Serving the Very Small Enterprise (VSE) Segment by Microfinance Institutions in the Arab World IN PARTNERSHIP WITH: This research is funded under the MENA Micro, Small, and Medium Enterprise Technical Assistance Facility, a joint initiative between IFC and the World Bank. It is supported by the Government of Canada under GAC – Global Affairs Canada, the Danish International Development Agency, Japan, Switzerland’s State Secretariat for Economic Affairs and UKAID-DFID. Abbreviations MENA Middle East and North Africa MFB Microfinance Bank MFI Microfinance Institution NBFI Non-Bank Financial Institution NGO Non-Governmental Organization SE Small Enterprise SME Small and Medium Enterprise VSE Very Small Enterprise Table of Contents 1. CONTEXTUAL BACKGROUND 5 2. DEFINITIONS 5 3. WHY SHOULD MFIs TARGET THE VSE SEGMENT? 8 4. WHAT DO VSEs NEED? 13 5. HOW WELL ARE MFIs TARGETING THE VSE SEGMENT IN THE ARAB WORLD? 14 6. LESSONS LEARNED FROM MFIs’ EXPERIENCES WITH THE VSE SEGMENT 21 7. CONCLUDING REMARKS 27 ANNEX 1: METHODOLOGY AND RESPONDENTS 28 ANNEX 2: AN ATTEMPT TO DEFINE THE VSE SEGMENT 30 ANNEX 3: SOME OFFICIAL DEFINITIONS FOR SMALL ENTERPRISES IN THE ARAB WORLD 32 ANNEX 4: SURVEY FINDINGS ON MFIs THAT CURRENTLY DO NOT SERVE VSEs 33 Acknowledgments The authors would like to thank the microfinance institutions that have contributed to this report. Without their efforts, this study would not have been possible. The authors are also grateful for the guidance and support of Sanabel and the IFC MENA FIG Advisory - Microfinance team, as well as all of those who have provided feedback on the report (Andrew Pospielovsky, Elza Hermann, Gaamaa Hishigsuren, Martin Spahr, Meritxell Martinez, Nadine Chehade, Teymour Abdel Aziz and Xavier Reille). This research is funded under the MENA Micro, Small, and Medium Enterprise Technical Assistance Facility, a joint initiative between IFC and the World Bank. The facility is supported by the Canadian Department of Foreign Affairs, Trade and Development, the Danish International Development Agency, Japan, Switzerland’s State Secretariat for Economic Affairs and UKAID. Authors: Mohammed Khaled, Senior Operations Officer and Karen Beshay, Operations Analyst 3 Foreword Increasing access to finance for Very Small, Small and Medium Enterprises (VSEs/SMEs) has become an important goal for many governments and development agencies as VSEs/SMEs are viewed as main drivers of economic growth and creators of employment. However, a missing middle between the ceiling of MFI lending and the segment defined by banks as SMEs is currently underserved and in some markets even unserved, despite the fact that it presents a significant growth opportunity for MFIs looking to upscale and/or to grow with their best clients. The report presents the findings of Sanabel’s and IFC’s VSE Survey which aimed to identify what has been done to date to serve the VSE segment, and how successful MFIs as well as other players in the region have been in catering to this segment and upscaling lending activities. What is clear from this survey is that MFIs in the Arab World do indeed recognize the opportunity that the VSE segment presents and as such are interested in upscaling to serve VSEs. Several reasons have been cited for this interest including job creation, supporting growing micro clients and business growth opportunities for the MFIs. Despite the high level of interest though, efforts to target VSEs in the region have remained quite humble to date. Limited know how, particularly relating to product development, has emerged as the most critical internal challenge that MFIs seeking to target this segment face. While this report documents where the sector stands today in terms of serving the VSE segment, it also offers some lessons learned by MFIs who have already upscaled to serve VSEs from the region and beyond, which MFIs in the Arab World can benefit from in order to be able to better serve this segment. This report represents the second report in a series of leadership papers, Voices, developed by Sanabel, the Microfinance Network of Arab Countries, and the International Finance Corporation (IFC). We hope you enjoy this report. Sahar Tieby Xavier Reille Executive Director Manager of Financial Institutions Sanabel, the Microfinance Network of Group Advisory Services Arab Countries International Finance Corporation 4 1. Contextual Background Over the last few years, some microfinance institutions1 (MFIs) in the Arab World have started to upscale and target the very small enterprises (VSE) segment2. Some MFIs recognized the market opportunity and intentionally region to help them expand their loan offerings and target expanded to serve the segment. But most have done so more the VSE segment; iii) a series of regional IFC workshops on organically, looking to retain clients whose business needs can lending to VSEs; and finally iv) a 2014 IFC study on MFI no longer be met through micro- loans. However, these shifts lending to VSEs in Latin America. are still in the nascent stage, and though some successes have been observed across the region, the results remain mixed. This report: i) attempts to define the VSE segment; ii) reviews the microfinance sector’s efforts to serve the VSE segment, This report, a joint effort between IFC and Sanabel3, is based on: based on survey results; iii) assesses the scale of these efforts; i) a survey conducted in May-June 2015 by IFC and Sanabel 4 iv) identifies key challenges; v) assesses the levels of MFI to better understand the efforts of MFIs in Arab countries to interest in serving this segment; and finally vi) draws some target the VSE segment and respond to their needs; ii) IFC’s lessons from the experiences thus far and offers some guidance experience providing advisory services to MFIs in the MENA for next steps. 2. Definitions What is a VSE? Defining a very small enterprise is challenging -- a consensus definition has yet to be created. In general, the VSE segment can be seen as a segment that overlaps with the upper micro- and lower small enterprise segments, as shown in Figure 1. According to the Microfinance Information Exchange (MIX), the lowest income (average loan balance is about 10 percent microfinance loans are loans whose average outstanding balance of GNI per capita). Given these considerations, the definition does not exceed 250 percent of the average income per person proposed in this paper is that a VSE loan is a loan that has an (GNI/capita). But looking at the current average MFI loan average loan balance from 25-250 percent of GNI per capita balances as a percentage of GNI/capita in the region today (see Annex 2 for further details of this proposal). reveals that MFIs are still largely only targeting clients with 1 The term ‘microfinance institution’ (MFI) in this report refers to all kinds of institutions that provide microfinance services. These include NGOs, for-profit and not-for-profit companies and microfinance banks. 2 VSE segment is typically defined as the segment between the micro and small enterprise segments. 3 The Microfinance Network of the Arab Countries. 4 The survey was sent to 32 MFIs, belonging to 10 different countries. Combined, the 32 responding MFIs are serving over 75% of the region’s active borrowers. Of the 32 MFIs surveyed, 25 have indicated that they do serve VSEs. Details on the survey methodology and the profile of respondents can be found in Annex 1. 5 Still, many countries of the region – including Sudan, Figure 1: Representing the VSE Segment Morocco, Tunisia, Egypt, Bahrain, and Yemen – maintain a cap on MFI loan size (see Table 1). The cap ranges from $3,500 in Sudan to $18,000 in Bahrain. Yemen is a slight exception because its ceiling is equal to one percent of shareholder equity Large - meaning that it can be raised by increasing an Banks MFB’s equity5. Jordan, Lebanon6, Iraq, and Palestine Medium do not cap MFI loan size. At first glance, it appears that the range in caps is quite broad. But if we Challenges to Small downscale assess the cap in relation to GNI per capita in VSEs each country, we find that, with the exception of Challenges to Bahrain7 , MFIs are generally allowed to disburse upscale Micro loans that are relatively equal to their country’s GNI/capita (between 85 percent - 130 percent). MFIs Informal Even though there are regulatory ceilings in place in many countries, MFIs often have the potential to disburse larger loans and remain within these ceilings. Table 1: Caps on Loan Size for MFIs and GNI/Capita by Country Country Sudan Morocco Tunisia Egypt Bahrain Yemen Jordan Lebanon Iraq Palestine 1% of total shareholder equity. As minimum capital Cap on is 500M Riyal/ loan size 3,500 6,000 10,000 13,000 18,000 --- No cap --- approximately ($)8 2M USD, this is equivalent to USD 20,000 GNI per 3,920 7,100 10,600 10,260 37,650 3,650 11,910 17,910 14,440 5,080 capita ($) Cap on Loan Size 89% 85% 94% 127% 48% 547%9 as % of GNI/Capita Notes: - Cap on loan size for MFIs is based on microfinance laws in respective countries - In Tunisia, the ceiling presented here is that placed on NBFIs. NGO MFIs may only disburse loans up to $2,500 - GNI per Capita data is extracted from World Bank Database 5 While this is applicable to the MFBs regulated by the Central Bank, it does not apply to the MFIs registered with the Ministry of Labor and Social Affairs. However, the average loan size of these NGOs and companies have been very small compared to those of MFBs as a result of self-imposed caps. 6 In Lebanon, while there is currently no microfinance law or regulations, the Central Bank defines small (microfinance) loans as loans up to $7,000. 7 While the ceiling on loan size in Bahrain appears to be the highest in absolute terms, it is in fact the lowest when we calculate the ceiling as a percentage of GNI/capita. 8 These values are approximate based on FX rates as of 29 January 2016. 9 The cap on loan size in Yemen is based on the minimum capital requirement for microfinance banks. A microfinance bank can increase its loan size by increasing its capital. 