Mm Article - Access To Finance (dec 2008)

October - December 2008

Noor Islamic Bank – Potentially another ‘Dubai’ Story

Guest Column

Credentials, challenges and opportunities for Noor Bank within the SME scenario and this competitive regional market A new start up with the publicly stated ambition of being the world’s largest nancial services player, Noor Islamic Bank (NIB) is no ordinary startup with a startup capital of AED 4 Bn, a direct equity stake by Sheikh Mohammad and his key lieutenants on the board. Noor Islamic Bank aims to launch full scale banking Mr. Ahsan Ali operations across the UAE with three Head - SME Banking, business lines Consumer, Corporate and Noor Islamic Bank PJSC treasury/FI; in excess of 75 products, a distribution foot print of 8 branches and over 100 ATMs. NIB has a focussed business banking division (Noor Business) dedicated to serving SME entities. What sets NIB apart is Noor Business that is a key focus area for the bank. Instead of taking the traditional approach of exhausting the bank’s balance sheet on big ticket nancing activities (a common regional phenomenon), NIB has dedicated a substantial portion of its resources to develop products and services for the SME segment. The bank denes SME as any entity with a revenue turnover of AED 0.5 Mn to AED 90 Mn. The interesting fact is that the bank’s solutions are not limited to established players.

Despite the booming economy SME’s access to nancing remains limited. The question remains as to why the banks are hesitant to cater to this client base. In order to understand this we need to look at both the nancier and the borrower’s perspectives. All banks consider the SME segment to be lucrative, as the spreads (banking terminology for the diěerence in deposits and nancing for the banks) are far higher (3% to 10%) than the established corporate businesses. However, when it comes to actual nancing the banks shy away and prefer dealing with established players. From the SME perspective the cost of nancing from the banks is prohibitive and access to nancing at best tedious and diĜcult. Unlike the big corporate concerns the products available are oě the shelf solutions and oěer liĴle or no customization.

“Noor Business has a strong undercurrent of Corporate Social Responsibility, as a local bank we are keen to participate in the development of the UAE. Secondly, as a startup concern we actually understand the challenges and frustrations our customers have had to endure when they launched their businesses. Therefore we have put together programs and products with the help of our partners which will cover SMEs at any stage of their life cycle. So for us you are a customer if you t either our commercial aspirations or developmental commitments.” Criteria Region

Employee size

Annual Turnover Receipts

Annual Balance Sheet tota;

Plant & machinery

Fixed Capital

Equity Status

Productive Assets

EU

Bank’s Perspective

Customer’s Perspective

Unknown entity, unknown auditors, liĴle or no collateral, limited track record

Starting out in business, good cash ows, conrmed orders, available bank statements, big auditors too expensive and not interested

Informal management and lack of succession planning

Specialized knowledge and a passion to succeed, formalization will take place along the way

High risk, a high probability of losing money

No access to nancing, availability at unaěordable cost, nancing costs throĴle the business

Limited understanding of nancial planning, cash ow management, marketing and accounting as a business

In business to make a prot, limited training but decent practical exposure, beĴing my own assets on the success

Small amounts of nancing translates to high costs for customized nancing, oě the shelf product, salesman approach, invest in collection staě

Needs specic to business, require business advisor rather than a sales person, need continued support and one interface to the bank

US

UAE

Singapore

India

Pakistan

Bangladesh

NIB recognizes the divergence of views and therefore has diěerentiated its business model by:

Defind Factors Factors not considerd

As per the table for the UAE an SME entity is not dened in terms of the factors outlined by any central authority or regulatory agency. In the absence of a universal denition each bank denes an SME on the basis of its own business model. This detracts from the developmental aspect as sectoral or segmental development strategies and consequently specialized programs cannot be formulated. NIB is working with multiple commercial and developmental organizations to formulate an SME Forum focussed on the long term development of SME concerns.

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1.

2.

