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United Arab Emirates: Selected Issues

Author(s):
International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
August 2015
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SME Access to Finance in the UAE1

A. Introduction

1. Access to finance ranks as a major constraint for the growth of small and medium enterprises (SMEs) in the United Arab Emirates (UAE). According to Khalifa Fund (2013), about 70 percent of formal SMEs have their credit applications rejected by banks.2 In addition, the Dubai SME Agency has identified that 80 percent of start-ups—and 77 percent of SMEs—do not have access to credit. This lack of access is even lower than many countries in the Middle East and North Africa (MENA) and other regions (Figure 1). Although bank lending is its main source of funding, the SME loan portfolio consists of only 4 percent of total loans. The constraints are primarily related to cost of finance, lack of long-term finance products, high reliance on real estate collateral, and limited availability of other types of collateral. Leasing, factoring, and other credit products are also underdeveloped.

Figure 1.SME Access to Finance

Sources: ADB; EIB; IFC; IMF; OECD; World Bank; and IMF staff calculations.

Note: AE = Advanced Economies; CCA = Caucasus and Central Asia; CEE = Central and Eastern Europe; LAC = Latin America and the Caribbean; MENA = Middle East and North Africa; SSA = Sub-Saharan Africa.

2. Expanding SME access to finance is crucial for economic growth and inclusion. Several indicators show that SMEs contribute to a large share of employment and social welfare in developing and emerging economies. In particular, SMEs contribute up to 86 percent of total employment and up to 60 percent of the non-hydrocarbon GDP in the UAE. The number of micro, and SMEs is estimated at about 300,000, representing 92 percent of all establishments in the Emirates. However, SMEs are unevenly distributed across the UAE, with most located either in Dubai (about 45 percent of total SMEs) or Abu Dhabi (about 32 percent). In addition, 73 percent of SMEs are in the trade and retail sectors.

B. Rationale for public intervention

3. Public sector support for SME finance could be justified when there is a market failure. Public intervention could mitigate against the overall risk due to asymmetric information between lenders and borrowers. Higher lending costs are caused by the lack of effective financial market infrastructures such as accounting and auditing standards, credit bureau, credit registry, and secured transactions on immovable and movable property and solvency regimes. These facilities allow lenders to mitigate against risks and reduce lending costs, thereby benefiting borrowers. Public intervention may play an important role to support SME financing while the development of such infrastructure is under way.

Figure 2.Firms Identifying Access to Finance as a Major Constraint

(Percent)

Sources: ADB; EIB; IFC; IMF; OECD; World Bank; and IMF staff calculations.

Note: AE = Advanced Economies; CCA = Caucasus and Central Asia; CEE = Central and Eastern Europe; LAC = Latin America and the Caribbean; MENA = Middle East and North Africa; SSA = Sub-Saharan Africa.

4. Public sector intervention could also be motivated by the lack of both collateral and sufficiently rigorous business records of borrowers. Lenders may be reluctant to grant loans to SMEs because of the lack of adequate collateral and financial statements, exacerbating the asymmetry of information—especially given the large percentage of expatriates in the population co-owning SMEs—and making lending to SMEs a risky and costly business. In addition, given the higher risk associated with SMEs, banks are required to hold higher capital accordingly. As result, lending rates charged to SMEs are higher than to established entities.

5. The institutional framework for SMEs is still under development. A new SME law has been approved that requires a uniform definition of SMEs across the Emirates, a minimum purchase of goods and services from SMEs in public tenders at the federal level, and grants other benefits. However, there is still no agreed definition of SMEs as the by-laws have still not been approved. The Abu Dhabi and the Dubai governments use different thresholds to define micro, small, and medium enterprises based not only on the number of employees but also on economic sector and turnover (Table 1).

Table 1.UAE: SME Definitions
EmployeesTurnover in AED Million
MicroSmallMediumMicroSmallMedium
Abu Dhabi<5>5 and ≤19>20 and ≤49
Dubai
Trading≤9>9 and ≤35>35 and ≤75≤9>9 and ≤50>50 and ≤250
Manufacturing≤20>20 and ≤100>100 and ≤250≤10>10 and ≤100>100 and ≤250
Services>3 and ≤25>25 and ≤150
UAE Banks Federation≤50>50 and ≤250

C. What Loans are offered to SMEs

6. The banking sector remains the main source of formal finance for the SME sector but the level of lending remains very low. More than 40 out of 52 banks provide credit facilities to SMEs. Products are customized to SMEs with credit facilities ranging from loans for working capital and investment, to receivables, asset-backed and real estate loans, and overdraft facilities, and vary according to the business purpose, collateral, term, amount, and other characteristics (Table 2). Even though there is a large number of products offered by banks, a large percentage of SMEs identify access to finance as the major constraint for business growth.

