The problems of Small Businesses: A Case of Lebanon
In 1996, and during a regional conference held in Beirut, hosting a large number of financial experts and economists, an internationally recognized economist and visiting professor of economists in a number of reputable universities worldwide announced that one of the indicators used to measure the development and performance of an economy was the performance of small and medium-sized enterprises (SMEs). This international economist was once a Prime Minister in the late 1970s, in the late 1980s and in the early 1990s. Towards the end of 1998, he was once again assigned as Prime Minister of Lebanon amidst severe economic decline and after three years of recession. Premiere Hoss, and several months of assuming office, has not yet had the time to deal with the problem of financial sources available to SMEs in Lebanon, partly because of the economic burdens facing the cabinet, and more emphatically, due to the nature and structure of financial sources and institutions that make funds available to enterprises in Lebanon.
SMEs have always been the backbone of the Lebanese economy. During the 1960s and early 1970s, the entire economy was based on the operations and performance of SMEs, except for exceptional corporations that were publicly enlisted on the Bourse of Beirut. During the civil war that extended from 1975 through 1991, the Bourse of Beirut was shut down, and the economy, suffering as it was, depended entirely on the operations and performance of SMEs. Today, SMEs still constitute the majority of enterprises in Lebanon, especially that the Bourse of Beirut has not yet become satisfactorily active. Nonetheless, between 1996 and 1999, SMEs suffered heavily as a result of the continuos recession that by the testimony of economists and experts is about to turn into a depression. Austerity measures recommended by the IMF and imposed by the state have further worsened the situation. The problems of small businesses can be similar across nations as well.
The situation of SMEs in Lebanon can be best summarized by the words of a janitor of a commercial center. “A year ago, there were twenty-four enterprises occupying this building; today it is a ghost tower with only five operating.”
At the same time, the Ministry of Labor found itself involved in a large number of labor conflicts resulting from the laying off of several hundred employees affiliated with a number of SMEs, including two small banks. The layoffs did not result from the SMEs going bankrupt. Rather, these SMEs were either purchased by holding companies, or were simply merged with other SMEs to cut costs down and make up for the severe lack of financial sources.
The laying off of employees and the disappearance of SMEs (through bankruptcy, termination of operations, mergers or buyouts) are both serious indicators that have to be taken into consideration when evaluating the causes of the problematic and unstable situation of SMEs in the Lebanese economy.
The current situation of SMEs in Lebanon is the product of various causes, the most important of which is the lack of funds and financial sources available for these enterprises. With more than seventy banks operating throughout the country and with the top twenty banks making profits sometimes reaching $70 million a year, the cause is obviously not in the lack of funds in the economy. The banking industry in Lebanon is one of the strongest in the Middle East, and now that the war is over, this industry is once again reviving the position of Lebanon as a financial safe haven for depositors, but not necessarily for investors.
One of the major causes for the strength of the banking industry in Lebanon is the strict and conservative banking management policies followed. Business, personal, industrial and agricultural loans are only granted under very tough conditions, tough to the extent that most SMEs are not able to fulfill them. In fact, bankers themselves complain that 80% of the loans are made to less than 5% of customers, very few of which are small businesses. As a matter of fact, financial trust and faith in SMEs and their ability to repay their loans has declined severely in the past few years, but his is not incidental or solely due to the economic decline. Interest rates, that is the cost of loans, has been tremendously high for SMEs to afford in the 1990s. At their lowest level, interest rates on business loans in Lebanese pounds range between 14% and 20%. The rate on US dollar loans is somewhere between 12% and 15%. Between 1996 and 1999, the officially declared growth rate in the economy was hardly 3% and skeptics argue it was far below 2%. The severe discrepancy between the economic growth rate and the interest rate on business loans clearly explains why SMEs are not theoretically able to pay back their loans or the interests on these loans.
The managers and owners of SMEs in Lebanon argue that they have been exposed to international competition too early. The state stopped subsidies and support to most industries, and at the same time, eliminated many of the customs to meet its obligations to international trade agreements. Lebanese SMEs were already exhausted from the war. They were suddenly made vulnerable to competitors who were far advanced financially and who also enjoyed a clear technological advantage. As a result, not did Lebanese SMEs have to suffer from financial limitations, but also from declining market shares and the loss of competitive advantage. The result of the decline further exacerbated the financial difficulties of the SMEs, especially as their declining performance made them less eligible than ever to qualify for receiving the very limited bank loans available.
