West Bank/Gaza Loan Guarantee Facility Transforming SME Lending practices in the Palestinian Territories
Background Small and medium sized enterprises (SMEs) are the life blood of the Palestinian economy. They comprise 90% of the region’s business units, are responsible for over 55% of all productive output, and employ more than 80% of private sector labor. In spite of their overall importance, however, these businesses are seriously handicapped by their limited access to commercial credit. Estimates of unmet SME credit demand range as high as $600 million. Among the many severe political and economic circumstances that Palestinian SMEs face, lack of access to credit is most challenging. The Middle East Investment Initiative (MEII) Loan Guarantee Facility (LGF), launched at the end of 2007, seeks to address this imbalance by opening the doors of commercial banks to Palestinian SMEs, allowing much needed access to credit and other financial services. Over the life of the program, LGF will stimulate more than $228 million in properly structured credit to eligible Palestinian SMEs. More importantly, LGF is preparing the Palestinian banking system to meet the on-going credit needs of all bankable SMEs on a sustainable basis and without donor financed intervention.
The LGF Approach Extremely conservative lending policies have long dominated banking in the Palestinian Territories. Credit risk has been managed by minimizing exposure and imposing extremely high collateral requirements, thereby restricting credit availability to large, highly-capitalized businesses. Lending also has tended to be short-term, ignoring the fixed capital requirements of borrowers. In addition to discriminating against SMEs, these practices isolate lenders from the enormous potential offered by this segment.
LGF stimulates SME lending by providing its nine partner banks (representing 85% of the Palestinian credit market) with guarantees for 70% of the principal amount of loans to bankable SMEs. More importantly, LGF provides its partner banks with technical assistance to assess the viability of its SME borrowers and structure loans to effectively meet working capital and longer-term needs of borrowers, maximizing potential for full repayment. Demonstrating success where other loan guarantee and SME credit programs have failed, LGF is encouraging and assisting banks to profitably and responsibly manage credit risk to an expanded marketplace.
Technical Assistance and Training Working “behind the scenes” with managers and credit officers of partner banks, LGF professionals provide handson assistance with all aspects of lending policy development and credit management. Major emphasis is placed on financial analysis and credit structuring to ensure that the viability of SME loan applicants is efficiently assessed, and that loans are structured to properly match the capital needs and cash flows of SME borrowers. Training also focuses on loan portfolio management to ensure that each loan is properly monitored and that effective, on-going due diligence protects the interests of both the lender and the borrower. The LGF approach is designed to maximize potential for a successful and profitable borrower-lender experience. LGF enables lenders to substitute heavy dependency on collateral with healthy risk assessment, new management
LGF at a Glance Program Goal – to stimulate lending to Palestinian SMEs and help transform the Palestinian lending culture. Impact • Additional $228 million in loans available to bankable SMEs • Job creation • Enhanced lending capacities of banks through technical assistance & training • SME growth and financial literacy capacity building LGF Dimensions • Guarantees 70% of loan principal in return for a utilization fee • Technical assistance continually provided to banks and SMEs • 10 year program with medium & long-term vs. “quick fix” strategy • All major banks participate • Loan size $10,000 - $500,000 • Working capital and/or fixed assets loans • All economic sectors & regions eligible • Any type of business, including start – ups. techniques, and properly structured, well-managed credit products. LGF also assists bank managers with strategic planning and policy development, and provides “hands-on” technical assistance and on-the-job training to loan officers. In addition, LGF works with banks & local accounting firms to provide SME managers with financial education to improve understanding of the loan application process, generate financial statements and address common loan application shortcomings.
Impact and Potential LGF is playing an important role in improving the Palestinian financial sector, facilitating economic growth and laying the groundwork for a sustainable peace in the region. In just over three years of operations, MEII has approved over $76 million in loan guarantees in the West Bank, generating over 1,500 documented direct jobs and 1,900 indirect jobs. Early LGF-facilitated lending tended to be concentrated in urban-based manufacturing – a more accessible market sector with which bank partners felt most comfortable. Currently, the LGF-supported loan portfolio has spread throughout all economic sectors and regions of the West Bank, including “difficult-to-bank” rural areas. More than 10% of LGF-facilitated loans are in agriculture, which is particularly important to the Palestinian economy. Further, nearly 10% of LGF-facilitated loans are for new business start ups. Generating business opportunity and employment for women is an important
Technical Assistance & Training: A Key Pillar of LGF In the first three years of LGF, capacity building efforts with the banks & SMEs were supported by USAID through the ESAF project. The TA was fundamental to initiating change and reaching the entire market. LGF staff delivered over 16,000 person hours of training to over 300 credit officers, working primarily at the branches of partner banks. LGF leveraged the on-the-job training approach to build relationships and expand comfort zones. LGF witnessed many loan officers advance through the ranks as their enhanced skills became more valuable in the bank. The SME credit transformation is at a critical juncture as key building blocks have been put in place, but to reach a deeper more systemic change, additional support is needed to both banks and SMEs.
LGF objective. Partner banks are encouraged to seek out businesses that are owned by women, and all loans are monitored and evaluated for employment generation for women. Currently, 26% of all employment attributed to LGFfacilitated lending has gone to females. Aware that opportunities for female entrepreneurs are concentrated in very small, informal businesses, LGF developed a guarantee product designed to support micro lending. To date, more than 85% of 1,223 LGF-supported micro loans have gone to businesses owned by women. On-going LGF management challenges include continued portfolio growth and diversification. Of particular importance is continued technical assistance, along with diligent monitoring and evaluation of LGF-influenced banking policies and credit management practices to ensure long-term adoption. As banks begin to successfully and profitably meet the credit and other financial service needs of SMEs with declining LGF support, the project will have accomplished its longterm objectives.
Efficiently Leveraging Public Resources and Local Partners LGF engages public resources to “unlock” credit for SMEs without being fully funded. In Palestine, the U.S. Overseas Private Investment Corporation (OPIC), the U.S. Government’s development finance institution, and the Palestine Investment Fund (PIF), an independent, state-owned investment fund, support LGF with $160 million letters of guarantee that will leverage $228 million of private bank capital for SME lending. Participating banks pay OPIC and PIF a utilization fee for participating in LGF, but use their own capital to finance the SME loans. Only in the event of a borrower default will OPIC and PIF need to inject funds in LGF to honor a call on a guarantee.
MEII-LGF signing ceremony in 2007
LGF was not designed to be a permanent economically sustainable facility. It is a temporary (10 year) intervention designed to address bottlenecks and stimulate lending to SMEs. While the loan guarantees are fully backed by OPIC and PIF, MEII must raise all of the operating funds for LGF and its technical assistance and training programs. Almost all of these funds support operations of the MEII office in Ramallah, which has 14 full-time staff, all of whom are local Palestinians. We thus seek financial support to not only sustain but enhance and extend LGF’s operations, which were designed to keep guarantee fees low to maximize outreach while providing technical assistance to partner banks. Additional funding will help ensure that LGF can maintain activities for the full 10-year life of the facility, allow LGF to accelerate lending and the development of new financial products, and to expand technical assistance outreach to include SMEs.