title: Essays on credit rationing for SMEs and the role of credit guarantee schemes – the case of Saudi Arabia
Creators: name: Muhandes, Rawaa Fouad
Publisher: name: University of Glasgow
Year: 2022

description: Financial constraints of small and medium-sized enterprises (SMEs) with respect to large corporations, and the role of banks as major suppliers of finance are well documented in the literature (Stephanou &amp; Rodriguez, 2008). The topic attains acknowledged relevance, especially because restrictions on bank credit to SMEs is a global phenomenon (Baas &amp; Schrooten, 2006) and the causes for it are complex and multidimensional. The ongoing efforts to investigate SMEs’ financing gap are particularly relevant for the oil-rich countries of the Gulf Cooperation Council (GCC), where SMEs are particularly financially constrained – the average share of SME lending amounts to only 2% of total bank loans, i.e., the lowest in the world (Rocha, 2011). In these countries, large banks dominate the banking sector while small-scale banks, those advantaged in lending to small firms, are not present which can create an especially challenging environment for SMEs. Interestingly, however, it is not possible to determine whether such financing gaps are due to supply-side factors (institutions not wanting to service them) or demand-side factors (firms do not want the financial services for religious reasons) (IMF, 2018a;b). This thesis, therefore, within three empirical chapters employs primary data to examine the nature of bank finance for SMEs in the largest GCC country: Saudi Arabia. The thesis assesses the extent to which such a low share of bank loans is supply-driven or demand-driven. It further provides a country-focus impact evaluation on Saudi’s public credit guarantee scheme “Kafalah”, as a common supply-side initiative by governments around the globe (Gozzi &amp; Schmukler, 2016). It also gathers hitherto unavailable information on commercial banks’ realities and lending practices from face-to-face interviews with the “ultimate” bank insiders: relationship managers and team leaders of SME banking. The first empirical chapter (Chapter 4) investigates arguments about large banks’ ability to provide credit to SMEs through business models that emphasise the cross-selling of fee-based non-lending activities (de la Torre et al., 2010), while incorporating demand-side factors. Using firm-level data gathered through a tailor-made questionnaire from a sample of 328 SMEs to conduct several empirical methods, the findings do not find evidence for the aforementioned argument, but that SMEs’ structural characteristics – mainly age and size – remain the maindeterminants in obtaining credit from large banks. The findings, however, provide evidence on the usefulness of Kafalah. Importantly, supply-side constraints appear to play a major role in deterring SMEs from seeking bank finance in the first place. While the majority of sampled SMEs (around 62%) indicate that they have never applied for bank finance, perceived high interest rates on the potential loan was found to be the major reason. Religious reasons were found to be less important. However, the findings suggest that the stringent laws in Saudi which incriminate defaulters seem to constitute an institutional barrier to entrepreneurs’ credit demand through creating a high level of risk aversion. The second empirical chapter (Chapter 5) focuses on evaluating the impact of Kafalah which has never previously been subject to independent empirical evaluation, to the best of the author's knowledge. Utilising primary firm-level data collected through a telephone survey from 124 firms of Kafalah’s recipients and the responses of the 328 sampled SMEs in Chapter 4 as a control group, the findings show that Kafalah results in high levels of finance additionality, i.e., 73.3% of Kafalah’s beneficiaries would have been rejected if it were not for the scheme, which is well above the average of 30-35% that exists in all credit guarantee schemes that are properly designed (Levitsky, 1997). However, subject to methodological limitations and the prevailing economic downturn in Saudi, the economic additionality analysis suggests that participating in Kafalah does not affect SMEs’ growth in terms of employment, which should be affected positively if growth is limited by the availability of external finance. This was attributed to the type of firms (i.e., older and larger SMEs) and loans extended (i.e., short-term loans) by commercial banks through the scheme. It was concluded that Kafalah has not fully achieved its goals. The research, however, does not find evidence for arguments on induced moral hazard by these schemes. The third empirical chapter (Chapter 6) examines commercial banks’ realities and how they adapt to different direct/indirect government interventions in the credit market, using qualitative primary data from face-to-face interviews with 11 bankers. The findings suggest Kafalah was a milestone in encouraging lending to SMEs and hence banks’ lending policies have witnessed some modifications to comply with Kafalah, which enabled lending to many more SMEs than would otherwise have been allowed under banks’ original policies. Recent government efforts to publicise SMEs as a new national priority have pressured banks to offer innovative lending solutions for SMEs’ working capital financing needs, such as the Point of Sales Financing product. Yet, in line with conventional wisdom, the findings suggest that large banks’ current business models appear to be suitable mainly for older, more transparent firms with audited financial statements (Berger &amp; Udel, 2006) who can mainly obtain short-term loans. Interestingly, bankers highlighted the importance of soft information in decision-making, despite the employment of financial statement lending. This raises doubts on policies that call for a larger presence of foreign-owned banks in developing countries, but who would lack the required local insights. Overall, the findings suggest that SMEs in Saudi are constrained in their access to bank finance, and that these constraints are mainly supply-driven. Younger and smaller firms are particularly credit-rationed and, hence, the findings cast doubts on arguments that large banks are just as able to extend credit to opaque SMEs as small banks (Berger et al., 2007). The findings, therefore, suggest there may be a room for government-directed lending programmes to provide finance of a long-term nature and to start-ups, given that this thesis’ evidence implies what commercial banks can currently do for SMEs in this regard is limited. Accordingly, Saudi Arabia’s decision to set up a bank dedicated to SMEs seems promising.