Small and medium enterprises (SMEs) in Middle East and revenues2) and in the accounts of buyers as trade North Africa (MENA), especially female entrepreneurs, payables (measured as days of annual costs of sales). face steep challenges in accessing finance and credit. The trade credit balance is the difference between the This situation is now even more dire with the Covid-19 trade receivables and the trade payables, measured in crisis. days of annual sales revenues. SMEs finance their activities in three main ways: (i) Both cross-border and domestic trade give rise to trade shareholder funds from family, business partners, and credit. Most global trade involves open trade credit (as investors (ii) payment facilities from suppliers and pre- opposed to trade payments secured by letters of credit payments from clients, known as inter-firm trade credit (in issued by banks). The total volume of domestic trade is short “trade credit”), and (iii) credit facilities from banks typically a multiple of GDP. In a mature economy like and other financial institutions, of which a large chunk is France, domestic trade, as measured by the aggregate for working capital. All these sources of funds are sales of firms, is around 2.3 times GDP. Not all countries required for SMEs to conduct their activities in a track trade credit, but its volume is very large. In France financially sustainable manner. for example, total inter-firm trade credit exceeds 50% of GDP. The focus of this quick note is on the latter aspects: SME access to inter-firm trade credit and bank facilities to In the MENA region, few countries systematically monitor finance trade. These have major implications for financial and publish information on inter-firm trade credit. In inclusion, private sector development, value chains, and Morocco, the central bank of Morocco has conducted ultimately, on employment and growth. IFC is already annual surveys of payment delays since 2010, and in very active in this segment, notably in poorer and fragile 2018 established an Observatory of Payment Delays. countries with the support of the IDA Private Sector Extrapolating from a sample of 70,000 firms surveyed, the Window, but more can be done by the World Bank. The volume of inter-firm credit in Morocco could be estimated financing of trade and value chains also needs to be much at over 40% of GDP. This is comparable to the total better understood by policymakers in our MENA client banking sector credit (45% of GDP) extended to non- countries. financial enterprises. Access to Trade Credit Central bank data show that larger firms (with stronger market power) disproportionately benefit from favorable Before diving into the public policy aspects of SME access payment conditions for both sales and purchases, while to trade credit in MENA countries, it is useful to keep in MSMEs are squeezed. During the last decade, the mind a few definitions and orders of magnitude. number of insolvencies in Morocco has tripled, and surpassed 8,000 in 2017 (of which over 7,000 ended in Trade credit is simply the deferred payment facilities that liquidation). Insolvencies occur mostly in the retail trade, suppliers (sellers) grant to their customers (buyers) to real estate and construction sectors. About 40% of settle invoices in their sales of goods or services. Trade insolvencies are related to client payment delays or credit is reflected in the accounts of sellers as trade defaults, including late payment in public procurement receivables (measured as days of annual sales contracts. A pre-Covid survey conducted by the Casablanca Regional Investment Center identified For firms, and especially for SMEs, trade credit insurance access to market as a major business challenge, faced by has positive externalities and brings benefits beyond pure 71% of MSMEs, ahead of access to finance. Slow risk mitigation: payment from clients seems to be the key factor (i) it supports financial inclusion, given that (identified as such by 45% of respondents) hindering receivables backed by credit insurance may be access to market. used by sellers to raise finance without pledging cash or fixed assets to their banks, through trade Other countries in MENA are taking measures to improve finance mechanisms such as bills discounting the collection and analysis of such data, with the support of the World Bank. In Tunisia, sample surveys pointed to (where a bank advances to the seller the net a severe deterioration in payment terms even before the present value of invoices before they are due for Covid-19 crisis. In particular, state-owned enterprises payment by the buyer) or invoice factoring (SOEs) pay slowly due to their tight cashflow situation, red (where a seller sells invoices receivable to a tape, and inefficient payment methods. This has a factoring company or a bank). negative ripple effect on value chains and hit SME the hardest, ultimately harming investment, employment, and (ii) it strengthens the balance sheet (on average, business growth. trade receivables account for 40% of the total assets of a company, and payment default by Trade credit is a very simple and flexible form of financing. large buyers is usually the single largest cause of It is essential for SMEs and generally contributes to the SME insolvency), efficiency and competitiveness of value chains. However, it exposes