Discarding the ‘salesman approach’ by developing diěerent product distribution channels which the customers trust, e.g. a free zone entity would be able to bundle nancial solutions along with the regular services it provides. This ensures continuity of contact coupled with business advice. Providing a ‘one window’ solution where the businesses are able to renew licenses, develop feasibility reports, undertake training, fulll labor requirements etc, apart from nancial products.

3.

Building a supply chain network, where suppliers to corporate concerns have the ability to obtain nancing facilities without any collateral requirements.

4.

Business networking and market access opportunities, where through NIB SME concerns can build a sustainable business through protected market places. Access to private equity, angel investors and development nance institutions through our trusted network.

5.

d) e)

The denition of SME under this project is: Annual Revenue should be ǂ AED 30.00 million

Case study of the Malaysia market as a model for SME nancing

and/or Paid up capital should be ǂ AED 5.00 million

Despite NIB’s two pronged approach (commercial and developmental) the SME space requires a far greater level of commitment for these enterprises to ourish. As an emerging market Malaysia has been able to sustain its growth momentum by focussing a large chunk of its developmental activities within the SME segment. The nancial sector has been instrumental in supporting SMEs throughout their life cycle as depicted by the table.

and/or Number of employees should be ǂ 50 Benets that SMEs would reap from this project are: •

As per the SME Annual Report (2006) a bank’s share of SME nancing grew to cross the RM 100Bn ($28Bn). This is particularly signicant as on an annual basis SME nancing is now 44.5% of the total business nancing that the banks undertake. The SMEs constitute 99.2% of the total entities in Malaysia and contribute 32% of the country’s GDP. The key learning points from the Malaysian success story are: a) b) c)

Clear denition of what constitutes an SME enterprise (turnover of RM 5Mn or less and Max of 50 employees. This is bifurcated into Micro, Small and Medium by sector). An independent body (SME Development Forum) that coordinates between commercial and developmental agencies and charts out a long term strategy. Mandatory financing targets for commercial institutions as well as incentives for meeting them from the central bank (particularly for the institutions in the growth phase onwards).

•

•

•

SME – Typical lifecycle (Malaysian Example)

SME Financing Landscape in Malaysia

•

Various providers to meet SME financing needs

Seed

Start-Up

Key Provides of SME Financing

Devt Fin Ins US$0.8 b total loans o/s SMEs in 2008

Growth

Established

Expasion/ Graduate to LE

Commercial Banks

US$26b total loans o/s to SMEs in 2005

Stages of Business Lifecycle Decline/ Distress

Leasing & Factoring US$0.2 b extended in 2005

Venture Capital 48 funds , US$0.7 b func size in 2005

Govt Funds/Schemes

84 funds, US$6.7 b allocation

Bursa Malaysia

MESDAQ, Second Board & Main Board

Small Debt Restruturing Scheme & Rehabilation Fund US$54 m

Provide SMEs access to the equity markets for raising funds in order for them to continue growing. Obtain assistance from development nance institutions, angel investors and introduce government funds and schemes to focus on SME institutions in the seed or startup phase.

•

Separate SME Trading Portal: SMEs would have access to separate auction /trading area for SME’s under this project on the Tejari portal. This would enable the SME’s to participate in the guaranteed Government Procurement Program (GPP) for SMEs. Currently as per a royal decree all governmental agencies are supposed to procure 5% of their total purchases from SME concerns. The bidding process takes place online on Tejari (B2B portal), however the orders are not segregated between 95% (open) and 5% (restricted to SMEs). Franchising Potential: A rating process would also benet the franchising of global brands to the UAE entrepreneurs, as well as help local businesses to franchise their brands. Shortlisted entrepreneurs will have access to start up nancing for seĴing up franchises or nancing to franchise their existing business activities. Global Rating: Dun & Bradstreet an International Credit rating agency would provide the SMEs with an internationally accredited rating. This will enable the rated entity (SME) the ability to tap into nancing with various banks. The rating standard would ensure that all banks view the concern with the same standards. Access to Financing: Noor Islamic bank would provide nancing to the rated SMEs preferential rates compared to the market. Training: Once the businesses have been proled and their weakness have been identied during that process, project partners in conjunction with training & polytechnic institutes would be engaged to help rectify and strengthen the productive resources employed by the businesses. Business matching: The shortlisted concerns will be provided access to guaranteed business through the SME Forum’s network, ensuring sustainability of the SME venture.