6 To account for the fact that no clear definition exists for the clarity on their understanding of the segment. These responses segment10, the survey asked the responding MFIs to include their are summarized in Table 211. own definition of what constitutes a VSE loan so that there is Table 2: VSE Definitions as Presented by Survey Respondents Country Definition Egypt No definition provided Iraq VSEs are formal and informal enterprises with loans between $10,000 and $25,000 Jordan No definition provided Bahrain No definition provided Lebanon No definition provided The VSE segment constitutes both formal and informal enterprises, employing 5-49 employees. Morocco VSE loans are loans that range from $10,000 to $50,000 The VSE segment constitutes enterprises with 5-49 employees. VSE loans range from $10,000 to Sudan $50,000 Tunisia The VSE segment constitutes formal enterprises with 3-6 employees Yemen No definition provided While a definition for the VSE segment has been proposed are family owned and run and their starting capital is generally here, for simplification purposes and to also incorporate the put up by the owner. They often have fixed assets and a fixed responding MFIs’ views, throughout the remainder of this paper, place of business in contrast to many micro-enterprises (e.g. it will be assumed that VSE loans are loans between $5,000 informal vendors13). Ownership and management are typically and $50,00012. the same individuals, and they generally maintain simple financial recordkeeping, often separated for business and household (Nails Characteristics of VSE: Regardless of the country context, VSEs & Sian, 2008). VSEs sometimes have more than one location/ in the Arab World tend to share similar characteristics and have branch and have some degree of legal formalization and credit/ similar business needs. In contrast to micro-enterprises, which financial history. In fewer cases, VSEs actually hire accountants are generally run by a sole entrepreneur, VSEs typically have 2-10 to file taxes (IFC, 2014). Figure 2 below summarizes the basic employees and in some cases as many as 20. In most cases, they characteristics and needs of typical VSEs. 10 In most cases if a definition exists, it is specifically for micro and small enterprises and not very small enterprises. Annex 3 presents some of the currently existing definitions in the different countries covered in this report. 11 It is important to note that not all responding MFIs have provided a definition. The definitions presented here a summary of the responses received to this question. 12 This is a broad range which is expected to differ by country. Table 6 in Annex 2 presents suggested range by country. However, for the purposes of simplification, this definition will be used throughout the remainder of this paper. 13 On the other hand, microenterprises are usually: one of multiple household income sources, composed from a household or sole- entrepreneur, have no or minimal fixed assets and is considered a “survival strategy” for poor households. 7 Figure 2: Characteristics and Needs of VSEs CHARACTERISTICS NEEDS BUSINESS CREDIT •• High concentration of semi — formal firms •• Fast decision making on credits •• Defined Business location & some fixed assets •• Solutions for working capital financing and/or •• Some degree of legal formalization investments •• Organization structure and management is more •• Higher loan limit, compared to Micro customers sophisticated compared to Micro •• Demand investment products and some fee based •• Have informal employees (including family members) services •• Prime household income source •• Lower requirements in terms of collateral (compared •• Heterogeneous groups with divergent financial needs to SME Segment) & cash based analysis •• More vulnerable with volatile growth, but also more NON CREDIT flexible (compared to SME segment) •• Tailored solutions/ products bundles for FINANCIAL MANAGEMENT daily banking •• Some form of financial records •• Simple solutions for deposits and cash management •• Bookkeeping is more sophisticated compared to most •• Simple and fast Fl access (e.g. accessible channels) •• Micro- but still opportunity for improvement •• Insurance solutions to absorb shocks •• May have tax ID/ pay minimal or partial taxes •• Non-financial services to increase their access to market opportunities, training (e.g. financial OWNER(S) management, accounting), and network to improve •• Have some basic financial education but could benefit their business performance •• From additional financial, accounting, and management skills OTHER •• Typically older (over 35) •• Predictability of costs for banking and financial •• More men than women services (transparent banking policies) 3. Why should MFIs target the VSE segment? Market Opportunity: In the Arab World, serving the VSE segment represents a substantial market opportunity for MFIs. A 2008 IFC study developed by McKinsey estimated that the Arab region had about five million VSEs. As shown in Figure 3 below, only 10 percent of them are well-served, leading to a credit gap of roughly $13.5 billion (McKinsey Data for IFC, 2008)14. These statistics do not take into account informal VSEs, which financing to unregistered businesses. In some of these markets, are typically smaller and are estimated to be more numerous banks work around the regulations by extending consumer than formal ones and with even less access to credit. Banks have loans to individuals. But regulations in some countries proscribe typically shied away from lending to this segment as they lack the consumer loans to individuals without formal salaries. Serving knowledge to accurately assess credit risk and thus perceive them VSEs thus presents a key, and potentially profitable, growth as highly risky and more costly to serve. Furthermore, in some area for many MFIs in the region today. countries, regulations prohibit banks from extending business 14 The data shows the percentage of enterprises who are well-served, under-served, unserved or not interested for each segment. It must be noted here that the authors considered enterprises classified as ‘micro’ and ‘very small’ in the initial dataset as ‘VSEs’ and enterprises classified as ‘informal’ as ‘micro’. The reason for this reclassification is that, according to the survey, micro enterprises are formal enterprises with 0-4 employees and very small enterprises are formal enterprises with 5-9 employees. However, in practice, micro enterprises tend to be informal and do not have additional employees whereas VSEs have a higher degree of formality and a few employees. The definitions used throughout the study are as follows: • Well-served: Enterprises that need credit and have access to it • Unserved: Enterprises that need credit but don’t have access to any form of credit • Underserved: Enterprises that need credit and find financing as a constraint i.e. do not get access to desired credit. 8 Diversification: Serving the VSE segment also presents MFIs with Figure 3: VSEs Access to Credit an opportunity to diversify their product offerings. As shown in Figure 4 below, since 2008, the micro credit market has largely stagnated. In 2008, the sector’s outreach (measured in terms of 40% credit) was 2.74 million active borrowers, with an outstanding 35% loan portfolio of $1.26 billion. By the end of 2014, the sector had 34% only grown to 2.99 million active borrowers with an outstanding 30% 31% loan portfolio of $1.82 billion15. Several factors have caused this 25% decline in momentum, including political instability arising from 24% the Arab Spring, security concerns in parts of the region, and the 20% repayment crises in some of the larger markets (IFC and Sanabel, 15% 2015). It is believed that such instability has manifested itself 10% in risk-averse behavior on the part of MFIs, resulting in a lack 10% of interest in product diversification. Today, MFIs in the region 5% offer one main credit product, despite variations in names and 0% slight variations in specifications. With adequate risk management Unserved Underserved Well- Not Served Interested systems in place, VSEs offer MFIs an opportunity to grow their portfolios and spread their risk as they move beyond dependence Source: McKinsey data for IFC (2008) on one product and begin to serve new client segments. Figure 4: Outstanding Loan Portfolios for MFIs in Arab World 3,500,000 2,000,000,000 1,800,000,000 3,000,000 1,600,000,000 GROSS LOAN PORTFOLIO (USD) 2,500,000 1,400,000,000 # OF ACTIVE CLIENTS 1,200,000,000 2,000,000 1,000,000,000 1,500,000 800,000,000 1,000,000 600,000,000 400,000,000 500,000 200,000,000 0 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 # OF ACTIVE BORROWERS GROSS LOAN PORTFOLIO 15 IFC aggregated date on the outreach of the microfinance sector in the Arab World. 9 Job Creation: Promoting access to finance, particularly for VSEs, Figure 5: Percentage has become a priority for many governments in the Arab World. Despite noticeable economic progress in some countries, the region of VSEs that began as continues to suffer from high unemployment, poverty, and illiteracy, micro clients particularly in rural areas. Observers widely agree that financing VSEs and supporting entrepreneurship can create jobs for little cost and spur empowerment and economic development, given their potential to generate employment at a lower capital cost. It is also believed that the development of such enterprises can play a critical role in social inclusion and reduce political unrest. 2 MOSTLY EXISTING CLIENTS MOSTLY NEW CLIENTS 7 Client Retention: Serving the VSE segment enables MFIs to support micro clients along their growth trajectory. This allows MFIs to 6 support job creation and retain their best and most loyal clients -- those who have shown potential to grow and may have already outgrown the typical smaller loans. 