sellers to credit risks on buyers. This risk can be covered by trade credit insurance. (iii) it also facilitates the exporters’ business development and sales diversification (indeed, Access to Trade Credit Insurance credit opinions from credit insurers represent a major market intelligence tool). Trade credit insurance covers sellers against the risk that buyers might fail to pay on time for the goods or services Econometric studies have estimated the short-term delivered to them. Trade credit insurance first arose in multiplier effect of credit insurance on export trade at 2.3 Western Europe towards the end of the 19th century, to 3.23. The long-term multiplier effect of credit insurance initially as a private business, and later as a policy tool in on export trade is higher than the short-term multiplier. the wake of the first and second world wars. In the 1990s, trade credit insurance became a global industry The availability of trade credit insurance varies dominated by a mix of privately-owned global players, considerably within the MENA region. Morocco has a state agencies (with the largest based in China, Korea relatively deep and competitive credit insurance market, and Japan) and specialist institutions such as Lloyd’s in served by two international credit insurers, plus a London. domestic provider partly owned by the state. About 600 firms in Morocco use trade credit insurance. Insured trade In 2019, total insured trade flows were estimated at nearly flows are estimated at around USD 7 billion annually, of USD 6 trillion or 7% of world GDP. In more advanced which around USD 5 billion in domestic trade and USD 2 markets (Europe, South Africa), insured trade flows are billion in export trade (notably phosphate exports). The typically around 15% of GDP. Globally, approximately penetration of trade credit insurance in Morocco half of insured trade flows are domestic, and half cross- (equivalent to 7 percent of GDP) is significantly higher border. Overall, trade credit insurance underpins 15% of than in any other MENA countries, but only represents world exports (and up to 20% for major exporting half of the penetration rates seen in Europe or South countries such as China or Korea). Market penetration Africa. varies across geographies (highest in Europe and East Asia) and sectors (higher for manufactured goods and Beyond Morocco, trade credit insurance is burgeoning agroindustry exports, lower for hydrocarbons and among World Bank MENA client countries. minerals, seldom used in intra-group trade except to cover political risk). Historically, trade credit insurance - Tunisia ranks second, with an insured volume of has been a significant enabling factor for trade integration around 4% of GDP – approximately half export in Europe. and half domestic. The market is dominated by one partly state-owned player (Cotunace), private sector employment in the MENA region, they reinsured by one of the three leading international receive on average only 7% of the banks’ credit facilities, credit insurers. with financing volumes disproportionately absorbed by the largest corporates. - Lebanon, before the current crisis, was well served by local provider in which IFC previously SME access to finance in the MENA region mostly had an equity stake. consists of general banking credit facilities secured by a mortgage on residential/commercial real estate (“external - Egypt, with a market penetration estimated at collateral”), typically with very high ratios of collateral to less than 1% of exports, probably has the largest loan value: 127% in Jordan, 167% in Morocco and 251% under-tapped potential in the MENA region. in Tunisia. This is particularly challenging for women Jordan authorities have identified credit entrepreneurs, in view of their relatively weaker ownership of real estate assets that banks require as insurance as a key step to enhance the collateral. Mortgage loans are expensive for borrowers competitiveness and growth of exports. The main and reduce competition among banks – once an provider, Jordan Loan Guarantee Corporation entrepreneur has mortgaged its real estate assets to a (JLGC), created in 1994, is 49% owned by the bank, it becomes very difficult to switch to another bank. Central Bank. JLGC has been upgrading its Loan guarantee schemes may partly fill this gap by capabilities and increased its market penetration allowing beneficiary SMEs to access bank loans without the need for mortgage collateral, but the capital and scale in national exports to around 2%. of operation of these schemes is seldom large enough to - In addition to national providers, two regional make a significant dent in the SME loan market. agencies provide trade credit insurance: ICIEC (a subsidiary of the Islamic Development Bank, In addition to general banking facilities, entrepreneurs need access to more specialized types of finance to based in Saudi Arabia), and Dhaman (based in operate, trade and compete successfully – especially Kuwait). trade finance instruments, ranging from letters of credit, Challenges hindering the provision of trade credit to bid and performance bonds, receivable discounting, insurance in MENA countries include: relatively weak inventory financing, and bank guarantees. In advanced credit infrastructure, in terms of credit information, emerging markets, banks and specialized