A new study reveals a billion-dollar gap for Islamic SME financing in the MENA region with Morocco leading in SME financing and Egypt trailing the pack

Thousands of small and medium enterprises (SMEs) across the Middle East and North Africa are not accessing banking services because of a lack of Shari'ah-compliant products, according to a new study released by the International Finance Corporation (IFC), a member of the World Bank Group. The study, Islamic Banking Opportunities Across Small and Medium Enterprises in MENA, highlights a potential gap of up to $13.2 billion for Islamic SME financing across nine countries in the region.

While the study indicated that 35 per cent of SMEs were excluded from the formal banking sector because of the lack of Islamic products, IFC Director for the MENA region Mouayed Makhlouf pointed out that Islamic financing mechanisms for SMEs were quite strong in North Africa, particularly Tunisia and Morocco, compared to other countries in the region.

"I think that in general [North African countries] are more fortunate that some others. When we look at Morocco, I think it has the highest access to finance for SMEs, and same thing for microfinance. I think the governments there have established that ecosystem for SMEs and microfinance. And there was at some point a lot of support from Europe to these at that stage," Makhlouf told Banker Africa.

The IFC found that despite the 'huge' demand for Islamic finance across MENA, of the 36 per cent of banks in the region with an SME offering, only 17 per cent currently have an Islamic SME offering. The report claimed an estimated 32.19 per cent of SMEs across the nine countries are totally excluded from access to finance, mainly because of lack of Shari'ah-compliant products.

The study was carried out in Morocco, Tunisia and Egypt, as well as Iraq, Pakistan, Yemen, the Kingdom of Saudi Arabia, Lebanon and Jordan. Unsurprisingly there was a significant variation in Islamic financing engagement and interest across the countries, ranging from 90 per cent interest in Saudi Arabia to just four per cent in Lebanon. Tunisia, Morocco and Egypt fell at 18 per cent, 54 per cent and 20 per cent respectively.

"The study reiterates several of the well-documented reasons for the lack of access to finance for SMEs in the region. More importantly, it reveals a significant, untapped 'new to bank' funding opportunity, as banks and other financial institutions lack adequate strategic focus on this segment to offer Shari'ah-compliant products. It also highlights the measures they need to take to overcome this," Makhlouf said.

Morocco took top place among the nine countries for SME penetration--both conventional and Islamic-- as a percentage of total lending, at 24 per cent. Tunisia's SME lending accounts for 15 per cent of the total, while Egypt's stands at just eight per cent.

Yet the study listed Egypt as a 'high-potential' market for Islamic funding opportunities, with an estimated $1.3-2.38 billion funding potential. It said that Egypt led the countries in terms of 'depository potential,' to the tune of $2.52-4.56 billion.

Attiq-Ur-Rehman, Partner at Israa Capital and a contributor to the study's research, said that Egypt's capacity for the Islamic banking sector mostly lies in its unbanked population.

"Because they are unbanked right now, and in this study we found that the total market share for Islamic banking is about eight per cent of lending...there is a lot of potential," he said. However, significant challenges remain for Egypt's budding Islamic financing products.

"There is still no common Islamic law and no SME focus included [in Egypt]. So some of the main problems we discussed with some of the banks...is that they have to go through the same tedious process of the conventional institutions and then recognise the contract with Islamic regulations...it's a challenge there," he said. "This is not only about the people's demand, sometimes it's the government and external factors."

Morocco and Tunisia, on the other hand, were identified as medium-potential markets. "Morocco and Tunisia are nascent markets; although they have the necessary conditions in place--government support, strong domestic demand--they are likely to realise their potential only in the long-term," the report said.

In the study, manufacturing was highlighted as the most attractive sector for Islamic funding across the board, followed by trade and commerce. Transportation was also indicated as an attractive sector in Tunisia, as was the services sector in Morocco.

Challenges to Islamic SME financing

Regulatory frameworks, perceptions of Islamic finance and availability of products vary strongly by country and play a significant role in the growth of Islamic SME financing. The IFC said that Pakistan is 'the only country with a well-defined regulatory framework for promoting Islamic banking' but that Morocco, Tunisia and Egypt were in the process of developing frameworks.

"The development of the sector in the medium- to long-term would be contingent on the effectiveness of regulations framed," the report said. "A strong enabling environment across most countries, coupled with high penetration rates ranging from three to 10 per cent [Egypt] and 10 to 25 per cent [Pakistan and Jordan], and a high demand from SMEs for Islamic finance promises strong growth for SME funding in the short- to medium-term."

IFC suggested that banks avoid a 'one-size-fits-all' approach when establishing Islamic SME financing products and offer customised value additions similar to conventional banks' competitive products. Furthermore, IFC said that a dedicated Islamic SME banking strategy and business model, including opportunity assessment, appropriate propositions and optimal operating models, would be essential.

"Customers' lack of awareness of banks and institutions [especially Islamic ones] that offer SME finance propositions creates a huge supply-side gap. Islamic banks can fill this gap by effectively branding and marketing Islamic propositions for SMEs as well as by creating separate business units...with specialized SME strategies," IFC said.

Across all nine countries include in the study, IFC found a potential gap of $8.63 billion to $13.20 billion for Islamic SME financing, with a corresponding deposit potential of $9.71 billion to $15.05 billion.

© Banker Africa 2014