In addition, financial intermediaries often lack the capacity to lend to SMEs, with high administrative costs for small-scale lending, as well as, inadequate banking skills for dealing with SMEs. Most banks have outdated SME lending technologies and are not able to expand SME lending significantly while also managing costs and risks. Banks therefore prefer to lend to large well-established firms or to buy government bonds and treasury bills. The “crowding-out” effect-whereby government borrowing reduces bank lending to the private sector is a concern. Some countries in the region have tried to reduce this effect by borrowing externally rather than domestically. Increased demand from governments led to banks and other financiers having a reduced appetite for overall lending, especially to SMEs that are considered more risky. Banks in the Arab region have not fully emerged from a reliance on lending to governments and a narrow set of well-established corporates.

# **C. Skills Development**

SMEs in the Arab countries suffer from various deficiencies and face problems limiting their development. These problems include the SME’s difficulty in finding skilled workers, lack of capacity to prepare a business plan and loan application, opaque or non-existent financial statements, and insufficient collateral. SMEs also lack the managerial skills and connections in order to deal with the cumbersome legal and regulatory framework as well as a highly bureaucratic system. They suffer from a lack of adequate business development services, accurate information, advanced technology, and skilled labor. Moreover, there are also gender related constraints in terms of access to finance; these include higher costs of finance, difficulties in gaining approval for financing and stricter collateral requirements. These problems complicate lending to SMEs by non-governmental organizations (NGOs) and explain the low level of bank finance to them.

The World Bank’s enterprises surveys show that between 20 percent and 40 percent of firms in most developing regions identify the lack of appropriate skills as a major constraint to development. In the Arab region, relevant and quality skills continue to be scarce. The region has the highest percentage in the world of firms reporting that inadequate labor force skills are an obstacle to growth. At the same time, firms offer little training to their workers, probably because their low exposure to competition provides few incentives to do so. With limited demand, and voice, from the private sector, and a long history of state-led industrialization, according to the recent World Development Report on Jobs (2013), the main focus of the education system continues to be the production of future employees for the public sector. Skills acquired do not meet the needs of the market—there is a skills mismatch. Although lack of skilled workers is a problem confronting all firms, SMEs face a bigger challenge because it is more difficult for them to attract top talents. Skills development systems are adversely affected by government failures as well as inefficiencies, rent-seeking, corruption. Regardless of the source of the problem, low quality government provision of education and training services depresses demand for such services, and contributes to the observed low levels of skills.

Poor quality financial statements, informality, and lack of business skills of enterprises are key aspects of lack of transparency and information asymmetry on the part of SMEs. Information asymmetry as a constraint on SME finance has not yet been effectively addressed in the MENA region. An SME’s ability to provide relevant quantitative and qualitative information for rating assessments increasingly determines its ability to access finance, and the cost and terms of that finance. Probability of default is also calculated in part based on past credit history. The Basel II framework further increased the need for good quality SME information, given its emphasis on ratings-based approaches for risk and capital adequacy assessment. Although the intention to make lending decisions and capital adequacy assessment more risk sensitive and contingent on the individual quality of borrowers is important, its application can in practice be a constraint on broadening SME access to finance.

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