Table 2.UAE: SME Loans Offered by Banks
NBADENDBABCDMashreq
Working capitalYes
SME definitionAnnual turnover of AED 50 million AED 150 millionAnnual turnover up to AED 100 millionMinimum annual tunrover of AED 1.5 million
AmountUp to AED 3 millionUp to AED 30 millionUp to AED 2 million
TenorUp to 48 monthsUp to 48 monthsUp to 48 months
CollateralFreeFreeFlexbileFree
Trade financingYesYesNA
AmountUp to Dhs5 million
TenorUp to 48 months
CollateralFree
Asset-backedYesYesNA
AmountUp to Dhs30 million
TenorUp to 48 months
Commercial real estateFlexibleYesYesNA
AmountAED 100,000 to AED 1.5 million
TenorUpt to 48 months
OverdraftFlexibleYesYesNA
Term loansFlexibleYesYesNA
Source: Company web pages.
Source: Company web pages.

D. Barriers to SME Development

7. There are many reasons why banks are hesitant to lend to SMEs. Banks’ preference for name-lending, SMEs’ financial literacy, and less developed infrastructure—including the credit registry, collateral enforcement, (movable) collateral registry, bankruptcy regime—can be listed as the main factors. As in other countries, SMEs’ limited access to finance in the UAE reflects the interaction of demand, supply, institutional, regulatory, and other impediments.

8. Several constraints have been indentified for SMEs access to credit and the respective policy actions needed to mitigate them:3

