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Financial infrastructure—the set of rules and standards, institutions, information, technologies, and systems within which economic agents (that is, firms and households) carry out their financial transactions—is the underlying foundation of a country’s financial system (Bossone, Mahajan, and Zahir 2003). A well-developed financial infrastructure reduces the cost of financial intermediation, because it reduces legal uncertainties and information asymmetries between borrowers and lenders, thus enabling lenders to extend credit and expand financial services. According to the World Bank Financial Infrastructure Index, only Sub-Saharan Africa has a lower index value than the Arab world (World Bank 2009).

Financial infrastructure is particularly critical to the development of small and medium enterprises (SMEs), a noted priority for many Arab nations. The share of SME lending in total bank lending in the region is only 8 percent, of which 2 percent is in the Gulf Cooperation Council (GCC) countries, and 13 percent is in the non-GCC countries (Rocha et al. 2010). The two key infrastructure challenges hampering SME investment are the weak credit information architecture and the absence of effective legal structures.

Despite recent improvements enhancing the quality of credit information through the establishment of private credit bureaus (Bahrain, Egypt, Morocco, Saudi Arabia and the UAE) and the upgrading of some public credit registries (Lebanon, Tunisia and UAE), credit reporting systems remain inadequate. The main challenge is the lack of coverage. About 60 percent of the Arab countries rely entirely on public credit registries, which have half the coverage of private registries. In addition to poor coverage, public registries lack integration with unregulated financial institutions such as those in microfinance (Rocha, Arvai, and Farazi 2011).

Further, less than 30 percent of banks rely on credit scoring methods for automated decisions. In many countries, credit risk assessment has been centralized and relies heavily on physical collateral (Rocha, Arvai, and Farazi 2011). A weak regulatory framework and concerns about data privacy have hindered credit information sharing and do not inspire lender and consumer confidence. Some countries, such as Jordan, Saudi Arabia and the UAE have enacted customized private credit bureau laws. Egypt and Morocco have chosen to regulate through their central banks while Bahrain relies on a code of conduct (Madeddu 2010).

The absence of an effective legal system for secured transactions remains the region’s greatest infrastructural weakness. None of the Arab countries has a modern law on secured transactions. Immovable property, with the exception of automobiles, remains the main source of collateral as movable assets are not considered legal. Collateral registry is inefficient and weak. With the exception of Bahrain and Qatar, out-of-court collateral enforcement procedures do not exist in the region. Court enforcement varies from being time-consuming, costly, and unpredictable in Jordan, Lebanon, Morocco, and Oman to being fast and efficient in Tunisia. Lengthy and inefficient collateral sale procedures in many countries have made it difficult to dispose of secured assets (De la Campa 2011).

Finally, insolvency systems remain underdeveloped in the region. Debtors are considered wrongdoers rather than economic agents in distress. Countries that have insolvency regimes usually use them as tools for collection by creditors and closure of companies. According to international standards, no Arab country has an efficient liquidation mechanism; rather, liquidation is a time-consuming process with cumbersome asset sale procedures. This is due to the absence of an efficient legal system, a well-developed institutional framework and effective technical capacity. Creditors’ rights are often unprotected during bankruptcy procedures in the region, with countries like Egypt, Jordan, Kuwait, Morocco, and Qatar giving higher priority to public policy exceptions such as court costs and taxes (Uttamchandani 2011).

In their efforts to promote SME development and allow them access to external financing, Arab governments need to focus on the availability and access of credit reporting, the enabling nature of the legal system and the effectiveness of dispute resolution mechanisms.

Wafik Grais is an International Senior Adviser specializing in Islamic finance, financial regulation, investment financing, private equity management, and corporate governance with expertise in SMEs and green growth financing. He was co-founder and chairman of Viveris Mashrek, a Cairo-based, financial advisory services company specialized in private equity investments in SMEs, licensed by Egypt's Financial Supervisory Authority. He spent 28 years in international finance notably with the World Bank in Washington DC where he held several senior positions both in operations and at corporate levels. He holds a Ph.D. in Economics.