2 But according to the survey, the majority of responding MFIs 3 in the MENA region that offer VSE loans do not offer them to 5 existing micro- clients, but rather to entirely new clients. As shown in figure 5, less than a quarter (24 percent) of responding MFIs believe that existing clients make up more than half of their VSE portfolio. This is an interesting result given that “following growing micro clients” was identified by respondents as one of the main reasons MFIs target VSEs. This suggests there are different 1%-5% 6%-10% 11%-20% types of expansion models- MFIs may upscale organically – by 21%-50% 51%-100% DON’T KNOW graduating their clients – or proactively, as outlined in Box 1. Box 1: Serving VSEs: Proactive vs. Organic Models MFIs generally follow two types of business models when moving into the VSE segment. The first is the Proactive Model, which borrows from the know-how and processes typical in banks, including those that have downscaled to VSEs. It is more complex and in many ways more deliberate in that it requires important structural decisions and adaptations from the start. The alternative model is the Organic Model, which is relatively self-explanatory. This shift is often a reaction to a trend observed as an MFI’s microenterprise portfolio begins to grow, as larger clients require larger loans and even resort to other financial service providers if MFIs are unable to meet their needs. Both models are common today, and we also see hybrids that borrow practices from both to help balance the trade-offs between efficiency and depth. See Figure 6. 10 Figure 6: Drivers of Proactive and Organic Models for MFIs Proactive Model Organic Model Blue Ocean Client Opportunity Retention High Competition Long-Term Liquidity in”Micro” Strategy Asset “Leap-up” Diversification “Step-up” Large SE Regulatory Limited SE Market Potential Incentives Market Regulated Institution NGO Source: “Experiences of Microfinance Institutions Serving Very Small to Small Enterprises in Latin America”, IFC Microfinance Version 2.0 – The Emergence of Digital Financial phone services can be limited. Given that this can all be done Services: As previously mentioned, VSEs offer MFIs an opportunity through automated processes, such a model can have minimal to diversify their product offering. This will become even more operational costs for the credit providers, allowing the lender to crucial as technological improvements continue to change the way significantly undercut traditional MFIs while maintaining higher clients interact with financial institutions. The widespread use of profit margins. Box 2 presents examples in which digital financial mobile and digital technologies has helped develop platforms that solutions have been developed to play the traditional role of enable clients to conduct basic transactions (save, earn interest, MFIs. As this model becomes more widespread, MFIs that want and access small amounts of credit) instantly via their mobile to survive will need to expand their product offerings and move phones. This has led to technology companies and mobile network beyond cycled loans – or lending Model 1.0 – by adding value operators (MNOs) increasingly playing the role traditionally to their client propositions. Providing more financing to VSEs, played by MFIs in some parts of the world. For example, mobile based on business needs and repayment capacity, is one way to phone providers can now screen their clients, identify those with do so – particularly when assessing the repayment capacity of an a decent phone-payment history, and disburse loans to a mobile informal business without reliable financial statements requires wallet on this basis . If loans are repaid on time, higher loan 16 skilled loan officers and is thus nearly impossible to automate. amounts can be offered. If loans are not repaid on time, the client’s 16 Repayment would typically be $10 per week for 11 weeks. Given the high APR (83%) and the automated disbursement process (no loan officers), the operational cost is minimal and the profit margin is very high, allowing the mobile company to absorb some defaults. If the client pays back on time, then s/he is offered a bigger loan. 11 Box 2: How Digital Models Can Disrupt Conventional Microfinance The Case of M-Shwari: M-Shwari is a combined savings and loan product launched in Kenya in November 2012. It is a collaboration between the Commercial Bank of Africa (CBA) and mobile network operator Safaricom, through its mobile money service, M-PESA. The M-Shwari account is issued by CBA but must be linked to an M-PESA mobile money account provided by Safaricom. The only way for a client to withdraw or deposit money is via the M-PESA wallet. The Case of Cash Credit: Cash Credit is a non-banking financial institution founded in 2011 in Bulgaria that partners with mobile network operators to offer micro financial services to mobile subscribers. The company uses an innovative, proprietary credit scoring approach to offer consumers rapid credit decisions with convenient service and billing through partner operators. Cash Credit offers loans from BCN 200- 2000 (approximately $110-1,100) for 1-18 months. Approval is given within six minutes, disbursement is immediate and repayment is available through five different channels. Source: www.deltapartnersgroup.com So what are the main reasons MFIs in the Arab World serve that the most important reason for serving this segment was VSEs? The results of the survey show that many MFIs who have job creation (19 MFIs, or 76 percent of the sample), followed begun serving this segment have done so for some of the reasons by business growth opportunities (17 MFIs, 68 percent) and mentioned above. When asked, as clear in figure 7, MFIs stated following micro clients over time (15 MFIs, 60 percent). Figure 7: Reasons for Serving VSEs Job creation 19 6 0 Business growth opportunities 17 8 0 Following growing micro clients over time 15 9 1 Diverification of portfolio and/or risks 15 10 0 Increased competition for micro clients 13 11 1 Disbursement targets/ pressure 9 12 4 Interest rate caps 5 11 9 Higher profitability 5 15 5 Incentives from government 5 6 14 Incentives from funders 3 11 11 0 5 10 15 20 25 VERY IMPORTANT SOMEWHAT IMPORTANT NOT IMPORTANT 12 4. What do VSEs need? When asked in the survey what services are most needed by VSEs, Figure 8 shows that MFIs have pointed to short-term and long-term loans with little emphasis on other products or services. Of course, given the regulatory framework that has historically limited the legal structure of most of the responding MFIs to credit-only institutions, micro and VSE loans are typically the only products these MFIs are able to offer. Interestingly, the majority of MFIs believe that their offerings the identification, understanding, and design of these products is already meet the needs of their clients, contradicting the literature, essential. Furthermore, MFIs need to develop long-term strategies which says VSE clients need an array of financial services such as to meet these needs. If the regulations do not allow MFIs to offer savings, transfers, and overdrafts. IFC’s study of Latin American certain financial products internally, then MFIs should consider MFIs upscaling to serve VSEs found that in many cases VSEs, setting up partnerships with other banks or financial service providers even more so than micro-enterprises, have financial needs that go such as insurance companies. This is crucial, as taking a broader, beyond typical credit products. These include savings and current longer-term approach to VSEs/SEs can increase the profitability accounts, transfer and payment services, guarantees/letters of credit, of a relationship with a VSE, as it begins to incorporate not only business development services, leasing, insurance, overdrafts, and the VSE loans, but a broader relationship with the enterprise, its more17. For MFIs hoping to serve this segment in the longer term, owners, family members, and employees. Figure 8: Services that are mostly required by VSEs Short term loans 14 7 2 Long term loans 11 7 5 Deposits 4 4 8 Business Development Services 3 14 3 Guarantees 3 5 9 Insurance 3 7 7 Leasing 2 8 9 Transfers and payments 2 8 8 Overdrafts 2 5 9 1 3 13 Factoring 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% MOST REQUIRED SOMETIMES REQUIRED NOT REQUIRED 17 In fact, research has shown that not only do very small enterprises need an array of products and services besides credit, financial institutions that effectively target these segments typically start with payments and savings products as the transaction decision point is simple and low risk. Furthermore, these products and services provide a higher financial return for the financial service provider when compared to credit products. 13 5. How well are MFIs targeting the VSE Segment in the Arab World? Very Humble Results to Date: Despite the fact that the majority of the responding MFIs (78 percent) said that they do serve VSEs, when we examine their portfolio data, we see a different picture. Looking at the data of all 25 MFIs that reported serving VSE/ find a slightly different picture because larger loans typically SEs combined in the last three and a half years, as shown in account for a higher percentage of MFI portfolios. Approximately figure 9, we find that about three of every four loans are for less 35 percent of the total value of loans disbursed by responding than $1,000. Meanwhile, about a quarter of loans disbursed MFIs are for less than $1,000, half are between $1,001 and fall between $1,001 and $3,000 and very few (3-4 percent) are $3,000 and about 10 percent are greater than $3,000. worth more. When we look at the value of loans disbursed, we Figure 9: Regional Data on Number and Value of Loans Disbursed Regional Data: Breakdown by Number of Loans Disbursed Regional Data: Breakdown by Value of Loans Disbursed 1% 0% 1% 1% 0% 0% 0% 0% 1% 1% 1% 1% 1% 1% 2% 2% 1% 2% 2% 2% 3% 2% 2% 2% 3% 100% 100% 90% 90% 9% 11% 11% 19% 21% 11% 24% 24% 80% 80% 70% 70% 60% 60% 42% 46% 50% 49% 50% 50% 40% 78% 40% 76% 74% 72% 30% 30% 45% 20% 20% 39% 35% 33% 10% 10% 0% 0% 2012 2013 2014 2015 2012 2013 2014 2015 < $1,000 $1,001-$3,000 $3,001-$5,000 $5,001-$10,000 $10,001-$25,000 >$25,000 14 Based on the assumption that the definition of a VSE loan is a loan in the sector given the initial survey finding that 78 percent of that is roughly greater than $5,000, the respondent data shows MFIs say they serve VSEs. This is because while many MFIs that only about one percent of loans disbursed and five percent provide larger loans to serve this segment, the number that can of value of loans disbursed can actually be considered VSE loans. indeed be classified as VSE loans as per the suggested definition This is clarified in Figure 10 below. These findings suggest that represents only a small percentage of the overall disbursement. perhaps there is a weak understanding of this market segment Figure 10: Regional Data Based on Proposed Definition Regional Data: Breakdown by Number of Loans