  • Insufficient financial information on SMEs. The lack of financial information on SMEs exacerbates the problems arising from asymmetry of information, especially the adverse selection problem. As there is no corporation tax, SMEs are not required to keep adequate accounting records, implying a lack of financial information for credit assessment. In addition, the lack of effective credit registry and credit bureau coverage has contributed to unreliable credit histories for SMEs (Table 3). As a result, bank loans to SMEs are usually granted based on payrolls, which are not always accurate. Federal initiatives to address insufficient financial information include establishing a credit bureau and an SME rating agency to improve SME transparency. The central bank, with the support of the bank federation, has established a credit bureau containing positive and negative credit information. The Dubai government has also encouraged SMEs to use SME Financial Reporting Requirements.
  • Limited funding sources. Alternative funding sources available to SMEs are limited in the UAE. Lending to SMEs is costly and risky, requiring more bank capital to cover high unexpected losses than under other business lines, and limiting the supply of bank credit to SMEs. In addition, nonbank financial institutions—such as microfinance institutions, leasing companies, private equity, or venture capital firms—are underdeveloped. As alternative sources of funding, there are 26 finance companies and 25 financial investment companies licensed by the central bank. Their share is less than 1 percent of the total financial system and their activities are mainly concentrated toward leasing and equity trading. In addition, the recently established secondary market for trading in shares of private joint-stock companies—an initiative under the Securities and Commodities Commission—could provide a new funding source for SMEs and a way-out to venture capital and other investors. The lack of alternative funding sources and the high interest rates and fees charged by banks result in SMEs relying on their own funds for working capital and investment.
  • Weak legal framework. Given the nature of their operations, SMEs lack adequate collateral and cannot restructure delinquent loans under the umbrella of a bankruptcy regime. Some important legal impediments preventing greater levels of collateral include: (i) the requirement that pledged assets be under the control of a lender, discouraging the pledge of movable assets needed for business operations—market practice in Dubai allows for possessory pledge with a delivery of title to the pledged assets and affixation of plates; (ii) the ineligibility of sole establishments or civil partnership companies with no commercial register to take commercial mortgages; (iii) the inability of limited liability companies to pledge quotas in their capital; (iv) the lack of a central security register to ensure pledged assets do not have a lien; and (v) the absence of a trustee law.4 A weak bankruptcy regime implies that bankruptcies in the UAE are expensive (20 percent of the estate) and have a low recovery rate (28 cents on the dollar) (Table 4). To reduce the high cost of bankruptcy and the low associated recovery, a new bankruptcy framework is currently under discussion.
  • Lack of a supportive regulatory framework. The central bank regulations do not have a standard definition of SMEs for reporting purposes. The new SME law is currently awaiting the agreement of a definition at the federal level to enact its regulations. The lack of a regulatory guidance for loan guarantee schemes does not allow banks to benefit from the associated capital relief either. According to regulatory restrictions, only SMEs that are 100 percent owned by nationals have access to public funds and guarantees.
  • Financial literacy. SMEs have a weak understanding of the requirements in a loan application. Capacity building is needed to make SMEs bankable. Initiatives to mitigate against lack of financial literacy include designing training programs with banks and universities and other official programs. SME compliance costs with bank requirements have also increased as a result of anti-money laundering and financing of terrorism legislation at the domestic and international levels.
Table 3.Getting Credit in Different Jurisdictions, 2014
RegionStrength of legal rights index (0–12)Credit registry coverage (% of adults)Credit bureau coverage (% of adults)
East Asia & Pacific6.211.020.4
Europe & Central Asia6.019.333.7
Latin America & Caribbean4.812.639.3
OECD high income5.812.167.0
South Asia5.03.211.3
Sub-Saharan Africa4.74.55.8
Middle East & North Africa1.38.711.6
Bahrain1.00.048.3
Kuwait2.00.032.0
Oman1.020.60.0
Qatar1.023.30.0
Saudi Arabia2.00.047.0
United Arab Emirates2.06.828.3
Source: World Bank Doing Business.
Source: World Bank Doing Business.
Table 4.Resolving Bankruptcy in Different Jurisdictions, 2014
RegionTime (years)Cost (% of estate)Recovery rate (cents on the dollar)Management of debtor’s assets index (0–6) 1/Reorganization proceedings index (0–3) 2/Strength of insolvency framework index (0–16) 3/
East Asia & Pacific2.621.836.83.20.98.1
Europe & Central Asia2.313.337.73.71.49.2
Latin America & Caribbean2.916.436.03.00.58.2
OECD high income1.78.871.95.41.812.2
South Asia2.610.136.22.00.25.6
Sub-Saharan Africa3.123.324.14.00.47.9
Middle East & North Africa3.113.934.03.10.16.6
Bahrain2.59.541.64.00.07.0
Kuwait4.210.032.13.00.06.0
Oman4.03.537.73.00.06.0
Qatar2.822.056.06.00.09.0
Saudi Arabia2.822.028.70.00.02.0
United Arab Emirates3.220.028.64.00.09.0
Source: World Bank Doing Business.

Ranges from 0 to 6, with higher values indicating more advantageous treatment of the debtor’s assets.

Ranges from 0 to 3, with higher values indicating greater compliance with internationally accepted practices.

Ranges from 0 to 4, with higher values indicating greater participation and rights of creditors.

Source: World Bank Doing Business.

Ranges from 0 to 6, with higher values indicating more advantageous treatment of the debtor’s assets.

Ranges from 0 to 3, with higher values indicating greater compliance with internationally accepted practices.

Ranges from 0 to 4, with higher values indicating greater participation and rights of creditors.

9. Authorities have also strived to reduce high transaction and setup costs, which will help SME bankability. According to the World Bank Doing Business Report, the cost of doing business in the UAE is high. For instance, the cost of starting a business is about 6 percent of the per-capita income, which is higher than in other GCC and high income OECD countries (Table 5). High transaction and setup costs are the result of high fees at different government agencies. The federal and local governments have been active in reducing the transaction and setup costs. Initiatives include: (i) the new company law, which has exempted minimum capital requirements for company establishment; (ii) the new SME law, which has reduced fees at a federal level and has triggered similar reduction by the Emirates; and (iii) a new forthcoming bankruptcy law, which will reduce the costs involved in closing companies.

