On the ground, Salem Art for Woodwork is the model of a successful small business. Located in Egypt's woodworking hub, Damietta, it employs 30 craftsmen spanning three generations. It buys most of its materials locally and exports around 90 percent of its chairs and table fixtures to Cyprus, where it supplies small hotels, restaurants and shops. "The Cypriots seem to like our work and we are getting more requests," says Saleh Salem, the company's CEO. However, Salem can't grow his business without access to capital, and Salem Art for Woodwork can't get a bank loan because, like the vast majority of Egyptian SMEs, it's not registered. "I can't take out a loan because I am an informal business," Salem explains.

While SMEs account for an estimated 90 percent of Egypt's economy, they have long struggled to gain access to financing--a problem that has become particularly acute in the last five years, as Egypt's economy spiraled downward. Recognizing that solving it is key to creating jobs and spurring growth, the Central Bank, at the behest of President Abdel Fattah el-Sisi, announced in January that it was launching a "comprehensive program" to encourage banks to lend money to small businesses. "Banks have long perceived SMEs as highly risky," says Naglaa Bahr, the CEO of Credit Insurance Co. a firm that insures banks against loan defaults. According to Bahr, around 80 percent of SMEs that apply for financing are rejected. "The deficit has traditionally gotten bigger the further away from Cairo the business is," he adds.

But the perception of businesses outside Cairo as riskier may not necessarily be true. While SMEs in developing countries have traditionally recorded high default rates, there are notable exceptions--and identifying what kinds of small businesses are likely to make reliable borrowers are key to banks in light of the CBEs recently announced SME lending plan, which requires banks to increase loans to small firms to 20 percent of their total portfolios by 2020, up from 8 percent at the end of 2015. According to a June report by the state-owned National Bank of Egypt, SMEs in the Delta and the North Coast are four times less likely to default on loans than their Cairo-based counterparts and twice as likely to pay back their debts on time than large firms generally. The data is based on the portfolios of several state-owned banks.

In an interview, Yehia Aboul Fetouh, a deputy chairman at NBE, explained that the default rate for SMEs in this region dropped from 60 percent in 2008 to just 1.5 percent at of the end of 2015. By way of comparison, NBE's overall loan default rate was 6.8 percent last year.

In a speech, the president claimed that the new SME lending plan would benefit "350,000 companies that will offer job opportunities to more than four million people." Banks will not be allowed to charge more than 5 percent interest on these loans, which is less than half the benchmark interbank lending rate and well below the consumer market rate of 15 percent. In exchange, the Central Bank will lower reserve requirements for participating banks, allowing them to deduct the money they loan to SMEs from their required cash reserves, providing banks with an incentive to loan to micro-enterprises (companies with less than LE 1 million in annual revenue and fewer than 10 employees), small enterprises (no more than LE 20 million in annual revenue and 200 employees) and medium enterprises (up to LE 100 million a year and 200 employees).

Salem observed that the government has a long record of vague announcements on supporting SMEs but little action. Since the new regulations were announced in January, commercial banks have shifted their SME lending activities into high gear. "This is the first time we have limits on our portfolio," says Mounir el Zahid, chairman and CEO of the state-owned Banque du Caire, adding that the bank will coordinate between its corporate and SME loan departments to "make sure that both are working at a comparable pace to reach the percentage decreed by 2020." In 2016, Banque du Caire aims to exceed the LE 2 billion it loaned to small businesses last year. The NBE, meanwhile, says that in the first half of 2016, its SME lending was up 34 percent over the first half of 2015, amounting to LE 8.3 billion lent to 16,000 enterprises.

In the private sector, Commercial International Bank, Egypt's largest private bank, aims to add LE 1 billion in SME financing this year, bringing its annual total to LE 5 billion. Speaking to Al Mal in August, Rashwan Hamdy, head of banking services at CIB, said that to meet the new targets, the bank will have to issue loans to 70,000 to 80,000 small businesses, up from 30,000 currently.

"Even if no one will admit it, banks have entered crisis mode since the announcement was made," says Bahr. "The time-frame is limited, and they are being asked to lend to businesses they deem the riskiest." Indeed, international credit rating agencies have noted that the "20-percent target will likely weaken loan performance, a credit negative for Egyptian banks," as Moody's put it in a January report.