Disbursed Regional Data: Breakdown by Value of Loans Disbursed 0% 1% 1% 1% 1% 0% 0% 0% 0% 1% 1% 1% 1% 1% 2% 2% 3% 2% 1% 2% 3% 100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 99% 99% 99% 99% 96% 96% 95% 94% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 2012 2013 2014 2015 2012 2013 2014 2015 < $5,000 $5,001-$10,000 $10,001-$25,000 >$25,000 There are Some Exceptions: While this is the overall regional 45 percent of portfolio value were from loans above $5,000. This picture, some countries in the region are actually further ahead is not surprising as Palestine has the highest average loan balance/ than others when it comes to VSE lending, such as Palestine GNI per capita (54 percent), suggesting that in Palestine, MFIs and - to a lesser degree - Jordan. Figures 11 and 12 show that have begun moving past the bottom of the pyramid to target in these countries, average loan size has increased gradually larger enterprises. In Jordan, although in terms of number, only over the past three and a half years. Today, some MFIs in these one percent of the loans disbursed were worth more than $5,000, countries are disbursing loans worth more than $25,000. In the they represent 15 percent in terms of value of loans disbursed. case of Palestine, in 2015, 14 percent of the loans disbursed and 15 16 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2012 100% 81% 15% 4% 2013 99% 1% 2012 77% 5% MFI 1 2014 98% 1% 1% 2013 18% 2015 97% 2014 78% 18% 4% MFI 1 1% 1% 2015 75% 16% 8% 1% 1% 1% 2% 2012 97% 2013 98% 1% 1% 2012 94% 4% 1% 2014 97% MFI 2 1% 2% 2013 94% 4% 2% 2015 94% 1% 1% 3% 2014 91% 6% 3% MFI 2 2012 99% 1% 2015 88% 7% 4% 2013 100% 2014 5% MFI 3 99% 2012 95% 2015 99% 93% 7% 2013 2014 88% 11% 1% MFI 3 2012 100% 2015 80% 15% 5% 2013 100% 2014 100% MFI 4 2012 99% 1% 2015 100% 2013 99% 1% 2012 100% 2014 98% 2% MFI 4 2013 100% 2015 90% 9% 2% 2014 100% MFI 5 2015 99% 5% 1% 2012 94% 2013 93% 5% 2% 2012 100% Palestine: Breakdown by Number of Loans Disbursed 90% 7% 3% lever 2013 100% 2014 Jordan: Breakdown by Number of Loans Disbursed Country- 2015 86% 9% lever 2014 99% 5% Country- 2015 99% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 0% 100% 10% 20% 30% 40% 50% 60% 70% 80% 90% 3% 1% 1% 2012 95% 4% 4% 1% 2012 59% 27% 13% 2013 90% 54% 31% 15% MFI 1 2014 79% 6% 9% 6% 2013 2015 72% 6% 15% 2014 55% 31% 14% MFI 1 6% 2015 45% 24% 25% 6% 2% 3% < $5,000 2012 63% 32% 2013 68% 29% 1% 2% 2012 76% 15% 9% 2014 61% 35% MFI 2 2% 2% 2013 72% 15% 13% 2015 48% 43% 2% 6% 2014 60% 17% 22% 1% MFI 2 5% 5% 1% 2015 55% 18% 24% 2012 89% 3% 2013 95% 3% 1% 1% 2014 92% 12% MFI 3 3% 3% 2% 2012 88% 2015 85% $5,001-$10,000 3% 5% 7% 2013 83% 17% 1% 1% 0% 2014 72% 25% 3% MFI 3 2012 98% 1% 0% 2015 59% 26% 15% 2013 98% 2014 98% Figure 12: VSEs Lending Breakdown in Jordan MFI 4 1% 1% 0% Figure 11: VSEs Lending Breakdown in Palestine 2012 93% 6% 2015 96% 1% 0% 2% 2013 92% 7% 1% 2%2% 3% 2012 94% 2014 88% 9% 3% MFI 4 2013 95% 1%2% 2% 2015 71% 22% 8% $10,001-$25,000 2014 94% MFI 5 2% 2% 2% 2015 92% 8% 2% 2% 4% 2012 75% 17% 2% 2% 2013 70% 17% 12% 2012 91% 4% Palestine: Breakdown by Value of Loans Disbursed Jordan: Breakdown by Value of Loans Disbursed 61% 20% 18% lever 2013 93% 4% 2% 2% 2014 Country- 2015 55% 20% 22% lever 2014 90% 5% 2% 2% 3% >$25,000 Country- 2015 85% 9% 2% 4% Caps on Loan Size are not the Only Reason: Of course it is This suggests that the ceiling is not necessarily the only reason important to recognize that in the countries where the local MFIs in Morocco are not disbursing larger loans, as very few regulations enforce a cap on loan size, MFIs are simply unable to disbursed loans are even close to the ceiling ($3,000-$6,000). disburse larger VSE loans. One example is Morocco, where the This is likely due to self-restraint by MFIs related to issues cap is approximately $6,00018. Looking back at the breakdown of capacity and/or the perceptions identified in the survey and of the loans disbursed in Morocco, Figure 13 reveals that most discussed further in the next section. Until regulations evolve, loans are for less than $1,000 and the next largest bracket is MFIs in Morocco should at least be able to disburse larger loans $1,001-$3,000. In terms of value of loans disbursed, the same to qualifying clients within the current ceiling. two brackets are the most common. Figure 13: VSEs Lending Breakdown in Morocco Morocco: Breakdown by Number of Loans Disbursed Morocco: Breakdown by Value of Loans Disbursed 1% 1% 1% 1% 1% 1% 2% 2% 2% 3% 4% 5% 2% 3% 3% 1% 3% 1% 3% 1% 4% 1% 2% 5% 5% 5% 5% 4% 5% 5% 100% 100% 9% 8% 14% 14% 11% 12% 15% 13% 9% 9% 10% 90% 90% 11% 33% 33% 33% 35% 31% 30% 36% 36% 80% 80% 38% 38% 39% 42% 44% 52% 52% 53% 47% 45% 45% 70% 70% 53% 50% 48% 53% 45% 56% 53% 57% 60% 60% 57% 56% 59% 59% 59% 50% 50% 40% 40% 64% 48% 66% 54% 65% 58% 58% 59% 62% 67% 67% 67% 61% 51% 51% 51% 30% 30% 20% 20% 30% 30% 42% 45% 45% 45% 39% 27% 25% 35% 41% 31% 34% 29% 26% 43% 10% 10% 0% 0% 2012 2013 2014 2015 2012 2013 2014 2015 2012 2013 2014 2015 2012 2013 2014 2015 2012 2013 2014 2015 2012 2013 2014 2015 2012 2013 2014 2015 2012 2013 2014 2015 MFI 1 MFI 2 MFI 3 Country- MFI 1 MFI 2 MFI 3 Country- lever lever < $1,000 $1,001-$3,000 $3,001-$5,000 $5,001-$10,000 $10,001-$25,000 >$25,000 MFIs Recognize that Serving VSEs Comes with Challenges: As to the absence of thorough product development processes within shown in Figure 14, MFIs that have started to venture into the MFIs; the common practice tends to focus on modifying existing VSE space have indeed recognized that targeting this segment products rather than undertaking a full product development process comes with its challenges. When asked about the most critical that includes designing, piloting, evaluating and modifying a new internal challenges they face, the most pressing issue listed was an product prior to rolling it out. Lack of staff capacity to analyze inability to develop adequate VSE products. This is likely linked and process VSE loans also emerged as a key challenge and this in 18 Morocco is used here as an example as it has one of the lowest caps on loan size. Similar patterns are indeed observed in other countries across the region. 17 particular has proven to be an issue in the region given that most with lending to this segment, and perhaps these MFIs are indeed MFIs’ staff have grown up with the group lending methodology doing the right thing by not rushing into the VSE segment given and often lack the skill set needed for sufficient analysis of larger that they often do not have adequate capacity. But shying away loans. However, many MFIs find it difficult to recruit externally from the VSE segment for these reasons is a lost opportunity, for this line of business and prefer to use the introduction of as discussed in section 3, particularly now that the sector has such products as a means to promote their current staff despite accumulated the necessary experience to serve this segment and limited capacity. This of course increases the risks associated MFIs in the Arab World can safely profit from this experience19. Figure 14: Internal Challenges Facing MFIs Inadequate products 9 10 3 Management perceives segment as too risky 9 11 1 High cost of operations 8 8 4 Lack of staff capacity to analyze the business 8 11 3 Lack of appropriate risk assessment methodologies 8 13 1 Perceptions of loan officers 7 13 1 Lack of capital to finance growth 6 8 7 Lack of internal processes 6 12 6 Lack of financial statements 3 14 3 0 5 10 15 20 25 VERY IMPORTANT SOMEWHAT IMPORTANT NOT IMPORTANT In terms of the external challenges MFIs face when lending to be little concern regarding the clients themselves. Despite to VSEs, it appears that the most critical are related to the the perception that serving the VSE segment is risky given the enabling environment. As shown in Figure 15, at the top of larger loan size, non-reliable VSE clients ranked quite low on the list are restrictive regulations, the lack of credit bureaus the list of external challenges and over-indebted clients ranked and movable assets registries, and a judicial system that does even lower20. Perhaps this is a result of the fact that MFIs have not ensure MFIs will get repaid should their clients become not necessarily been targeting VSEs, as has been argued in the delinquent. These are serious concerns, but they can be addressed previous section, but rather serving their clients who have by central banks and relevant regulatory bodies, with the support outgrown their previously available product range. of international donors. Interestingly enough, there appears 19 Based on its global experience, IFC has developed solutions that address these issues and is working with some first-tier MFIs in the MENA region to implement them. 20 Some hold the view that serving the VSE segment is less risky than serving informal, and in many cases, more vulnerable micro clients, as VSEs do have some documentation and some collateral to provide. 