financial especially in the informal sector (to be insurable, firms institutions offer a broad range of trade finance need to have acceptable governance, invoicing and instruments. In MENA, SMEs have very limited access to accounting practices as well as claims enforcement) and such trade finance instruments. For SME importers, local the relatively small size of entrepreneurs in developing banks mostly shun clean (unsecured) credit terms when MENA countries (credit insurers tend to target firms with issuing import letters of credit. Instead, they usually annual sales of at least USD 1 million). As a result, the require full cash collateral, or a mortgage. Likewise, SME size of national markets in developing MENA is often exporters in MENA seldom have access to export finance. small to attract direct investment from international credit insurers. These smaller markets can be covered by For most SMEs in MENA, trade finance services domestic state-owned or private providers, but they also essentially consist of basic payment remittances and need a minimum scale of operation to cover operating documentary collections. The banks’ ability and cost, invest in systems, and attract quality reinsurance. willingness to serve SMEs is further constrained by Anti- Money Laundering (AML) and Know-Your-Customer (KYC) requirements. Domestically, SMEs need trade Access to Trade Finance finance to meaningfully participate in public procurement: when bidding for projects, they need to provide bid bonds, SME financial inclusion is problematic in the MENA region performance bonds, advance payment bonds, etc. Once –more so than most other parts of the world. In World awarded a public procurement contract, SMEs need to be Bank Enterprise Surveys, 32% of firms in MENA declared able to discount receivables from their public sector that limited access to credit was a major constraint, clients. versus 26% globally. Among MSMEs that are led by women (on average 23% of all MSMEs), 55% do not have In advanced emerging markets, SMEs can finance their access to credit financing, and only 4% declare being receivables not only through invoice discounting (bank well-served by financial institutions. There are of course financing secured by secured by invoices) but also differences within MENA. For example, Morocco does through invoice factoring (i.e. selling their invoices to so- significantly better than the regional average, but Tunisia called factoring companies). This also allows them to and Egypt significantly worse. The World Bank and the outsource time-intensive receivables management, thus IMF estimate that, although SMEs generate over 50% of allowing them to cut their operating cost and to focus on has factoring volumes close to world average, but this is core commercial and productive activities. mostly for domestic factoring. Export factoring in Morocco was only USD 200 million in 2017 – less than 1% of The global factoring market is estimated at around USD merchandise exports, versus a global average of 3%. 3.5 trillion, equivalent to 4.3% of global GDP. In West Factoring is barely available in other MENA client Europe factoring volumes are around 15-20% of GDP. countries (for example, volumes in Tunisia and Egypt are Among World Bank client countries in MENA, Morocco less than 0.5% of GDP). Box 1: Levels of access to trade credit and finance The degree of access that entrepreneurs, value chains or countries may have to trade credit and finance can be measured against four successive levels of development, ranging from “no access” (level 0) to “advanced access” (level 3). Level 0 - no access. At the lowest level, firms have virtually no access to bank finance. Inter-firm trade credit is largely based on personal trust along kinship, family or patronage lines, else transactions are paid cash. This situation typically prevails for small entrepreneurs in less advanced markets. Level 1 – basic access. Bank credit is typically not in the form of trade finance, but rather as overdrafts or other general short-term facilities extensively secured by mortgages on real estate assets. Trade credit insurance is not available. Inter- firm trade credit exposes sellers to substantial credit risk on buyers. Payment delays, notably on sales to state-owned enterprises, tend to hinder SME access to the domestic public procurement market. This would be the typical situation for SMEs in intermediate markets, or for regular corporates in less advanced markets. Level 2 – intermediate access. Entrepreneurs can access some basic trade finance instruments, notably letters of credit for imports, albeit secured by external collateral (cash deposit or mortgage). Incipient trade credit insurance services focus on imports rather than domestic trade although imports are still often paid by letters of credit rather than open trade credit. Level 3 – advanced access. Firms access a wide range of specialized trade finance products, both from banks (e.g. non-recourse discounting of receivables, warehouse receipt financing, etc.) and non-banks (e.g. domestic and export factoring). Receivables can be used as a borrowing base. Banks can tailor their facilities based on the trade cycle of their clients and offer transaction-specific financing instruments in addition to standard, general banking facilities. The trade credit insurance market