The lending policies demands further elaboration at this point. Most Lebanese banks have the same policy with respect to lending, namely, demanding convincing guarantees that the loan would be repaid. It is noticeable that almost all business loans are made by the top twenty banks, all sharing similar strict policies with respect to lending to SMEs. In a typical case, the bank will not only require the accounting and financial statements of the SME for the past two years, but it will demand guarantees from the owners such as a mortgage, financial or other kinds of assets that may be useful. Interestingly, the smaller the business and its loan, the higher the risk calculated by the bank, and hence, the higher the interest rate to be paid. This is an ultimate disadvantage for SMEs, since it simply means that those who need small funds to generate small profits will be penalized by paying higher prices for these funds while at the same time the larger enterprises will access larger funds to generate more profits at less costs. This relationship is evidently impeding to the performance and growth of SMEs, since even if the SME gets a loan from the bank, it will have to pay a higher price for it than a larger firm would.
Another impediment to SMEs is that banks demand a full commercial registration of the firm with the commercial authorities. According to the commercial regulations in Lebanon, such a registration is only needed to give the owner of the business the right to vote in the elections of the Chamber of Commerce, not for any other reason. Registration fees vary, depending on the size of the business and other legal fees, but in general, the cost starts at £2,300 and above. In a country where the annual per capita is only £3,500 such a condition imposed by banks is similar to a penalty to SMEs.
Needless to mention, banks will almost always refrain from lending SMEs that have been in business for less than three years. This is despite the fact that it is these newly established SMEs that are in need of funds and loans than other enterprises.
One of the controversial and contradicting policies adopted by banks towards SMEs is that an enterprise will be eligible to receive a loan if it freezes in its account a sum equal to or at best 20% less than the loan demanded. Thus, an SME that demands a loan of £10,000 will have to deposit and freeze in its account between £8,000 and £10,000. Put in plain words, SMEs have to deposit their funds in the bank in order to get them back at an interest. Although this policy is often the source of ridicule and protestation by SME owners, it is strictly adhered to by the banks. Bankers argue that such a policy is only adopted with an SME for a period that ranges between one to two years during which the SME should prove its ability to generate a satisfactory level of revenues and profitability. Yet, such an achievement on the side of the SMEs is arguable, especially when considering the restrictions and limitations, not to mention the economic recession.
All these issues and various others related to the policy of the state will be discussed in this research, with a comparison and contrast to the policies adopted in the United Kingdom.
Bank-Related Limitations to SME Development
Any economy with a healthy banking structure and industry is more likely to be stable, and accordingly, its SMEs are more likely to benefit from the stability that the banking sector bestows upon the economy. The major source of benefits for SMEs in this case is the availability of capital and funding for projects undertaken by these enterprises.
A typical SME in Lebanon can be started with a capital ranging between £3,000 up to £1 million and more. While some of these businesses may be industrially oriented, the majority are service-oriented. Industrially oriented SMEs depend on funding from banks and other financial institutions in order to afford their capital investment, specifically in machinery, raw materials and others. Traditionally, industrial SMEs have enjoyed better relations with banks, resulting in more credit facilities, especially that their machinery and inventories were usually used for mortgaging purposes. Since the mid-1990s, however, this has not been the case, especially as a number of banks ended up with bad debts resulting from the bankruptcy or inadequate practices by SMEs.
As a result, banks eventually began to develop tough policies towards industrial SMEs that demand credit, requiring that more liquid guarantees be available to back up the loans. Yet, by resorting to more conservative policies towards industrial SMEs, banks have thus rendered a severe blow to a number of industries, especially poultry, dairy, florists, petrochemical fabrication businesses and many others.
On another level, service-oriented SMEs suffered even more, especially that most banks did not provide sufficient facilities to these SMEs from the beginning. To illustrate, while an industrial SME was granted loans even before it started, loans to service-oriented SMEs were usually restricted, usually for three years after starting up and proving profitability. Evidently, an SME that is capable of succeeding for three years and earning profits would no longer be in need for bank loans. At the same time, without adequate capital, a service-oriented SME (eg. tourist agencies, car rental agencies and others) could drag on for years without adequate financial performance, and eventually would either end up for sale or bankrupt, or at best, unable to meet the standards demanded by banks to receive a loan.
SMEs also face another procedural impediment to seek and obtain loans from banks, namely registration. Every SME in Lebanon (that is a proprietorship or a partnership) has to be registered at the Commercial Registrar if the owners of the SME wish to enjoy the facilities provided by the Chamber of Commerce or to participate in the Chamber elections. The law, however, does not demand such a registration, although it demands registering the initiation of the business at the municipality for taxing purposes. Banks, however, insist that every SME wishing to obtain a bank loan should be registered with the Commercial Registrar. Bankers often justify this condition on the basis that they need to make sure that all transactions related to the loan are legal. Registration fees could range widely, depending on the fees of the lawyer as well as the number of owners, thus, fluctuating between a low £2,500 and a high £5,000. In an economy where an average small business starts with £7,000 registration fees are not only a burden, but also an unjustified one.
