More bank competition in Gulf countries could be a boon for small businesses

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Against the backdrop of low oil and gas prices and fiscal consolidation, economic diversification and private sector development is a top policy priority for the countries of the Gulf Cooperation Council (GCC).

Supporting small- and medium-sized enterprises (SMEs) is central to this agenda.
Formal SMEs in GCC countries account for 25% of jobs  , which is significantly below the global average where SMEs account for 40% of employment.

Inadequate access to finance, especially bank lending, is constraining SMEs in GCC countries. Only 11% of SMEs have access to credit and some 40% of SMEs cite a lack of financial access as a major constraint.

Bank competition in the GCC is among the lowest in the world. Strict entry requirements, restrictions on bank activities, relatively weak credit information systems, and a lack of competition from foreign banks and nonbank financial institutions all contribute to weak competition in the banking sector.
By conducting fieldwork and reviewing available literature, we have analyzed what rules and regulations may be impeding bank competition in the GCC SME lending  markets as well as the institutional framework for competition policy underpinning those rules and regulations.

Here are our main findings:
  • State-owned banks play a significant role in SME lending markets and may have important advantages, including access to lower funding cost and a lower perceived level of risk among investors and depositors, which may negatively affect competition and reduce benefits for SMEs and their customers.
  • State-sponsored initiatives, such as subsidized loans and credit guarantee schemes, launched to improve SMEs’ access to finance may be distorting the level playing field in the banking industry and displacing private operators.
  • Current bank licensing criteria may potentially stifle competition, and prevent small-scale banks from entering the market. GCC rules and regulations outlining the licensing process aren’t always clear. Half of the GCC countries lack clear rules on approval times and the possibility of appealing a rejection. Some countries have residual restrictions on licenses and branches that limit banks’ entry and expansion. More generally, initial capital requirements in the GCC are much higher on average than in comparable countries.
  • Some GCC countries set interest rate ceilings on customer loans. While interest rate ceilings may be justified in the absence of competition, price restrictions suppress market signals and may lead to decreased quantity and quality of loans supplied to SMEs.
  • Credit information coverage varies across GCC countries, and some employ cut-off thresholds for loan reporting. Existing credit information sharing mechanisms provide both positive and negative information about SMEs, but their reliability and timeliness aren’t always assured.
  • Existing regulations constrain SMEs’ ability to switch banks to access other financing options. Early settlement fees and closing charges may discourage SME borrowers from closing existing lines of credit and moving to another bank. Deposit insurance schemes may positively affect bank switching by influencing customers’ perception about banks’ riskiness and compensating for reputation that larger and state-owned banks enjoy. While deposit insurance schemes are present in the GCC, their design and implementation vary across countries.
  • Competition law systems in the GCC may need strengthening. Although all but one of the GCC countries have adopted explicit rules to protect competition, public awareness of relevant legislation is limited. Criteria for distinguishing between anti-competitive conduct and legitimate behavior aren’t clearly delineated. The independence and authority of institutions overseeing competition may also need strengthening. Rules governing merger control aren’t always clear, and appropriate working relationships between competition authorities and central banks may need to be fostered.
Our study findings also point to the need for additional analytical work. We have identified eight broad policy areas for GCC policy makers to consider:
  1. Conduct a detailed assessment of the anticompetitive effects of public bank ownership.
  2. Explore measures to ensure that state-sponsored initiatives don’t distort competition in the banking sector
  3. Review the bank licensing process to make it clearer and more transparent
  4. Consider options to introduce a tiered approach to prudential regulation.
  5. Review regulations limiting banks’ strategic options such as interest rate caps and portfolio allocation requirements.
  6. Assess the credit information sharing system to strengthen the role of credit bureaus and credit registries
  7. Analyze options to increase customers’ mobility between banks.
  8. Assess the different components of the institutional setup for the enforcement of competition policy to improve its effectiveness.
Read  Competition in the GCC SME Lending Markets: An Initial Assessment for more information.  

Photo credit: IFC Photo Collection.


Pietro Calice

Senior Financial Sector Specialist

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