The project has been on for the last 6 months and is anticipated to be launched in November 2008.

Denition of “Discounting”, how it works, how it can be applied (small example of a business that could benet from the discount system; how the math works). Discounting of receivables is one of the key products required for SME concerns. The biggest constraint to any SME business is

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October - December 2008

the receivables being tied up with its customers. This can happen because of the trade terms (payments due aĞer 60 days), contingent payments (event A happens for the payment to be made) or simply delays (common in the UAE market). Discounting is a process where a bank undertakes the responsibility of recovering the receivables on the due date from the SME concern’s customer and pays an equivalent amount (less charges and fees) to the SME concern today. For example ABC Stationery suppliers provide goods worth AED 500,000 to a large corporate concern. The payment is supposed to be received in 60 days and ABC’s prot margin is 10%. This means that ABC has invested AED 450,000 of its own money in the order. Assuming that this amount was most of the free cash available, ABC is unable to meet any other orders till the payment is received from its customers. Here a bank can come in and ‘discount’ the receivable, i.e. provide AED 490,000 against the receivable of AED 500,000 today (the diěerence being fees and charges). This frees up the cash for the SME to use for other orders. The fees and charges need to be oěset against the opportunity cost of leĴing go of incremental business. To clarify if ABC avails discounting it generates a prot of AED 40,000 versus AED 50,000, but it can undertake another order of a similar size and create a prot margin within the next 60 days as opposed to aĞer 60 days. Discounting can be with recourse (in case the SME customer does not pay, ABC has to pay the money back), or without recourse (the bank carries the default risk for ABC’s customer). What facility ABC would get is a factor of ABC’s relationship with the bank, ABC’s transactional history, the relationship ABC shares with its customer and the customer’s credit rating with the bank.

How do Noor Bank Islamic products sit within the SME remit? What has been the history of Islamic products within SME consumer banking? What are the benets?

Islamic Finance has been rapidly evolving over the last few years. From basic Morahaba (Bank buys and sells to the customer at a prot on deferred payments) transactions today an Islamic structure exists for almost all conventional banking products. Depending on the Shariah interpretation of the Shariah Board governing any Islamic institution, the Islamic Finance has equivalent products for Trade, Installment Finance, Discounting of receivables, Liquidity Management, FX, Derivatives, OverdraĞ facilities and Investments. NIB has over 20 product solutions available to the SME customer which are available as either ‘Oě the shelf’ or as a ‘Tailored’ oěering. All of these solutions follow Shariah approved Islamic processes, legal contracts and accounting standards. Islamic Finance has the following advantages over conventional means: •

• •

Transparent charges and contractual terms, under Islamic Finance there cannot be any ‘hidden’ charges or fees. As an example any penalty fees recovered by an Islamic bank needs to be given to charity. This reduces the likelihood of unfair penal charges as the money does not go into the bank’s income. Ethical returns - an Islamic institution ensures that the use of funds is not in avenues which are detrimental to the society in general. A greater understanding of the business needs and increased involvement, Islamic structures by design involve the bank in actual transactions through either equity or buying on behalf of the customer. This forces the bank to aĴune itself to the customer’s business and raise its level of involvement to ensure delivery.

Noor Islamic Bank PJSC, Grosvenor Tower, Sh Zayed Road, P.O. Box 8822, Dubai, United Arab Emirates Oě: +971-4-4268096. Fax: +971-4-3653212 Email: [email protected], Web: www.noorbank.com

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