Banks are even strict on offering cash, credit and debit card machines to their SME customers if these SMEs are not registered. Accordingly, many SMEs are not able to offer cashless transactions to their customers. In addition to this, even with a registration available, the rates at which these machines are offered vary considerably. For example, American Express usually demands about 4.5% of all transactions whereas Master Card demands a monthly fee that could run as high as £50 in addition to a percentage on every transaction which could run between 3% and 8% depending on the negotiations between the SME and the bank.
The general policy of banks in Lebanon today is to refrain from lending SMEs because SMEs are the sector suffering most in the economy. Accordingly, the risks are higher, and it is more likely that the banks would suffer as well. Furthermore, at best, the bank is capable of receiving higher returns and profits on investment if it lends the government through short term and long term Treasury Bills whose interest rates vary between 14% and 18%. Indeed, investment in Treasury Bills has been the major source of income for most banks in the past few years, and destructive as this is to the economy and to SMEs, the government has not shown any intention of limiting the involvement of banks in lending to the government because of the government’s need for domestic loans.
Banks have tried to support SMEs by making credit available to the customers of these SMEs. For example, it is now possible to purchase cars, household items, and other various goods and products on credit from SMEs, as a bank and an SME would enter a trade arrangement through which the SME will require from its customers certain guarantees (statement of employment, statement of income, endorsement of income for the bank, etc). This means that customers can purchase more of the products or services of SMEs even if they did not have the cash on hand. However, this policy has proven to be very risky, and even damaging for SMEs for several reasons.
First of all, in most arrangements, the SME has to wait for a period of one to four weeks before it is cashed the amount owed by the bank, and since many SMEs have to pay for their inventories in cash, this imposes liquidity limitations upon them. Secondly, in most deals, the SME has to lose a considerable percentage of its profit to the bank as an interest rate, not counting the interest rate that the SME’s customer would pay to the bank as well. As a result, even when sales at the SME increase, in reality, there is little benefit from this increase. Thirdly, although credit facilities are available to the SME’s customers, in reality, no income increase has been noted in several years on the economic level, and accordingly, the purchasing ability of these customers has not improved significantly. Accordingly, SMEs do not actually benefit from the arrangements that they make with their banks, and all in all, it is only the bank that benefits first and last from any arrangement with the SME, whereas the SME has to mobilize its efforts in order to cover its dues to the bank.
Failure to cash bank transfers on time is also another serious limitation imposed on SMEs in Lebanon by banks. This situation is specifically apparent when the SME is dealing with customers in other countries. Banks in Lebanon, specifically in Europe, cannot send money directly to banks in Lebanon. The majority of Lebanese banks have affiliations with banking institutions in New York, such as Chase and Citibank Corp. Once a transaction is made, the money has to be transferred to the US bank where it is deposited in the account of the Lebanese bank. From there, it is then transferred to Beirut. Such an operation takes up to four weeks, and mistakes and other inconveniences are not irregular. This problem is due to the slow reaction of local banks and the Central Bank to the changes in international business. Another reason is that on many occasions, the banks would delay the cashing of the transfer for several days or even a week in order to generate more interest income for themselves, thus inflicting more damage to the operations of the SME. In general, such a problem has been destructive to the international operations of SMEs.
What remains the most serious limitation to the funding of SMEs through Lebanese banks is the set of financial terms and conditions that are imposed prior to the approval of a business loan. First of all, any business willing to be granted a loan from a bank has to provide collateral. While in the past inventory was sufficient as collateral, the situation is no longer applicable today, especially with a weak liquidity in the economy. Real estate mortgage are effective either for the majority of banks will only grant 10% to 30% of the value of the mortgage to the business, and even then, the interest rate is quite high, reaching in usual cases an average of 15%. Almost all banks require an 80% to 100% collateral in cash. This means that if a business intends to borrow £15,000 from the bank, it has to deposit 80% to 100% of this amount in the bank’s accounts, and the business would not be allowed to withdraw any amount from this account. This condition obviously discourages businesses from borrowing from the bank, since it defies the purpose of lending in the first place. A business that owns the cash already will not borrow the same amount from a bank and further pay a higher interest rate than it would actually gain in interest income for keeping the deposit in the bank.