18 Figure 15: External Challenges Facing MFIs Restrictive regulations 14 6 3 Lack of credit registry 13 8 1 Judicial system 12 4 6 Poor credit culture 12 7 2 Banks already serving this segment 11 9 3 Lack of demand for MFI products by enterprises 11 11 2 Competition from subsidized government facilities 8 12 4 Macroeconomic and policital environments 7 11 3 High competition 7 12 4 Non-reliable VSE clients 5 6 11 Lack of collateral to secure the loan 5 12 3 Lack of basic infrastructure in the country 5 16 2 No clear separation between household and business accounts 4 10 7 Over-indebted clients 3 9 9 Businesses are not registered 3 13 7 0 5 10 15 20 25 VERY IMPORTANT SOMEWHAT IMPORTANT NOT IMPORTANT Box 3: Credit Bureaus and Moveable Asset Registries Credit bureaus play an important role in helping small and very small businesses access financing. Reliable credit information on individuals and small businesses helps lenders reduce the uncertainty typically associated with lending, as reliable credit information allows financial institutions to reduce risks, loan processing times, costs, and most importantly default rates. In addition, detailed credit information also benefits small businesses as it often leads to lower interest rates, making loans more available and more affordable. Credit bureaus also support responsible lending practices and help borrowers avoid over-indebtedness. Collateral provides the basis for free-flowing credit markets, reducing the potential losses lenders face from non-payment. While land and buildings are widely accepted as collateral for loans, the use of movable collateral is also important as it allows businesses to leverage their assets into capital for investment and growth, making it easier for smaller businesses to access finance. While these mechanisms are important for MFIs seeking to serve the VSE segment, their presence depends on having effective regulations in place to support them. Unfortunately, in the MENA region, many countries still do not have such regulations in place. But in the absence of such mechanisms, some national microfinance networks have been working to establish information exchange platforms for their members. Although this may not be an ideal solution, it is a positive step in offsetting the obstacles posed by the lack of credit bureaus. Various IFC Sources 19 MFIs Need Support to Scale-Up VSE Lending: To be able to possible) and partial credit guarantees (to mitigate the risk) will scale up their VSE portfolios more successfully, MFIs in the Arab also be needed. In terms of technical assistance, the majority of World have, in the survey, pointed to the need for various forms respondents (64percent) expressed an interest in advisory services of external support. In terms of external financing, as shown in (see Box 4) and exposure visits to MFIs who have successfully Figure 16, most responding MFIs are interested in long-term upscaled (52percent). MFIs who have not yet ventured into the senior debt (76percent). Indeed, as MFIs begin providing larger VSE space but have expressed interest in doing so in the next 3-5 loans to clients, their own institutional funding profile (liabilities) years require similar forms of external support (Annex 4 presents needs to evolve to match their portfolio (assets). Equity (where more details on the MFIs that are not yet serving VSEs/SEs). Figure 16: Support Needed to Boost VSE Portfolio External Financing Long term senior debt 19 6 Equity 5 20 Partial credit guarantee 4 21 Quasi-equity or convertible debt 4 21 Deposits are sufficient to finance VSE growth 3 22 Subordinated or mezzanine debt 3 22 No need 1 24 0 5 10 15 20 25 NEEDED NOT NEEDED Assistance Required Technical Assistance/Consultants 16 9 Exposure Visits 14 11 NO Need 2 23 Sustainable partnerships with equipment 1 24 vendors and manufacturers 0 5 10 15 20 25 NEEDED NOT NEEDED 20 Box 4: IFC’s Proposed VSE Product Development Life Cycle This box presents a typical VSE product development life cycle21. This process is general and in practice is often tailored to the needs of the client and its level of maturity. 10-15 Months Identify Build and Launch Evaluate Pilot Review 3. 4. Orga- Product nization Refinement Design of VSE 2. VSE 1. VSE Market Prepare for Diagnostic Assessment 5. VSE Pilot Roll out Launch (Assess MFI (Assess MFI capability) capability) Select/Hire VSE Officers Branch Selection Training of Staff 1-2 months 2-3 months 2 months 3-6 months 2 months Pilot-test Coaching and Support Plan & KPIs 6. Some Lessons Learnt from MFIs’ Experiences with the VSE Segment The following section presents a brief review of the lessons drawn from the experiences of MFIs serving VSEs in other regions and the very early experiences of the few MFIs in the MENA region that have begun to serve this segment. This information should be taken into consideration by any 1) In order for MFIs in the region to scale up their VSE lending MFI seeking to target this segment. It is important to remember operations, it is important that first and foremost, they recognize though that the approach an MFI takes to serve VSEs largely that VSE lending is different from micro-lending and that a VSE depends on the market and regulatory context as well as the loan is not just a bigger loan that can be processed in the same given institution’s strategy and goals (IFC, 2014). Therefore, this way as a micro loan and by the same staff without significant section is not prescriptive but simply outlines the array of issues additional training. As discussed earlier, micro loans are often that MFIs should consider when upscaling to serve VSEs. cycle-based loans in which the MFI begins by lending a very 21 IFC’s experience in the MENA region has shown the VSE product development life cycle may take more than 15 months. 21 small amount to the borrower, and upon timely repayment, the While these records and statements do not need to be extremely borrower becomes eligible for a larger loan (thus, the cycle). accurate, they should be accurate enough to assist MFIs in Furthermore, micro enterprises are typically one of several income answering three core questions: sources for the household and not necessarily even the prime household income source. Thus if the business deteriorates, the a. Is the owner risking their own equity in the business? client can usually repay from other household income sources This can be answered through a simple balance sheet that (perhaps over a longer period of time). Hence, micro lending shows how much capital the owner has invested in the can be client-character focused. In the case of VSEs, however, VSE. In other words, how much will he/she lose if this the VSE business is typically already the prime and dominant business fails?23 household income source and the main focus of the household. b. Is the business profitable? This can be answered though If the business deteriorates, the loan is unlikely to be repaid a simple income statement. from other income sources. Thus, while the client’s character c. Is the business generating sufficient cash to cover repayment? is still vital, analysis of the actual business and repayment And are there certain revenue cycles or seasonality to capacity becomes even more crucial in VSE lending. consider? This can be answered through a simple cash flow statement that shows an MFI the capacity of the 2) There is no hard rule when it comes to organizing VSE lending VSE to pay loan repayment amounts on schedule. within an MFI. MFIs may choose to have a separate VSE unit or have their VSE lending integrated into their existing credit So even though VSE loans can be seen as simply larger loans, department as a separate product. This is largely dependent on they should not be processed in the same manner as micro- the structure of the MFI’s current business and the extent and loans, given that a sound financial analysis is required to concentration of the market opportunity. While a separate VSE ensure that they will be repaid. unit with separate targets may increase the number and volume of VSE loans, it may also discourage ‘graduation’ of micro clients 4) While conducting a thorough financial analysis on VSE clients as micro loan officers may be reluctant to give up their best is crucial, VSE loan officers should also conduct a character clients. Either way, whether VSE lending is organized within and risk analysis on the business as well as its owner. This may a separate unit or as part of the existing credit department, vary from one context to another but could include visiting the VSE loans should only be processed by appropriately skilled VSE’s suppliers, understanding the history of the business and and trained staff. For risk management purposes, it is also the management experience, assessing its market potential and important that MFIs are able to report separately about the understanding the competitive environment in which the business VSE business at all the levels of the institution, regardless of operates. Taking all of these factors into account will allow for whether it is set up as an independent unit or integrated within a more informed loan decision given the better understanding the existing credit department. In the Arab World today, among of the business at hand and the risks associated with it. the MFIs that have started to serve VSEs, some 72 percent 5) Even though micro- loans are designed to support a micro- have a dedicated VSE unit or department, 80 percent have business, in practice, little emphasis is placed on whether the dedicated VSE staff and 88 percent have training programs client uses her/his loan in the business or not, as long as s/ specifically designed for VSE loan officers22. he has a business.24 Lending to a VSE does not only require 3) Understanding that VSEs have minimal records, it is crucial having a business, but before a VSE loan is approved, it is that loan officers conduct a thorough financial analysis by crucial to ensure that the VSE loan will contribute to the developing financial statements from whatever information growth of the business activity and income. If this is not is available (account records, bank statements, invoices, etc.). done, risk increases considerably25. Ensuring this requires 22 While it is not essential for VSE loan officers to focus exclusively on VSE loans, it is essential that they be appropriately trained to undertake VSE lending. 23 This is usually not the case with a micro business where the borrower has very little capital. Whatever capital is available is typically working capital. 24 Indeed, many institutions no longer insist on clients having a business as a condition for a loan and in some MFIs/Markets, it is estimated that more than 50% of the microloans disbursed are used for consumption purposes. 25 Theoretically, this should be the case in a micro-loan, but in reality, a good percentage of those loans do not rely on the capacity of the business to generate enough profit and cash to pay back the loan. This is because most households have multiple income sources and are capable of repaying the loan even if their micro business is weak. This is why in most of the cases we find that the amount of the micro- loan exceeds the amount of the assets of the micro- business and while officially the loan is taken for the business, in many cases, some or part of the loan is used for consumption. 