Islamic Banks Miss Out On SME Business Opportunity Across MENA

Recently published research by the World Bank’s International Finance Corporation (IFC) suggests there is a huge demand for Islamic products by SMEs in the  MENA region and, according to the study entitled Islamic Banking Opportunities across Small and Medium Enterprises in MENA, approximately 35 percent of such businesses remain excluded from the formal banking sector because of a lack of Shari’ah-compliant products.

The countries covered by the IFC study are (1) Iraq, (2) Pakistan, (3) Yemen, (4) Kingdom of Saudi Arabia, (5) Egypt, (6) Lebanon, (7) Morocco, (8) Tunisia, and (9) Jordan.

The study reveals that there is a potential gap of $8.63 billion to $13.20 billion for Islamic SME financing, with a corresponding deposit potential of $9.71 billion to $15.05 billion across these countries. This is because several un-served and underserved SMEs do not borrow from conventional banks, owing to religious reasons. This potential is a ‘new to bank’ funding opportunity, which is still untapped, as banks and other financial institutions lack adequate strategic focus on this segment to offer Shari’ah-compliant products.

While Morocco, Lebanon, Egypt, and Saudi Arabia have witnessed a strong increase in lending to the SME sector, in the case of other countries (Jordan, Tunisia, and Iraq) SME lending has been more muted due to several reasons (lack of focus, a weak banking system, and a fragile political environment respectively).

The IFC notes that a comprehensive survey of more than 160 banks (out of the total +270 banks) in MENA reveals that they are currently ill-equipped to handle the SME business. The survey revealed that, in total, only 36 percent of the surveyed banks demonstrated readiness for an effective SME proposition that is built on sound branding and marketing strategies, along with a product portfolio suited to meet the needs of the SME sector. Among banks offering Islamic products to SMEs, only 17 percent have the marketing, product, and operational capabilities to effectively serve the requirements of the Islamic SME banking sector.

The report goes on to say that overall, 66 percent of the market offers an SME proposition, out of which only 50 percent offer an Islamic SME offering (i.e. 31 percent of the overall market), even though half the market offers Islamic banking services. This indicates that 19 percent of these banks are yet to consider offering Islamic SME products, primarily due to not being aware of, or understanding, the demand-driven by religious beliefs.

Despite 66 percent of the banks offering SME proposition and 47 percent having adequate SME product offerings, the overall SME portfolio penetration is only at 37 percent. The IFC said that this indicates that either the banks’ strategies are not geared towards SMEs or they are reluctant to offer SME products due to the high risk, which would again be owing to inadequate procedures.

Furthermore, 31 percent of the market offers an Islamic SME proposition (and most of them are aligning their offering with separate business units and branding), yet only 16 percent have an adequate Islamic SME product offering. Such a scenario has adversely affected the portfolio penetration, which stands at just 11 percent. To enhance Islamic SME offerings, the IFC said the banks need to align their strategies to the rising demand for Shari’ah-compliant products, with a clear focus on the advancement of Islamic product offerings through effective marketing.

The report found that Pakistan, the Kingdom of Saudi Arabia (KSA), and Morocco are the only countries where banks have a moderate degree of SME propositions, but it is still not enough to fully meet SME needs. Egypt, Yemen, and Lebanon have low penetration and there is significant scope for improvement. Banks in Tunisia and Iraq are at the lower end of the spectrum and need to boost their SME offerings significantly.

In terms of Islamic SME offerings, most banks across the various countries have limited products for SMEs that are inadequate to meet their needs. Only the KSA and Pakistan have a fair share of products to meet SME needs. The limited supply-side capabilities of banks to meet SME needs allow for classifying the enterprise landscape across the target countries into three distinct categories – well-served enterprises, un-served enterprises, and underserved enterprises. Well-served enterprises are at the apex of the funding pyramid and can access funds easily. In most countries, the category is between one percent to 23 percent of the total SME population, with the sole exception being Lebanon.

Underserved enterprises can access formal finance to meet some of their needs; the segment varies between two percent to 35 percent of the total SME population across countries. The highest proportion of SMEs is concentrated in the un-served category with 50 percent to 91 percent of enterprises having no access to formal financial channels to meet their needs. A large number of SMEs (80 percent to 90 percent) in Jordan, Tunisia, and Iraq fall in the un-served category, which points to the lack of focus on the part of banks to tap the SME sector.

In addition to the ‘new to bank’ funding opportunity, the IFC believes there is significant potential for conversion/cannibalization of the existing well-served SMEs portfolio that avail of finance from formal conventional banking channels. This opportunity is worth an estimated $4.1 billion (eight percent of the existing SME lending of $51.1 billion) and varies widely from two percent to four percent in Yemen, Iraq, Lebanon, Tunisia, Morocco, and Jordan, to as high as 82 percent in Pakistan.

Currently, an estimated 32.19 percent of small and medium enterprises (SMEs) across the nine countries are excluded from access to finance, mainly because of a lack of Shari’ah-compliant products. The ‘risk averse’ approach of banks has led to a narrow product range on offer for SMEs in these countries. Several SMEs are seeking exclusively Islamic banking products to meet their financing needs and would not opt for conventional banking products due to the lack of Shari’ah-compliance.

There is a great degree of variation across these nine countries concerning the proportion of SMEs looking for Shari’ah-compliant products (it is as high as 90 percent in Saudi Arabia, moderating to 45 percent in Jordan, and decreasing to four percent in Lebanon). However, banks are currently unprepared to capitalize on this latent demand as, overall, SME offerings by banks stand at 36 percent while Islamic SME offerings stand at 17 percent. This gap indicates that some banks are not considering offering Islamic SME products, either due to the high risks involved or an unclear business strategy.

Furthermore, the IFC notes that only 47 percent of banks have adequate products, whereas, overall SME portfolio penetration is only at 37 percent. There are also lapses concerning the branding of products, as most SMEs are unaware of the availability of such products from their banks. As a result, banks have been unable to service the SME sector effectively in these countries.

There is a strong demand for Islamic banking in MENA (including Pakistan). However, the current supply scenario is far from ideal with just 17 percent of the banks surveyed in the region having an Islamic SME offering (of the 36 percent of banks that have an SME offering). However, a strong enabling environment across most countries, coupled with high penetration rates ranging from three percent to 10 percent (Egypt) to 10 percent to 25 percent (Pakistan and Jordan), and a high demand from SMEs for Islamic finance promises strong growth for SME funding in the short to medium term.

The IFC concludes that to tap the underlying potential, Islamic banks need to build capacity and develop Shari’ah-compliant products to cater to this emerging sector. The full report, Islamic Banking Opportunities across Small and Medium Enterprises in MENA is available on the IFC website.

Originally published on www.cpifinancial.net