Bankers themselves are not responsible for this situation, as the Central Bank has been imposing severe limitations on lending to SMEs. The Central Bank’s policy is due to two causes. First of all, it wants to protect banks and stabilize the banking industry by eliminating the possibility of bank failures through bad loans. And secondly, the Central Bank wants to assure that banks will be lending the government rather than the community, since the government is in a real need for domestic loans.
The Decline of Community Investors and Lenders
Traditionally, owners of SMEs, especially smaller business enterprises in Lebanon did not usually resort to banks as a source of banking. Rather, they resort to their families, relatives, friends and interested investors. This huge informal network of fund providers have always provided SMEs with the necessary cash and funds needed to start, improve, and expand an SME.
Until the early 1990s, this informal network of investors was responsible for providing the funds needed to start up the ultimate majority of SMEs. Today, these investors are no longer available due to four major reasons.
First of all, the collapse of the real-estate sector in the past four years has consumed most of the funds available in the hands of these investors, while at the same time, warning many others against investing in SMEs in Lebanon. This problem further exacerbated as Lebanese expatriates working the Gulf and other countries, traditionally constituting most of these investors, reduced or stopped their cash flows into the Lebanese economy. This factor alone was responsible for a severe reduction in the movement and availability of funds in the economic sectors, not to mention the fact that it also led to money hoarding as the political situation fluctuated in 1996 and again in 1999.
Secondly, the ongoing economic recession since 1996 has made many investors uncertain about the value of their investments in Lebanon. Accordingly, many of them have transferred their funds outside the economy, or simply preferred to lend the government instead. Lending the government through Treasury Bills is not only safe and secure, but also profitable, and as a matter of fact, much more profitable than lending SMEs. In 1996, for example, lending the government through Treasury Bills yielded between 25% and 30% annually whereas lending SMEs hardly generated 20%. Today, yields from SMEs have further dropped, and even though Treasury Bills interest rates have also dropped significantly, most investors are willing to lend the government rather than take a higher risk and lend SMEs. Accordingly, the majority of SMEs in the Lebanese economy today are either under-financed or inadequately financed.
A third important reason that discourages community investors from investing in SMEs today is the lack of the legal settings that protect their investments against fraud. Commercial laws in Lebanon have not been updated in many years. An investment who enjoys the status of partner is less likely to end up as a victim of fraud, but an investor who merely invests his money cannot secure his rights even if all documents are formulated and signed through a lawyer. The reason is that commercial laws in Lebanon, especially those governing SMEs have not been updated, nor have they paid any special attention to interests of investors who only invest capital with SMEs. In the past, this did not constitute a serious problem, especially that among community investors and SMEs dealings were based on traditions such as honor and personal commitment. Yet, following the socio-economic upheaval in the 1990s, the collapse of commercial ethics and standards, and more seriously, the failure of a large number of SMEs, many investors have refrained from investing in these enterprises. To strike an example, if a community investor invests £10,000 in a business, but documents them as a loan, the loan is immediately treated as a commercial loan if the intention was to generate profits for the investor. Commercial loans, unlike noncommercial loans, are dealt with softly by the law in a way that hardly protects the interests of the investor. For example, in such a case, if the small enterprise fails, the owner of the enterprise can repay the investor by installments for a period that might extend for several years.
The fourth reason that has contributed to the decline of community investors is the availability of other opportunities of investment for them, other than SMEs. In the past, a community investor would scan the market in search for an adequate SME that would generate profits for him. Today, this is no longer the case. Many community investors are now either starting their own businesses, or simply investing in other areas such as stocks. The opening of the Bourse of Beirut was an opportunity for many of these investors to experience profitability through direct management of their funds. However, three years later, the losses in the Bourse of Beirut have shunned many of these investors away, and most of them have either turned to lending the government or are simply investing in international money markets. All these developments came at the expense of SMEs which now have to put a double effort in order to identify new sources of funds for their operations and expansion.
Exchange and transfer desks that are specialized in currency exchange played a significant role in financing SMEs during the early 1990s. The availability of high liquidity in the hands of these small but highly liquid institutions enabled them to play the role of investors. They demanded higher interest rates, usually at 25% per year, and at the same time, their lending terms and conditions were relatively friendly when compared to those of banks. However, as the currency speculation market died in 1994, and as a number of these lending enterprises lost heavy amounts of cash, especially after speculating in the Euro market early in 1999, they no longer play any significant role in lending SMEs in Lebanon. Furthermore, the tight money market that has been dominating the Lebanese economy for the past five years has forced many of these lending and exchange enterprises out of business, not to mention the fact that the tough regulation by the Central Bank has deprived them of much of their liquidity.