22 that the loan officer checks the VSE’s business outlook. The does not generate the anticipated income. These sources could loan may even be incorporated into a forward-looking cash include sale of assets, household goods, and guarantors, among flow projection, as mentioned above. Post-disbursal visits other things. The challenge an MFI is likely to face is coming to the enterprise to ensure the money has been used for the up with a list of possible pieces of collateral that guarantee intended purpose are crucial. Moreover, frequent visits to the repayment of the loan, fit under the client protection clients, including those who are paying on time26, not only principles, and are permitted by local regulations, yet can be serve to build strong relationships and allow for cross-sales of made available by the VSE owners. products and services but are also useful as an early warning system in case a given VSE is facing financial difficulties. If an MFI complicates its collateral requirements so much Frequent visits also allow for the provision of timely advice that they are similar to those of banks, many VSE owners to help the client resolve these difficulties and avoid becoming will not be able to provide them. It is important to bear in delinquent. mind that the existence of collateral does not necessarily reduce the probability of default; it may only reduce the losses 6) In VSE lending, with larger exposures, MFIs typically want to resulting from such default28. An MFI may gain a competitive have firmer collateral27 than the group guarantee, the client’s advantage and speed up its processes if it establishes robust credit history, and other forms of collateral typically required and transparent collateral registration procedures and offers for micro- loans. MFIs developing such a product need to them as a service to clients. In general, collateral should be identify alternative sources of repayment if the client’s business kept in a place that is safe and accessible for evaluation. Box 5: Collateral Collateral is something pledged as security for repayment of a loan, to be forfeited in the event of a default Collateral is more important in VSE lending than in micro lending because: • Higher repayment amounts are more difficult to collect from VSEs than in micro lending, even if the client is willing to pay • Business may not be able to rebound quickly when they are in distress • Given that in micro lending individual loans are smaller and interest margins tend to be higher, it is possible to write-off a larger number of micro loans and remain profitable. In the case of VSE lending, where not only are loans larger, but margins are typically smaller, writing off individual loans will have a greater impact on profitability. When analyzing collateral, the following points need to be taken into account: • Collateral coverage: This covers the capital, interests and recovery costs (120-150 percent of the loan). If a large proportion of this is not easily liquidated, it is better to have lower coverage with higher liquidation value. Trusted repeat customers can get lower coverage requirements. • Choice of collateral: which depends on i) what is permitted as collateral under the local legislation and ii) 26 In micro- loans, MFIs tend to focus follow up on delinquent loans only. 27 Based on the results of the survey, MFIs are requiring additional and firmer forms of collateral from their VSE clients. These include physical assets, letters of guarantee, real estate guarantees, and deposits/cash. 28 This means that risk and financial analysis are even more important for VSE/SEs than in microfinance. 23 the probability that the collateral can be sold when needed. The choice of collateral of VSE clients is wider than that of micro- enterprises, but not always abundant. In VSE lending, we usually find the following categories: business assets; vehicles; guarantors; mortgages; deposits; household assets (excluding vehicles); bonds and post-dated cheques. Given the advantages and disadvantages of the different collaterals, it is good to envision a mix, where it is possible. It is also possible to collateralize goods that are part of the investment purpose of the loan, if appropriate control and monitoring mechanisms are in place. • Collateral evaluation: Though it is possible to use external evaluators (very costly for the customers) to conduct a collateral evaluation, for most VSEs, the collateral amounts are too small to make external evaluators worthwhile. At the same time, loan officers are biased and may also over-value collateral, and in many cases they may not have the expertise to assess the right value. While this bias and lack of expertise may do only marginal damage in microfinance, in VSE finance, the damage can be major due to the amounts at stake and the reputation of the MFI. Some ways to overcome the dilemma are: • Have some internal personnel trained to do the evaluation • Have the loan officer’s evaluation validated by an independent internal evaluator, although this can be challenging in a large branch network • Train the loan officers and supervisors and conduct peer evaluations with respective portfolio responsibility • Have reference list for ranges of collateral value for common collaterals Before considering an item as collateral that the institution is not familiar with, it is important to know: • The legislation and the procedural requirements - There are different formalization and registration procedures for different types of collateral. These include how and where the collateral is to be registered, how much time is needed for registration, how much registration costs and who pays the registration fee. - There will also be specific requirements for specific types of collateral. For example, does the person signing a mortgage contract need a power of attorney from the Board of Directors • The evaluation process requirements - An internal evaluation process is required that conforms to local standards and legislation • Staff are appropriately trained and have current information - Staff need to know how to analyze collateral and any changes in legislation that may affect this - Staff need to keep customers informed so as to avoid surprises, particularly in terms of cost or timing • Respect all legal requirements - Whilst legal requirements exist in micro lending, but the power asymmetry in VSEs may lead towards VSE clients having more difficult attitudes regarding their obligation towards financial institutions - All MFIs are required to observe legal requirements. However, when lending to VSEs, reputational and legal risks become more significant Source: IFC VSE Training Course developed by Elza Hermann 24 7) An MFI seeking to serve the VSE segment should ensure that of loan officers from loan processers to loan analysts. MFIs its staff, particularly loan officers working on VSE loans, seeking to serve VSEs need to identify those loans officers with receive the necessary training on financial analysis using a analytical skills and provide them with the necessary training mix of classroom and on the job/field training and guidance. to become VSE loan officers. This can also become a means In addition, loan officers should be trained to think critically of promoting competent loan officers29. If MFIs fail to find when making a recommendation on a VSE loan. As most VSEs the right profile for VSE officers among their existing staff, will have incomplete or informal financial records – and some they should resort to external recruitment –which brings its will have none at all – loan officers need to be able to assess own set of challenges (particularly if recruiting from banks, the outlook for the business, the intensity of the competition, where there may not be a strong cultural fit with an MFI). whether a client is the owner of the business, and skilled enough In any case, it is important that MFIs exploring the VSE to succeed, whether the client is inflating their assets, sales, business dedicate full-time staff to work on this during the or revenues, whether the business has any hidden debt. For pilot phase. Later, these staff can become supervisors, trainers, MFI’s operating ‘Model 1.0” (‘loan-cycle’ based lending), this is and coaches for new loan officers assigned to VSE lending. typically the biggest challenge as it requires the transformation Box 6: Loan Approval Processes For microloans, speed of service is key. As such, loan approval is generally decentralized. For very small micro loans, senior loan officers or credit committees comprised of several loan officers may even have approval authority. For larger micro loans, loan approval often requires branch manager signoff. However, for VSEs, full autonomy for loan approval should generally not rest at the branch level, despite potential reductions in the agility of loan disbursement. If they do not already exist, an MFI should establish different levels of loan approval based on loan size and segment served. It is best that for larger loans such as VSE/SE loans, loan decisions are made through the presentation of comprehensive loan files to credit committees that include senior management as well as branch staff, whose incentives are not linked to approval amounts. (IFC, 2014) Source: “Experiences of Microfinance Institutions Serving Very Small to Small Enterprises in Latin America”, IFC 8) It is crucial that during this process, MFIs strike the right support VSE officers and have ownership of the VSE portfolio balance between head office involvement and branch manager in their branches. involvement. In some cases, when MFIs introduce a new VSE product, they tend to bypass branch managers in the VSE loan 9) It is also crucial that MFIs seeking to serve VSEs have strong approval process, based on the assumptions that they do not controls and risk management structures in place. By definition, have sufficient time or knowledge to process VSE loans. This VSE loans are larger loans and as such, they carry both higher approach typically creates internal conflicts and in some cases default and fraud risk, be it by the client or MFI staff. Furthermore, bottlenecks in the processing as head office management tend many VSEs in the region today have minimal records and credit to be too busy to review every VSE loan, especially beyond history, which makes it more difficult to assess the risks associated the pilot phase. It is important that MFIs moving into the VSE with their borrowing. Analysis of risk becomes dependent on segment invest in training their branch managers so that they can verbally collected information and the loan officers’ ability to 29 This can also contribute to partially solving the issue of limited career paths for loans officers who have been with a given MFI for a while and who cannot become branch managers either because of their own capacity or because there is a limited number of branches. 