The Central Bank has directed banks to prioritize SMEs that work in industry, make foreign exports and are labor intensive--like Salem's. At NBE, the encouraging data on Delta and North Coast SMEs has influenced its lending practices. In the first half of 2016, businesses from the region received nearly a third of the bank's total SME loans, followed by Upper Egypt-based enterprises, which got 27 percent.
Cairo-based SMEs received slightly less than 10 percent of its SME financing.

Moataz el Tabaa, executive director of the Alexandria Business Association, says it's easier for companies to build reputations in the smaller, less crowded regional marketplace--especially among vendors who can ship their products abroad. "These companies are small and cater to a small market segment," says Tabaa. Many of these businesses depend on keeping their prices low, so margins are tight, says Ahmed Magdy, an independent financial consultant who advises SMEs in the Nile Delta. "This is why business owners are willing to pay out of pocket to maintain their reputations for financial stability," says Tabaa. "Cairo, on the other hand, is a very big market," he says. "There, SMEs can easily find new clients or suppliers."

The Delta--which consists of a handful of cities surrounded by smaller villages connected by a relatively functional transportation network--is well positioned near the Mediterranean coast, at the intersection of three continents. SMEs can locate themselves near urban centers where products are sold or shipped and still attract a cheap workforce from nearby villages. "This slashes operating costs and hence lowers the prices of products," says Gomaa. Salem, for example, enjoys a large supply of nearby skilled woodworkers to make his furniture as well as proximity to a port from which he can export his finished products. "My business and cost set-up wouldn't work anywhere else," says Salem. Even SMEs that cater exclusively to the local market can do well, because the various sectors are less saturated than in the capital.

Moreover, the regional infrastructure is relatively reliable. "They don't have problems buying and maintaining equipment, securing energy, sewage, transportation or have other tedious problems similar to those faced in other regions," argues Ali Gomaa, head of the Social Fund for Development's regional office in Alexandria. "I am not sure why life is easier for manufacturers there, but it is." He says that in the first three months of 2016, the SFD allocated LE 15 million in loans to projects in the Delta and North Coast region, creating 900 new jobs.

The CBE has also told banks to prioritize SME loans in Egypt's underdeveloped South. "Upper Egypt has the same benefits of being in a small market, but it faces infrastructure problems," says Gomaa. On the other hand, small firms in the much larger and more diffuse market of Cairo tend to be much less stable, with new SMEs constantly opening and failing. It's not uncommon for such outfits to "close the business and start a new company rather than repay the debt," he says.  

Still, identifying creditworthy SMEs outside Cairo is difficult, says Hamdy Azzam, a board member at the Industrial Development & Workers' Bank, mainly because there is simply more accessible market data available about Cairo companies, which have a relatively larger digital presence. Outside the capital, banks must consult SME development associations, industry bodies comprised of financial advisors who assess small businesses for creditworthiness. These groups have detailed knowledge about what makes a sustainably successful SME and follow up with new enterprises with the aim of identifying financial problems early, before they default. NBE works with six different such associations in the Delta and North Coast. "They are a very important source of information for us," says Aboul Fetouh. 

However, as the example of Salem Art for Woodwork demonstrates, most of Egypt's SMEs are unregistered, barring them from formal financing no matter how successful. Nader Abdel Hady, head of the SME Development Association in Egypt, says that even outfits that are certified exporters abroad remain largely informal at home--thanks to the infamous amount of red tape Egypt requires to register a business. Salem would love nothing more than to formalize so he could qualify for a bank loan, but the state requires financial documents going back three years, and he simply doesn't have them. This is by far the biggest barrier to financing for Egyptian SMEs; businesses small enough to avoid dealing with the government and paying taxes usually do so.

"These companies were often able to survive and thrive because they stayed away from the bureaucracy and corruption of the Egyptian government," says Mahmoud Fouad, head of the furniture and woodworking chamber at the Federation of Industries.

He says that two months ago, 40 Damietta-based SMEs applied for the new, low-interest bank loans, but only 10 of them were approved. "Almost all the rejections were because their paperwork was incomplete," says Fouad. Damietta, home to a proud Egyptian tradition of furniture manufacturing, has some 38,000 workshops, according to the FEI. "We are throwing away a massive opportunity by not finding a way to lend to informal businesses that have a solid export market," says Abdel Hady of the SME Development Association. "This is the sentiment of every bank manager I've sat with in the past six months."

"It's like there is a glass wall between us and banks," says Salem. "We can see each other, but we can't reach each other."

© Business Monthly 2016