Lack of Proper Accounting & Taxing Laws
The Lebanese laws related to trading and commerce, especially among SMEs is based on the laws that were applied in France during the 1940s. On several occasions, these laws have been updated and upgraded. However, until now, SMEs suffer a lot because of the inadequacy of the accounting and taxing laws.
To illustrate, a proprietorship for example, is not demanded to keep proper accounts, but it is never actually taxed according to these accounts. In practice, the tax officer would simply take a look at the enterprise, estimate its annual income and then scribble down a figure that has to be paid by the owner. The owner of the enterprise would be lucky if the inspector arrives on a poor business day because in that case, the enterprise would be under-taxed. In reality, however, the majority of proprietorship owners simply bribe the tax inspectors and clerks and rarely pay any taxes at all. In fact, they even rarely keep any books at all. As a result, accounting procedures at small businesses have been very sloppy and inadequate, and this alone has been a major reason why many investors and banks shun away from lending proprietorships or funding them on any basis. There are simply no legal or procedural forms that can protect investors or lenders, and accordingly, with the economy in recession, these prefer to refrain from funding or lending any proprietorships, unless the proprietorship has been in business for many years, and enjoys a very strong name in the market. Yet, in such a case, the proprietorship does not need to borrow from banks, but rather, can expand its operations depending on its own goodwill and reputation.
For partnerships, however, and these constitute almost all medium-size businesses, taxing is based on the accounting books kept by the enterprise. Accounting procedures and laws are very clear and have to be presented to the Ministry of Finance on a regular annual basis for taxation. All these enterprises are required to have their books maintained, updated, and presented to the tax department through certified accountants. The problem, however, is that the accounting procedures themselves are very flawed, containing numerous loopholes through which the accountant manipulates the books. Accordingly, and by tradition, each partnership has two parallel procedures of book keeping, one for the tax department, and the other for the management. This does not only reflect poorly on the integrity of the enterprise, but it also gives the managing director of the enterprise, usually a partner, an upper hand with respect to other partners in the enterprise. So many complicated legal cases have emerged in the past few years as a result of this malpractice. The law has not been able to curb these problems, and accordingly, less and less investors are encouraged to invest as partners in small and medium size partnerships.
The reflections on the banking sector are even more severe. Bankers are more willing to lend to a large proprietorship rather than to a small partnership, unless the partnership enjoys a clean name in the markets. This is particularly that much of the banker’s decision to lend or not to lend the enterprise depends on the books and the financial results of the enterprise.
Furthermore, the majority of banks demand that any proprietorship or partnership applying for a bank loan, should provide detailed and audited financial statements for the past three years. Providing such audited statements, however, can be costly, especially that auditing expenses are relatively very high in Lebanon. Many SMEs are simply discouraged from seeking a bank loan on this basis because the provision of financial audited statements does not under any condition secure getting the loan by the enterprise.
Lack of Finances for New Emerging SMEs
Following the Internet boom in the mid-1990s, a number of Lebanese small and middle size enterprises started online businesses in 1995 and 1996. Today, hundreds of Lebanese enterprises use the Internet for commercial purposes. However, serious procedural restrictions still prevent these enterprises from making any significant profits or money from going online.
The single most impeding problem is that Lebanese enterprises are still unable to cash their customers online. A law firm, for example that is established online, is not able to charge the credit card of its customers simply because the credit card companies established in Lebanon have not provided such a facility yet (American Express, Visa and Mastercard). The Ministry of Finance has allowed these companies to provide such services to the commercial community, but so far, almost no enterprises have benefited from such a provision for three major reasons.
First of all, the procedure is very costly. While American Express requires only a 4.5% commission on any transaction that takes place online, Visa and Mastercard have not yet finalized their offer to the SME community. Yet, in most cases, a £730 is demanded by every SME as a starting expense, in addition to 8% on every transaction and a £50 monthly fee. These terms are very discouraging and so far no SME has ventured to get involved. Negotiations between banks and the commercial community, however, promise to lead to some compromise, particularly after American Express announced a soon-to-come competitive package. Banking analysts believe that before the beginning of 2000 Lebanese SMEs online will be able to charge their customer at a cost of 3% to 4.5% as a commission on every transaction.
However, even in that case, the credit card companies believe that these SMEs will still face a serious problem, namely that any transaction completed online can be challenged by the card holder within 180 days after the transaction was completed. Only transactions under £35 will be spared such a term. In other words, Lebanese SMEs that operate online enjoy almost no protection under the law from fraud or from mishandling by customers. This problem could eventually be resolved in the future, but currently, very few if any SMEs at all are willing to take such risks and make use of the vast opportunities available for them on the Internet.