25 critically evaluate this information. In practice, clients have an a longer processing time, it is equally important not to overly incentive to be optimistic about the prospects of their business complicate the process. MFIs seeking to increase their efficiency in order to receive a loan and loan officers have an incentive to can resort to various forms of technology to do so. Some examples believe the client in order to disburse the loan. Sound controls include the aforementioned credit scoring systems, reviewing thus become essential. An MFI seeking to serve VSEs should information from credit bureaus, providing tablets for loan clearly define its risk appetite, including the client segment/ officers so that data can be entered in the field, the use of mobile profile to be served, risk thresholds, and product limits (exposure wallets for disbursements and repayments and automated client limits, maturity, and grace periods) . The MFI should also 30 communication systems via SMS. Also, more advanced analytics make sure to conduct constant, random, and systematic checks in the form of MIS-generated reports can provide ample benefits prior to and after disbursal. These should be conducted by to management to enable quick diagnoses and decisions. different levels within the organization including team leaders, branch managers, and business managers, who should visit Before MFIs begin serving VSEs, which represents both an 11) both the clients’ businesses and homes. In the head office, the important new business opportunity and also a differing risk risk department should develop risk management reports and profile than micro-, they should take the time needed to undertake engage in data mining to check on concentrations in certain a qualitative market research. Such an exercise can help MFIs not business activities or pinpoint where portfolio quality is affected only to better understand the types of activities most common and advise on corrective actions. Finally, the MFI’s internal within the local VSE market, but also to identify distinct sub- audit team needs to systematically and critically test controls segments operating within the VSE space (often considerably to ensure their effectiveness. less uniform than micro-) which can often vary widely in their cash flow, and hence better determine their financial needs and 10) Related to data mining, MFIs moving into the VSE space can risk characteristics. By segmenting the market effectively at the also utilize credit scoring to help them in the credit analysis outset of the product design process, MFIs can begin to identify decision. Credit scoring for MFIs entails mapping out existing the most promising or risky target segments, and design their client records in terms of contracts, product socio-economic products and strategy accordingly. context, business activities, lifestyle preference, credit history and reputation among other factors. Based on this information, 12) Sound practice dictates that before launching a new product, MFIs may develop a statistical scoring model, which includes a particularly one with a methodology that differs significantly combination of statistically validated variables and some expert from typical micro-lending and has much greater exposures, MFIs judgement on the risk factors prevalent in the market. Credit should carefully pilot-test it first in a few branches. Typically, it scoring is best suited for institutions already familiar with the makes sense that these are close to the headquarter (for oversight) concept and that have rich databases from which to develop a and for MFIs to start slowly and gradually before scaling up (so statistical credit scoring model. Developing such a model requires that losses are minimized). Modest initial targets also allow loan specific expertise though, which many MFIs may not have on officers the time to learn and absorb the new analysis method. staff. In addition, the MFI needs to have a sophisticated MIS Likewise, it is useful to involve as many relevant staff as is and a team able to track and analyze the efficacy of the model. feasible in the training, preparation and pilot-test, including An ill-designed model can quickly increase an MFI’s credit risk branch managers who will need to understand (and control) exposure. Even a well-designed model needs to be fine-tuned this product, other loan officers who may grow into or replace on a regular basis to provide the MFI with useful outputs. new VSE loan officers, and senior management who should have some exposure in order to fully grasp this new aspect of their While VSE loans are larger loans that require a more prudent business. Finally, before scaling up, it’s important to review approach in general, portfolio quality combined with efficiency what has worked and not worked in the pilot, and have a very are still the keys to profitability in the segment and it is important clear plan for scale up, carefully rolling out in new branches that MFIs moving into this space strike the right balance between by leveraging experienced VSE loan officers who can play a prudence and efficiency. VSE loans are still ‘small’ loans; despite significant role in training/coaching. requiring more analysis and documentation and consequently 30 These include: debt to equity ratio, repayment capacity ratios etc. 26 7. Concluding Remarks Based on the results of the survey, it appears that MFIs in the Arab World are interested in upscaling to serve the very small enterprise segment. Several reasons have been cited for this interest, including job creation, supporting growing micro clients, and business growth opportunities for the MFIs. Despite the high level of interest, however, efforts to target VSEs have remained minimal in the Arab region. This is mainly due to limited know-how as the most critical do so. Given that VSE loans carry higher risk due to their larger internal challenge that emerged from the survey was a lack of size, it is also essential that before approving any loan, MFIs are capacity to develop adequate products for VSEs. However, MFIs certain that the VSE loan will indeed contribute to the growth of in the Arab World can benefit from the experiences of MFIs in the business activity and income and that the loan is backed up other regions who have already upscaled to serve this segment by sufficient collateral. MFIs seeking to serve the VSE segment and have accumulated enough experience in VSE lending. The should have strong controls and risk management structures in most critical point to remember is that a VSE loan is not simply place, and where possible should leverage technology to strike a larger loan. In lending to VSEs, analysis of the actual business the right balance between prudence and efficiency. Finally, MFIs in terms of financial analysis and risk analysis becomes even seeking to serve the VSE segment should carefully pilot test any more critical than the client’s character. For this reason, loan products they have designed for VSEs before rolling them out officers working in VSE lending should have the capacity to to ensure that staff have the capacity and that there are strong analyze, not simply process a loan and be trained to effectively policies, procedures, and controls in place before rolling them out. 27 Annex 1: Methodology and Respondents SURVEY METHODOLOGY The findings of this report are based on a survey conducted in May and June of 2015 designed to better understand how MFIs in Arab countries have targeted the VSE/SE segments and what efforts have been made in this space thus far. The survey was sent to a select number of MFIs via email and was broken down into three main sections. The first section was designed to collect background information on the responding institutions. This included information on whether or not there exists a definition of VSE/SE in the countries in which they operate and whether or not they are serving the VSE/SE segment. The second section was designed only for the institutions who serve VSEs/SEs, with the objective of understanding MFIs’ reasons for serving VSEs/SEs, the differences they perceive between the microfinance segment and the VSE/SE segment, the size of their VSE/SE portfolios, and the challenges and opportunities that they face. The final section was designed for the institutions not currently serving the VSE/SE segment to better understand their willingness to move into this space. In addition to the survey, the authors have benefited from: multiple conversations with the leaders of many of the responding MFIs to better understand their involvement in the VSE/SE space; discussions during Sanabel’s 11th conference and the workshop IFC conducted on the subject prior to the conference; IFC’s study on the same subject, “Experiences of Microfinance Institutions Serving Very Small Enterprises in Latin America;” several VSE institutional assessments and/or product development support provided by IFC to five leading MFIs in the MENA region (in addition to IFC’s work on the topic globally); and finally CGAP’s focus note “Financing Small Enterprises: What Role for Microfinance Institutions”, written by Glisovic and Martinez in 2012. PROFILE OF RESPONDENTS The survey was sent to a select group of MFIs, who are either the leading/largest MFIs in their countries and/or who are known to have begun exploring the VSE/SE segment. Responses were received from 32 different institutions operating in ten different Arab countries,31 and are somewhat evenly distributed by country, with a slight preponderance in Jordan and a bit less response from Yemen, Tunisia, and Bahrain, where there are fewer MFIs operating in this space (breakdown shown below in Figure 17). In terms of the legal structure of the responding MFIs, just over half of them (53 percent) are NGOs while about 28 percent are non-bank financial institutions or for-profit companies. Meanwhile, 16 percent of the MFIs in the survey are microfinance banks (MFBs), but these are limited to certain countries where regulations allow for such a legal structure - namely Bahrain, Yemen, and Sudan. Of the 32 MFIs who completed the survey, 25 (78 percent) indicated that they do serve VSEs. Figure 17: Breakdown of Survey Responses Tunisia 3% Yemen Responses by Country 6% Egypt 12% Microfinance Legal Structure Sudan Bank 9% 16% Iraq 13% Palestine Non-bank NGO/Foundation/ 13% Financial Not for profit Institutions/for company profit 53% Jordan company Morocco 19% 28% 13% Lebanon 9% Bahrain Commercial Bank 3% 3% 31 While this may not seem like a large number of responses, these 32 MFIs combined serve more than 75% of the region’s active borrowers, so we can consider this sample to be representative. 