Table 5.Starting a Business in Different Jurisdictions, 2014
RegionProcedures (number)Time (days)Cost (% of income per capita)Paid-in min. capital (% of income per capita)
East Asia & Pacific7.334.427.7256.4
Europe & Central Asia5.012.15.35.8
Latin America & Caribbean8.330.131.13.2
OECD high income4.89.23.48.8
South Asia7.916.014.614.2
Sub-Saharan Africa7.827.356.295.6
Middle East & North Africa8.018.928.145.6
Bahrain7.09.00.8192.2
Kuwait12.031.01.974.0
Oman5.07.02.4206.3
Qatar8.08.55.262.6
Saudi Arabia9.020.54.00.0
United Arab Emirates6.08.06.30.0
Source: World Bank Doing Business
Source: World Bank Doing Business

E. Public Sector Interventions in the UAE

10. Public sector interventions to improve the limited access SMEs have to finance have focused on subsidized lending to eligible SMEs. Independent government agencies from the Abu Dhabi, Dubai, and Sharjah Emirates provide eligible SMEs with several forms of assistance, including funding and credit guarantees, training, infrastructure, and other facilities. However, the eligibility criteria restrict public funding only to nationals. As a result, the reach of public sector intervention is limited and reflected in the number of SMEs benefiting from different programs. In addition, the actions of each government agency are not coordinated at the national level.

Key public funding programs in the UAE include:

  • Mohammed Bin Rashid Fund (MBRF). Established in 2012 within the Dubai SME government agency, it provides loans and financial guarantees (with 80 percent coverage ratio) to support Dubai SMEs. The MBRF has three programs. The first is a credit guarantee scheme available to eight banks since 2003. The program guarantees loans up to AED 3 million, with a low interest rate, three-year grace period, and five-year settlement period. The second is the Seed Fund for startups created in 2010. Its loans are interest-free and cover up to AED 250,000. Finally, the venture capital program established in 2011 has funded more than 60 projects through the network of eight banks.
  • Khalifah Fund (KF). It was established in 2007 as an independent agency of the Abu Dhabi government. It supports entrepreneurship among UAE nationals and SME development in the UAE. It provides pre- and post-funding technical assistance, including counseling, training, business development plan, and monitoring. It has capital of AED 2 billion and has financed 317 projects with a total loan value of AED 500 million. Its loan portfolio consists of microfinance loans (up to AED 250,000), startup loans (up to AED 3 million), SME loans (up to 5 million), and small industrial enterprise loans (up to AED 10 million). It also has a credit guarantee scheme available to banks, with a coverage ratio of 15 percent of loan losses. The services and industrial sectors in Abu Dhabi benefit mostly from the programs, which fund mainly startups with loans up to AED 3 million.
  • Ruwad Establishment (RE). Set up in 2005, it provides technical and financial support for Sharjah-based SMEs compliant with Islamic financial principles. Furthermore, its objective is to coordinate public policy toward promoting SMEs by identifying and eliminating administrative and other impediments, and providing training. RE also cooperates with Islamic banks to increase their financing of SMEs.
  • Al Tomooh Finance Scheme: The Emirates Bank (an affiliate of UAE Dubai National Companies) has created Tamooh Program to provide funding to nationals for small-scale private projects. The credit facilities provide new and existing projects with loans up to AED 2 million, with a two-year grace period, a three-year exemption of interest payments, and a maximum eight-year term.
Table 6.UAE: Khalifa Fund Performance, 2013
Aproved by sectorApproved by gender
PercentageNumberPercentageNumber
Agriculture722Male77244
Industrial35111Female2373
Service58184
Approved by locationApproved by funding program
PercentageNumberPercentageNumber
Abu Dhabi69219Bedaya66209
Al Ain2682Khutwa1651
Al Gharbia516Zeyada1754
Tasnea13
Source: Khalifa Fund
Source: Khalifa Fund

11. Public sector interventions in the UAE are consistent with international experience. The G-20 stocktaking exercise listed public support schemes that encourage SME access to finance through funded financing facilities, credit guarantee schemes, and state banks.5 Funded financing facilities range from simple structures through intermediation of funds through the banking system, to more complex structures involving risk sharing in co-lending, capacity building, and technical assistance to SME borrowers and lenders. Some countries also offer subsidized lending and grants. Even though these funded financing facilities can be justified under certain conditions, they often lack sound credit analysis and risk management processes and can crowd out banks that do not participate in the SME financing activity. Successful initiatives included close coordination and support from stakeholders and the private sector and efficient structures with good-quality human capital and use of information and technology.