Evidently, Lebanese SMEs are in a very critical situation today. The number of SMEs that have closed down in the past two years is very high. Official records do not reveal such figures because most businesses that went out of business have not yet registered their termination for the simple reason that the termination of a business requires a heavy registration fee. Ironically, even the closing of an almost bankrupt business requires the availability of cash and liquidity. Most owners of closed SMEs prefer to remain in the market for a year or two, even with their establishments closed, because in this case they can enjoy cuts on taxes rather than having to pay a heavy termination fee which is arbitrarily set at the Ministry of Finance. The Ministry of Finance, on the other hand has been lax with such behaviors because of the tight economic situation and the need to update laws.
Furthermore, many owners of SMEs that have been shut down will not be able to terminate their enterprises before a settlement is made with the Ministry of Finance over previous taxes and over previous municipality fees. Due to the destruction of infrastructure and the failure to update the Ministry of Finance rapidly, collection of taxes and municipality fees has not taken place in years, and accordingly, businesses now find themselves forced to settle with the Ministry of Finance before they shut down. This, many owners of shut down SMEs will be leading to numerous legal problems in the coming years, thus further discouraging SMEs from playing a significant role in the economy.
The situation of SMEs in the Lebanese economy today is very seriously handicapped. The availability of funding is extremely scarce, and even with such scarcity, terms, conditions, and laws discourage the possibility of SMEs getting the finances they need in order to start up or improve their businesses.
The financial difficulties that SMEs have been suffering in the 1990s have seriously reflected on their operations. In every commercial sector, SMEs have been disappearing. In very few cases, they have been purchased by or merged with larger enterprises, but in the majority of cases, they have been forced to shut down and simply leave the economy without any further contribution.
Needless to mention, the closing down of hundreds of SMEs every year has not only resulted in complicating economic problems in general, but they have also contributed to a significant loss of income for many individuals and families, and at the same time, contributed to the ever increasing unemployment rate which is now estimated at a high 20 to 25%.
The situation and operation of SMEs in Lebanon cannot be improved or expected to develop without serious reformation of the economy, procedures, laws and lending terms. Neither can SMEs be expected to survive without developing new and innovative banking policies and procedures that will enable SMEs to have access to the funds that they need to improve their businesses. In other words, a full reform policy is required for the improvement of SMEs in Lebanon.
THE REFORM PLAN
Reforming Tax Laws
Reforming tax laws is perhaps perceived as an indirect contribution to the improvement of SMEs in Lebanon. However, the impact of such a reform cannot be overlooked. To start with, tax laws and tax collection should be highly regulated and clear so that SMEs will not resort to unethical and illegal means in order to evade taxes. Needless to mention, the evasion of taxes does not only affect the economy, but it also results in a severe reactions by the Ministry of Finances which inevitably have negative impacts on SMEs in general.
Reforming tax laws means that taxation will be based on the disclosure of sound and audited financial statements to the Ministry of Finance. Once tax laws are applied properly and SMEs show an adherence to these laws, they eventually become forced to have their financial statements in order, a prerequisite for any sound financial deal that involves financing or lending.
Furthermore, reforming tax laws will protect SMEs from violations by tax collectors who usually apply tax rates arbitrarily depending on highly subjective and personal observations. However, such a reform will also require that the Ministry of Finance combat corruption within its own ranks, not to mention the computerization of all its taxation-related procedures.
Reforming Accounting Procedures
Even if tax laws and procedures are reformed, the major challenge is to reform accounting procedures. So far, Lebanese accounting procedures are in many ways considered to be progressive, but the problem is in application. The Ministry of Finance should require that every SME provide its financial statements through an auditor and a certified public accountant. Auditors and CPAs who violate the procedures, usually for the benefit of the SME owner or owners should have their licenses cancelled, and this should on the long run force these auditors and CPAs to conform to the laws and regulations of the Ministry of Finance.
The overall objective of forcing SMEs to adhere to clear and fair accounting regulations and procedures is to achieve and attain accounting and financial transparency of SMEs, especially that such transparency is an indispensable prerequisite for sound financing. Banks and other financial institutions and investors would in such cases be more encouraged to finance and lend SMEs with less risks and degrees of uncertainty. In fact, bankers and SME owners alike admit today that the lack of transparency of SMEs remains the single most important psychological impediment to the granting of loans and funds to SMEs.
Many SMEs will definitely suffer in the short term, mainly by having to pay realistic taxes, but on the long run, the results will be favorable as the availability of funds and loans from banks and other investors will enable SMEs to improve and expand their business undertakings, hence resulting in more profitability.