28 Table 3: Responding MFIs Country Microfinance Institution Al Tadamun Microfinance Foundation Dakahlya Businessmen’s Association Egypt ABA Commercial International Bank CIB Al-Bashaer Microfinance Organization Al-Tadhamun Economic Development Center (TDMN) IRAQ VITAS Iraq Relief International National Microfinance Bank (Watani) Tamweelcom VITAS Jordan Jordan FINCA Jordan Ahli MicroFinance Company Microfund For Women Kingdom of Bahrain Family Bank Emkan Finance Lebanon Al Majmoua VITAS S.A.L Attadamoune Micro Finance Al Amana Microfinance Morocco Attawfiq Micro-Finance ALBARAKA (EX. FONDEP) VITAS Palestine FATEN - Palestine for credit & development Palestine The Arab Centre for Agricultural Development (ACAD) ASALA for Credit and Development PASED Sudan* Ebdaa Bank for Microfinance-Sudan Family Bank-Sudan Tunisia Enda inter-arabe Al-Amal Microfinance Bank Yemen* Alkuraimi Islamic Microfinance Bank (KIMB) Note: Sudan, Syria and Yemen are the only countries where regulations allow MFIs to collect deposits. 29 Annex 2: An Attempt to Define the VSE Segment According to the Microfinance Information Exchange (MIX), microfinance loans are loans whose average outstanding balance does not exceed 250 percent of the average income per person (GNI/capita). As the average loan size is approximately equal to 1.67 times the average loan balance32, one can calculate the ceiling on microfinance loans based on this definition, as shown in table 4 below. Comparing this ceiling to the one that exists based on the current regulations, we find that the ceiling for the size of loans disbursed by MFIs should be three to five times higher than the existing loan amount ceilings (in countries where there are specific regulations) and, in the case of Bahrain, it should be almost ten times higher. Table 4: Calculation of Loan Ceiling (USD – approximate figures based on FX rates at time of writing) Country Sudan Morocco Tunisia Egypt Bahrain Yemen Jordan Lebanon Iraq Palestine GNI/ capita 3,920 7,100 10,600 10,260 37,650 3,650 11,910 17,910 14,440 5,080 Cap on loan size 1% of total for MFIs (based on 3,500 6,000 10,000 13,000 18,000 shareholder regulation) equity Ceiling based on 16,366 29,643 44,255 42,836 157,189 15,239 49,724 74,774 60,287 21,209 MIX definition Ceiling based on MIX definition/ 5X 5X 4X 3X 9X cap on loan size Notes: - Number and value of outstanding loans are extracted from IFC’s database on MFIs in the Arab World which uses a combination of data from the MIX, data reported to IFC and the respective MFIs’ websites as of end of 2014. - Ceiling based on MIX definition = 250% x 1.67 x GNI per capita to demonstrate maximum loan size. When we calculate the current average loan balances as a percentage of GNI (table 5), we see that the average loan balance over GNI/capita is still quite low –approximately equal to or less than 10 percent of GNI in all countries, except Palestine and Sudan33. 32 Based on the assumption that the average loan balance lies somewhere between 55%-65% of the average loan size. 33 Based on the data that was presented in section 5, MFIs in Palestine are some of the few in the region that have actually started serving VSEs with any significance, and this is why their average loan balance and accordingly average loan size is relatively higher. In the case of Sudan, the authors believe that the data is not representative as data is only available for two MFIs when there are several others in the market. 30 Table 5: Average Loan Balance as Percentage of GNI/Capita Country Sudan Morocco Tunisia Egypt Bahrain Yemen Jordan Lebanon Iraq Palestine Outstanding Portfolio 65,132,702 607,023,463 125,803,526 293,334,240 47,707,666 264,994,050 91,592,160 139,867,131 182,054,865 (USD) Number of Active 66,384 838,906 253,245 1,135,430 111,247 321,695 88,002 93,795 66,593 Borrowers Average Loan 981 724 497 258 0 429 824 1,041 1,491 2,734 Balance GNI per 3,920 7,100 10,600 10,260 37,650 3,650 11,910 17,910 14,440 5,080 capita Average Loan Balance/ 25% 10% 5% 3% 0% 12% 7% 6% 10% 54% GNI Capita Given the low average loan balance/GNI per capita ratios prevalent in most countries (≈10%), which suggest that MFIs are only targeting the very poor clients, we propose here that a VSE loan is a loan with an average loan balance/GNI per capita between 25 percent and 250 percent34. Based on this definition, the ranges for the respective countries are presented in table 6 below. Table6: Suggested VSE Loan Size by Country Country Sudan Morocco Tunisia Egypt Bahrain Yemen Jordan Lebanon Iraq Palestine VSE Range 1,500 3,000 4,500 4,500 15,000 1,500 5,000 7,500 6,000 2,000 (lower bound) VSE Range 16,000 30,000 45,000 40,000 150,000 15,000 50,000 75,000 60,000 20,000 (upper bound) 34 One can argue why we are using the 250% figure from the MIX, which represents micro, and not taking something mid-way between micro- and something we might have on small or SME (e.g. 100%-500% for example). However, the fact that the average loan balance in the region as a percentage of GNI/capita is too low (≈10%) indicates that the ceiling the MIX had put for the micro definition is too high. 31 Annex 3: Some Official Definitions for Small Enterprises in the Arab World Table 7: Official Definitions for Small Enterprises in the Arab World Definition Country Entity Number of Employees Paid-In Capital/ Initial Annual Turnover Investment (USD) (USD) Egyptian Small Enterprise Law No. <50 $6,000-$125,000 141 of 2004 (EFSA, n.d.) Ministry of Trade and Industry35 <200 $ 1.2- 2.5 million (MTI) Egypt Central Bank of Egypt (VSE) $ 130,000 – 1.2 million Central Bank of Egypt (SME) $ 1.2-2.5 million Ministry of Industry and Trade 10-49 $42,000 (JEDCO) Jordan Department of Statistics (DOS) 5-19 (Young Entrepreneurs Association) Banque Du Liban (Ministry of Lebanon < $ 9 million Economy and Trade, 2014) Kafalat (Ministry of Economy and <40 Trade, 2014) Ministry of Industry and Trade Yemen 4-9 (Abdullah) Central Statistical Organization <5 (2004) (IFC) FONAPRAM (Di Tommaso, Tunisia < $25,000 Lanzoni, & Rubini) 35 The Ministry of Industry and Trade also has a definition for the VSE segment, which is enterprises with less than 200 employees and annual turnover of $ 130,000 – 1,200,000. 32 Annex 4: Survey Findings on MFIs that currently do not Serve VSEs Among the MFIs that do not offer VSE loans, there appears to be clear interest, with the majority saying that they are interested. These MFIs expect to move into the VSE space in the next 3-5 years. Figure 18: Survey Results for MFIs that are not Serving VSEs Main Reasons for Not Serving VSEs Is your institution interested in serving VSE? (5 responses) (6 responses) 0% Competition 0% Yes No 100% Mission drift 40% Proposed Timeline to Serve VSEs (of the 6 MFls interested in serving VSEs) Institutional capacity 40% 35% 33% 30% 25% Cap on loan size 80% 20% 17% 17% 17% 15% 10% Regulations 40% 5% 0% 0% 0% 20% 40% 60% 80% <1 year >1 year >2 years >3 years >5 years and and and <2 years <3 years <5 years In terms of the external assistance they require, the majority are interested in long-term senior debt and technical assistance in the form of advisory services, exposure visits and training workshops. Figure 19: Assistance Required by MFIs Currently not Serving VSEs What external financing would you What technical assistance/ capacity building would need to serve VSEs? you need to develop a VSE portfolio? (of the 6 MFIs interested) (of the 6 MFIs interested) No need 0 6 No assistance required 0 6 Deposits and sufficient to finance VSE growth 2 4 Partial credit guarantee 4 2 Training workshops 5 1 Equity 1 5 Quasi-equity of convertible debt 2 4 Exposure visits 6 0 Subordinated or mezzanine debt 1 2 Technical assistance/ 5 Long term senior debt 6 0 1 consultants 0 1 2 3 4 5 6 0 1 2 3 4 5 6 NEEDED NOT NEEDED NEEDED NOT NEEDED 33 Works Cited Abdullah, A. (n.d.). Measuring the E-Business Activities of SMEs In Yemen. First Asia Pacific Conference on Contemporary Research. Cook, T., & McKay, C. (2015). How M-Shwari Works: The Story So Far. CGAP. Di Tommaso, M., Lanzoni, E., & Rubini, L. (n.d.). Support to SMEs in the Arab Region: The Case of Tunisia. UNIDO/ UNDP. EFSA. (n.d.). Egyptian Financial Supervisory Authority . Retrieved from http://www.efsa.gov.eg/jtags/efsa_en/index_en.jsp IFC. (2014). Experiences of Microfinance Institutions Serving Very Small to Small Enterprises in Latin America. IFC and Sanabel. (2015). Voices: An Assessment of the perceived risks facing the microfinance sector in the Arab World. IFC. (n.d.). Market Research conducted for Al Kuraimi Islamic Microfinance Bank in Yemen. JEDCO. (n.d.). Jordan Enterprise Development Corporation: SME Development in Jordan. Retrieved from http:// worldsmeexpo.hktdc.com/pdf/2011/SeminarRoom_C/Dec_3/1630_1800_24/2_AAl-Ahmad.pdf (2008). McKinsey Data for IFC. Ministry of Economy and Trade. (2014, November). Lebanon SME Strategy: A Roadmap to 2020. Retrieved from http:// www.databank.com.lb/docs/National%20SME%20Strategy-%202014.pdf MTI. (n.d.). Retrieved from Ministy of Trade and Industry : http://www.mti.gov.eg/english/index.htm Nails, & Sian. (2008). CGAP. Young EntrepreneursAssociation.(n.d.).Small and Medium BusinessAgenda.Retrieved from http://www.cipe-arabia.org/files/ pdf/Bussiness_Associations/SEYA%20Sawtouna%20-%20Small%20and%20Medium%20Business%20Agenda.pdf 34 Notes Sahar Tieby Executive Director Sanabel, the Microfinance Network of Arab Countries 34 B South Police Academy New Cairo, Egypt Tel: +2 02 25 37 30 23 Fax: +2 02 25 37 31 70 www.sanabelnetwork.org Mohammed Khaled Microfinance Senior Operations Officer Middle East and North Africa 2005C Cornich El Nile Nile City Towers, North Tower, 24th floor. Phone: + 20 (2) 2461-9140 / 45 / 50 Fax: +20 (2) 2461-9130 / 60 Ifc.org August 2016