt the government authorities are doing everything possible to make the small businesses sector flourish, but SMEs themselves need to do their bit by breaking the barriers hindering their growth.

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Disclaimer: Views expressed by writers in this section are their own and do not reflect Al Arabiya English's point-of-view.