Registration of SMEs in the Commercial Registrar is not legally obligatory, but banks still demand that such registration be made. Registration in the Commercial Registrar is favorable for SMEs and the economy as a whole for many reasons. First of all, it facilitates the collection of taxes by the Ministry of Finance. Secondly, it gives SMEs access to commercial and trade information that would otherwise not be available to them. Thirdly, it enables SMEs to make use of and benefit from the contacts of the Chamber of Commerce, be these benefits represented in the form of conferences, new applications, or trade contacts, etc. Fourthly, when all SMEs register at the Commercial Registrar, such a registration will give the Ministry of Finance and the Chamber of Commerce better opportunities to regulate the commercial markets and establishments, and hence, making proper and reliable statistics available for investors and banks. This would definitely give banks better opportunities to be able to compare the performance of SMEs in their relative sectors and markets. At the same time, it would enable banks to have a better and a more realistic perception of the SME as a whole and of its opportunities in the market, with a clear evaluation of competition and its impact on the SME that is applying for loans.
Nonetheless, registration fees at the Commercial Registrar should be fundamentally revised. The aim of such a revision or reform is to assure that SMEs will be paying their registration fees based on clear-cut criteria. These criteria could be the size of capital, the commercial or industrial sector in which the SME operates, the number of employees, and various others. Furthermore, SMEs could be granted a grace period before they complete their registration fees, and in fact, making it possible for SMEs to pay these fees on installments or through credit facilities would encourage SMEs to voluntarily register at the Commercial Registrar and to pay their dues.
Lowering Interest Rates
High interest rates still constitute a major problem for investment in Lebanon. Instead of investing in any business and bearing additional risks that can be made up for by a higher return on investment, the majority of investors prefer to lend the government directly, thus enjoying both security (certain repayment) and a relatively very high interest income (15% in contrast to 6% in most other countries or banks).
At best, an SME can provide a return on investment of 20%. An average investor is willing to sacrifice the additional 5% that the SME promises because the risk that the investor takes with the SME is at least 10%. Meanwhile, the Central Bank has maintained a high rate of interests for a good reason.
The Central Bank wants to maintain a tight monetary policy that will protect the Lebanese pound from deteriorating. In the early 1990s, the Lebanese pound fluctuated very heavily, sometimes losing 80% of its value in one week. Since 1994, the Lebanese pound has been stable, at an established rate of 1,500 pound for ever US dollar. The Central Bank believes that high interest rates are still needed to discourage any speculation against the Lebanese pound. In fact, the Central Bank has been able over the past five years to reduce the interest rates from a high 32% on short term Treasury Bills down to 14% in the summer of 1999. Cuts in interest rates are still expected, but they will remain slow in order to avoid any undesired shocks in the economy. Meanwhile, SMEs will still have to suffer. However, the Central Bank has also eliminated a number of very short-term Treasury Bills (eg. the 90-day Bills) in order to set the bulk of the domestic debt on the long term. This could benefit SMEs since short term and immediate interest gains from lending the government will no longer be available.
However, it is obvious that the only way banks, financial institutions and investors will start lending SMEs on a significant level is through further cutting interest rates to the 8% level. Only in such a case will these investors find that investment with SMEs through direct investment or through lending will be profitable, even though such investment will remain might remain relatively risky.
Needless to mention, cutting down the interest rates will also make liquidity available in the market, and this alone will be a serious and strong motive for investment in MSEs as well as in newly emerging SMEs, eventually leading to a stronger and a healthier economic growth.
Bankers and financial analysts believe that major cuts in interest rates will not be significantly felt before a period of three or four years, a period during which the Five-year Economic Reform Plan set by the government in 1999 will have achieved most of its goals, one of which is the revival of the sectors in which SMEs operate. However, financial analysts are still skeptical about the plan and about the possibility of cutting down interest rates in significant levels without suffering a backlash on the exchange rate of the Lebanese pound.
Reforming Commercial Banking
Requiring banks to lend SMEs without collateral or at least transparent financial information is nothing but an act of folly that would put banks in a precarious situation, the last thing that the State or bankers want.
However, with the reformation of tax and accounting procedures, the availability of sound and audited financial statements and transparency, lending SMEs should no longer remain a major risk.
In fact, the Commercial Registrar can impose special subscriptions on SMEs such that a special fund will be established. The goal of this fund can be to help troubled SMEs repay the debts that they owe to banks. In this case, banks will be under less uncertainty when lending SMEs, given however that clear conditions are met before lending.
Furthermore, the Commercial Registrar, in collaboration with the Ministry of Finance and the Banking Association, can establish an insurance company whose sole duty is to insure all SME commercial loans. The Chamber of Commerce and SMEs can both contribute to the establishment and management of this insurance company so that bankers will be encouraged to lend SMEs and at the same time have their rights preserved and protected. Although such a step will be revolutionary by Lebanese standards, such insurance companies and provisions are available in many countries worldwide.