is well developed, not only for imports but also for domestic sales and exports. This allows SME sellers to insure the risk of payment default on their domestic and export transactions. Although this analysis has not yet been conducted systematically, countries at different levels of access probably require different types of public policy and state intervention instruments to attain the next stage of development in trade credit and finance. Further work is needed to better measure gaps in trade “externally”. Within value chains, sellers and buyers credit and finance needs in World Bank MENA client extend credit to each other in the form of inter-firm trade countries. These gaps could be assessed against a credit. Cashflow deficits within value chains are also typology outlined in Box 1 below. This typology can be financed “externally”, through trade finance and related used to assess access at firm, value chain or country instruments provided by banks and other financial level. institutions. A similar analysis can be conducted at the broader level Public policy implications of value chains. As a pilot, the World Bank is now conducting a financial mapping of Tunisia’s value chains, in cooperation with the Central Bank. Indeed, value The analysis points to clear public policy and market chains can be analyzed as reverse payment chains: while development implications for MENA countries. Trade goods and services flow downstream, conversely credit, credit insurance and trade finance require an payments flow upstream from buyers to sellers. At enabling environment - corporate governance, insolvency different stages of value chains, payment timing law, accounting systems, credit bureaus, etc. However, differences between purchases and sales create even in the most conducive environments, trade credit cashflow deficits, which need to be financed. Value chains and finance are susceptible to market failures, which calls are financed “internally” (organically) as well as for specific state intervention to facilitate, in particular, SME access to trade finance and credit. Policies Importantly, trade finance connects with the digitalization formulated by Moroccan authorities, as well as World agenda. Until now, trade finance has relied heavily on Bank technical assistance experience in Tunisia and manual, paper-based processes. Among banks, back- Jordan, broadly point to the need for a series of office processes need to become paperless. This will interventions that can be articulated around a four- facilitate the validation of documents and reduce pronged action plan: unnecessary delays. (i) Monitoring of trade credit and payment delays: giving policymakers the ability to understand the Among SMEs, the digitalization of accounts receivables scale of issue, to spot problems earlier, and more and payables enables several positive developments. accurately assess the impact of measures taken. These include (i) accelerating and facilitating KYC/AML procedures which until now have hindered SME access The monitoring would target government to trade finance from financial institutions, (ii) facilitating procurement, SOEs, SMEs and more broadly key the production of quick digital accounts which can help national value chains. lenders assess and monitor credit risk in real time, and (iii) credit scoring methodologies and other fintech (ii) Trade credit discipline: through regulation and solutions allowing small entrepreneurs to access new oversight, encourage larger enterprises to pay on financing products. time their SMEs suppliers. Finally, the potential for using e-commerce platforms to (iii) Trade credit insurance: deepen national credit facilitate access to trade credit and finance needs to be insurance markets (partly to cushion the impact further explored in the MENA region. Indeed, lessons can be drawn from the encouraging developments taking of the Covid-19 crisis) and incentivize the place in China and other parts of the world, where e- downscaling of access to trade credit insurance commerce giants such as Amazon and AliBaba play a by smaller firms; in small and nascent markets, growing role in SME lending. Other large players having pooled schemes could help state providers access to MSMEs transactions and supply chain data are access international reinsurance on better terms. entering the lending realm: logistics companies interested in financing their customers thereby fueling their own (iv) Trade and receivable finance: foster the use of business. The e-commerce revolution will widen and trade receivables as a borrowing base or deepen the financing of MSMEs and supply chains. collateral, thus expanding the availability of factoring services (through regulations, setting up To enhance the competitiveness of their value chains and registries of movable collateral, etc.) as well as allow SMEs to move a higher level of financial inclusion, MENA countries need better trade credit and finance. export finance including pre-shipment finance, to The World Bank is gearing up to more systematically complement general banking facilities help SMEs address this agenda through its lending operations, in export value chains raise financing for their incorporating the lessons it has learnt from its analytical production cycle and the procurement of inputs and technical activities. required for exports.