F. Prudential Regulations Associated with Credit Guarantees

12. There are different regulatory and supervisory models of credit guarantees. If classified as credit institutions, credit guarantee schemes can be licensed, regulated, and supervised. However, given high compliance costs, credit guarantee schemes are usually exempted from prudential and other regulations. If not qualified as a credit institution, credit guarantee schemes can be regulated and supervised by a government body. In the UAE, the central bank does not regulate and supervise public sector agencies that provide SMEs with loans and guarantees. As previously described, KF, MBRF, and RE are under the Abu Dhabi, Dubai, and Sharja Emirate governments. Consistent with international best practices and Basel II, the UAE central bank provides banks with regulatory incentives in terms of lower risk weighting and provisioning for loans with public sector guarantees.

13. Consistent with international best practices and Basel II, the UAE central bank provides banks with regulatory incentives in terms of lower risk weighting and provisioning for loans with public sector guarantees. The central bank regulation on loan loss provisions requires that minimum specific provisions consider the value of government guarantees in the definition of net exposures by assigning no haircuts.6 The prudential regulations by the central bank also allow guarantees—for capital adequacy purposes—to be used for credit risk mitigation provided they are direct, explicit, irrevocable, and unconditional, as deemed by the central bank on a case-by-case basis. In this case, capital relief is granted to the bank making use of the guarantee as if the credit guarantee would replace the risk represented by the SME by the one represented by the government, with a zero risk weight assigned to the SME. Only a few UAE public sector institutions are assigned a zero risk weight.

G. SME Credit guarantee Scheme in the Middle East and North Africa (MENA) region

14. SME access to finance seems constrained in many countries of the MENA region. According to a World Bank survey, 33 percent of SMEs report difficulties in getting finance, compared with an average of 25 percent in other developing and emerging economies.7 To a large extent, the lack of SME finance is attributed to asymmetric information due to weaknesses in financial market infrastructures, collateral regimes, and judiciary frameworks.

15. Several MENA countries have established Partial Credit Guarantee Schemes (PCGs) to facilitate SME access to finance. PCGs are a risk-sharing mechanism set up by the public sector aimed at reducing the risks and potential losses of creditors. Compared with other public interventions—such as directed lending programs or state banks—PCGs potentially generate fewer market distortions because they usually entail less interference in credit allocation and use private banks as the main vehicles for loan origination.

16. PCGs seem to have a positive impact on SME finance in the MENA region. Focusing on the number of benefiting SMEs, additional SME access, and financial sustainability of the scheme, it seems credit guarantee schemes have contributed to more SME lending in the region. Larger and more established PCGs, in particular, showed larger shares of SME lending.8

17. PSGs have multifaceted objectives and several eligibility criteria. As expected, there is no one-size-fits-all formula for designing effective guarantee schemes in the region. Some schemes have a narrow objective, such as compensating for the lack of collateral, while others see their objectives as to promote economic and social development, such as export promotion, supporting entrepreneurship, and implementing indigenous economic programs. Furthermore, the eligibility criteria were even more diversified. While all schemes cover start-ups, those in Morocco and Tunisia are especially generous regarding the size of SMEs (either in terms of equity or number of employees). By contrast, schemes in Egypt, Lebanon, and Palestine restrict the use of guarantees to smaller firms (respectively 50, 40 and 20 employees). Moreover, there are significant differences regarding the maximum size of loans which could be up to US$2 million, or the equivalent of 600 times GDP per capita (Morocco and Tunisia) to about 60 times GDP per capita (Lebanon, the Palestine, and Saudi Arabia). In addition, some schemes cover all economic sectors, while others exclude trade and service sectors.

18. PSGs’ financial conditions vary widely in MENA and may not be directly linked to the riskiness of the borrowers. The purpose of coverage ratios is to provide sufficient protection against credit risk, while preserving incentives for banks to screen and monitor borrowers. The coverage ratios in the MENA region are generally in line with those of other developing countries, which, on average, is between 60 percent and 75 percent, though some offer 90 percent coverage ratios. In several countries, the schemes do not link the coverage ratios to the borrowers’ risk profile. For instance, in Morocco, Tunisia, Egypt, and Saudi Arabia the schemes offer higher coverage ratios for riskier types of borrowers, while in Syria, Jordan, Iraq, and Palestine, the coverage ratio is not linked to credit risk exposure. Furthermore, the fees which should be related to risk exposure and contribute to the financial soundness of the scheme are mainly in line with other countries, which average 1.5 percent of the loan value per annum.