However, another more important aspect that relates to the reforming of bank lending operations is the establishment of clear-cut measures by banks, and this should be sponsored and closely monitored by the Central Bank. In reality, many banks do offer commercial loans, even to shaky SMEs. This, however, happens when the SMEs is backed by a political institution or figure, and accordingly, the SME obtains the loan merely on political rather than financial or managerial bases. It is such practices that had in the past led to the collapse of a number of banks, and even though this practice is very limited today, it still constitutes a major discriminatory practice against SMEs. Commercial banks should have their criteria for offering loans made very clear. If an SME qualifies for a loan, the only lack of funds at the bank should prevent the SME from getting the loan it deserves.
Furthermore, the Central Bank should start discouraging banks from investing in Treasury Bills, especially that this has had a destructive impact on the economy. A clear and low ceiling should be set such that most of the funds and financial resources available to commercial banks should be used in the original purpose that they are made for, namely lending SMEs and larger businesses. Lending the government, on the other hand, has only deprived the majority of SMEs of any chances to start up or expand their operations.
All these reforms are in the end intended at making more funds available at commercial banks for lending to SMEs, while at the same time, protecting the loans against the risk of default. Eventually, banks will be requiring less strict collateral to protect these loans, and thus, will be more encouraged to provide SMEs with the loans they demand, so long as these loans are justified and backed up with the necessary documentation and analysis.
Commercial banks should also start establishing credit analysis departments. Such departments are already available but in most cases, they are only responsible for rejecting loan applications. The reason is that most applications are not supported with transparent financial documents, which definitely leads to a negative response by the banks. With the availability of proper documenting procedures, sound financial statements and policies, these departments can carry out their duties, and as a result, a significant increase in the lending rates to SMEs will be witnessed.
Apart from this, and since commercial banks are directly involved in credit card servicing in Lebanon, reforms should also be made in this domain. This will inevitably affect companies that operate their businesses online. Experiences in this respect should be adopted from Europe and the United States in order to make credit card more effective, especially in its contribution to the growth of SMEs in Lebanon. Hence, regulations, laws and conditions should be in conformity with those that are established worldwide to protect both cardholders and SMEs.
Updating Commercial Laws
Commercial laws in Lebanon are classified as civil regulations rather than as criminal regulations. Civil laws have not been updated for many years, and as a result, a regular lawsuit could take years before it is resolved. This is one reason why banks try to refrain from lending SMEs that do not have strong guarantees. Another reason is that lawsuits can be very expensive, and often unproductive. To avoid all these risks, banks simply avoid lending SMEs unless liquid cash collateral is available.
One important way of changing the status quo is by updating commercial laws, making them more effective and productive. Accordingly, banks that lend SMEs should have at least the ability to seek effective and efficient redress in commercial courts, rather than simply suffer losses that they cannot compensate.
Updating commercial laws, however, requires a very comprehensive plan and a long legislative procedure. To resolve this problem, however, the banking association, together with the Chamber of Commerce can initiate a special independent commission that will establish a new set of laws agreed upon by the various sides involved. The government and the legislature can also be represented in the commission. Once the works of this commission are done, they can be submitted to the ministries of Finance, Economy and Justice to prepare a bill project. The bill project can then be discussed, modified and ratified in parliament. Choosing this path would take only a year or two rather than five or six years as it would actually consume under the current conditions.
Planning & Organization
The final step towards reforming the SME sector in Lebanon should be in planning. The Ministry of Planning was established in 1960, but today, it no longer exists. This Ministry or any alternative department that carries out planning functions should be deeply involved in reforming the status of SMEs.
Today, there are no rules or regulations that govern the operations of SMEs. For example, any number of small businesses offering the same services can open up in any area, thus competing against each other and destroying each other’s business. Planning and organizing SMEs should be the core responsibility of a planning department or ministry, not only to protect the SMEs against unfair competition, but also to make sure that these SMEs will survive and grow, otherwise their decline and collapse will only reflect negatively on the economy as it is doing today.
Finally, the Department of Consumer Protection should be vitalized in order to establish effective monitoring of SME operations in order to protect the interests of the consumer. Today, the lack of such regulations makes SMEs operate in manners that are not only unethical but also illegal. Lack of monitoring does not only harm the consumer, but also SMEs especially as many of them are looked at as operating against the interest of the community. With the availability of proper monitoring, competition is revived and at the same time, consumption will grow, thus reflecting positively on SMEs in terms of growing sales and profits.