19. The absence of financial obligations on the part of borrowers may increase the moral hazard by attracting riskier borrowers. Many schemes require borrowers to provide partial collateral and initial payments in order to mitigate against the risk of attracting riskier borrowers. In some countries, the schemes require a personal guarantee which is limited to a percentage of the loan value. In the MENA region, some banks require high levels of collateral even when using guarantees offered by the schemes, which may contradict the purpose of setting up such a scheme. As down payment, the majority of the schemes require the borrowers to pay around 25 percent of the loan value in addition to the collateral value.

H. Conclusion and Policy Recommendations

20. Access to finance remains a key constraint for SMEs in the UAE. A comprehensive strategy is emerging that would allow them to play a crucial role in the economy, although this policy is restricted to Emirati nationals. Authorities should strive to develop a comprehensive SME policy that includes all SMEs, as the UAE, as a whole, would benefit from higher inclusion and growth. Several important measures aimed at reducing borrowing costs and enhancing the borrower/lender relationship have already been identified, including a new credit registry and a new bankruptcy law. A collateral registry would allow SMEs to pledge movable collateral, broaden access to finance, and provide transparency to pledged assets with associated liens and priorities. Authorities may also provide the SME council with a strong mandate to monitor progress made by different initiatives and indentify specific measures to bridge the SME finance gap throughout the Emirates.

21. In addition to public guarantees and other subsidies, equity finance could be strengthened as a complementary financial product with support from government related agencies. Diversifying funding sources for SMEs would include developing venture capital and business angel financing networks. In this context, the Islamic banking model may play a greater role to provide equity financing. It is, however, crucial that such initiatives are introduced while taking into account financial stability, and transparent and accountable policy objectives.

22. Other best practices and recommendations related to credit guarantee schemes would also include:

  • Best accounting practices in the public sector would consider public sector guarantees as contingent liabilities that should be properly accounted for in the government’s balance sheet as memorandum items. In addition, if banks and borrowers are exempted from the payment of guarantee fees to the credit guarantee schemes—as a result of government policy to encourage SME access to finance—the guarantee fees should be explicitly accounted for in the government budget as a subsidy to the private sector and transferred to the credit guarantee schemes.
  • The schemes should have well defined objectives in terms of types of SMEs to be reached, size, activities, etc.
  • The banking sector, rather than public agencies, should make the credit assessments and lending decisions.
  • The scheme should have a transparent and accountable corporate governance structure.
  • The eligibility criteria should be defined to enhance additionality, reaching financially neglected SMEs. It is important that these criteria do not encourage banks to use the guarantee for large firms and loans, weakening the schemes’ purpose to reach new SMEs.
  • Coverage ratios, fees, payments, and collateral trade-offs should be linked to the risk exposure in order to reduce moral hazard and contribute to the financial soundness of the scheme, including its financial sustainability and risk minimization.
  • Payouts of the scheme should be delayed until recovery actions are taken by the lenders so as to reduce moral hazard.
  • The guarantees should be on pari passu basis in which recovery proceeds collected from the borrowers are shared between the bank and the guarantor.
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1Prepared by Elias Kazarian and André Oliveira Santos.
2Khalifa Fund is the independent Abu Dhabi government agency in charge of supporting SME development and growth.
4Dubai Economic Council (2013).
6For provisions and guarantees, see Clarification and Guidelines Manual for Circular no. 28/2010 (Regulation for Classification of Loans and their Provisions). Specific provisions are calculated by multiplying the provisioning rates by the net exposure amount, which is defined as the outstanding loan balance less the net realizable value of the collateral held. In the case of federal and local government securities and guarantees, the net realizable value is equivalent to the gross value without haircut.
8The survey covered the largest credit guarantee schemes in 10 MENA countries. The scheme equity ranges from US$10 million in Syria, to US$75 million in Morocco. Half of these guarantee schemes are majority state-owned (Morocco, Tunisia, Jordan, Syria, Saudi Arabia, UAE), while the others are majority owned by banks (Lebanon, Egypt, Iraq) or donors (Palestine).

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