Banks are tightening lending conditions for small, private companies in the Gulf - a sign that the region's economies are not escaping damage from the plunge of oil prices.

Mostly, the six rich nations of the Gulf Co-operation Council (GCC) are coping comfortably with the new era of cheap oil. Heavy state spending is keeping economies growing strongly.

Rather than borrow domestically or run down their deposits at local banks, governments of countries such as Saudi Arabia are covering much of the budget deficits due to cheap oil by bringing home some funds stored abroad.

This is preventing the drop in new oil revenues from shrinking the ample liquidity in GCC banking systems. Deposits are continuing to grow, though in some cases more slowly, and interbank lending rates are near multi-year lows.

So for many companies in the Gulf, it's still a borrowers' market for loans - credit is easily available at rock-bottom rates. The exception is small firms that do not have the advantage of shareholding links to governments.

They are finding it increasingly difficult to borrow and when they can secure loans, banks are demanding tougher terms such as more collateral, stricter documentation and shorter tenors, bankers and businessmen say.

"They are tightening credit lending norms because of the overall impact of low oil prices and the consequent freeze on oil industry capex-heavy projects..." said Dubai-based Vikram Venkataraman, managing director at Vianta Advisors, which works with smaller companies around the region to raise bank finance.

Lending to small and medium-sized enterprises (SMEs) is only a tiny part of banks' business; in 2010, SMEs accounted for about two per cent of GCC banks' loans, according to a World Bank study. SMEs rely heavily on other funding sources, such as non-bank financial companies.

But what's happening with SMEs could eventually become a trend for the wider corporate sector. And since SMEs account for much of the job creation in the GCC - they are officially estimated to employ over 40 per cent of the workforce in Dubai - their fate matters.

LIQUIDITY

Banks are still lending generously to bigger borrowers. The volume of new syndicated loans in the Middle East during the first quarter of 2015 doubled from the previous quarter to $23.25 billion, the second-highest quarterly total since 2008, according to Thomson Reuters data.

Loan rates are still falling for the big borrowers. State oil giant Saudi Aramco borrowed the equivalent of $10 billion in March at rates several basis points cheaper than its previous 2010 loan facilities.

But smaller, private companies are having a different experience. Dany El Eid, founder of digital technology firm pixelbug in Dubai, says banks are getting tougher.

"Banks make unreasonable demands that include time-consuming documentation, penalties on early repayments, and short repayment periods for giving loans besides charging heavy interest rates," he said.

Eid said he borrowed Dh200,000 ($54,500) in February from beehive, a peer-to-peer online lending platform for small businesses in the UAE, at 14 per cent compared to 24 per cent demanded by a local bank.

Bankers say they have become more cautious about lending to SMEs because low oil prices could deprive the companies of access to fresh business.

New economic projects awarded in the GCC totalled over $40 billion in the first quarter, up 9.9 per cent from the previous quarter, according to Abu Dhabi Commercial Bank.

But contract awards fell in some countries such as Saudi Arabia and the UAE as governments reacted to cheap oil by suspending some non-essential projects. Even in Qatar, where awards are increasing, the government is economising by offering less generous price terms to some contractors.

While bigger firms can easily cope with delays or cut-backs to contract awards, small companies can face life-or-death situations - making bankers more reluctant to lend to them.

There are other reasons for reluctance to lend to SMEs. Real estate markets in Dubai and some other GCC economies have peaked for now.

Also, a global US regulatory crackdown on money laundering has increased compliance costs for banks doing SME business; banks must spend more time and effort checking their clients are legitimate, which is economically worthwhile for big firms but not so much for small ones.

Last year, Standard Chartered Bank closed the accounts of thousands of SME clients in the UAE in an anti-money laundering settlement with US authorities. It explored the idea of selling the accounts, but no sale could be arranged by the deadline.

"We are seeing the SME sector under stress more often - sometimes a result of changes in commodity prices and sometimes liquidity-related, which may be due to some well-publicised exits from this market," said a senior banker handling loan portfolios at a UAE bank.

"Regional banks, as a result, are monitoring their exposures more intensely."

For many bankers, the key question is whether the tightening of loans to SMEs presages any broader tightening of the Gulf loan market later this year.

A major tightening looks unlikely as long as GCC finance ministries continue to manage their money in a way that avoids putting banking system liquidity under stress.

But if oil stays below $70 or $80 per barrel, that won't be possible indefinitely, especially for the GCC countries with the weakest finances. To maintain high state spending, they will have to raise money by squeezing out private sector borrowing.

Oman's central bank seemed to have this risk in mind last month when it pressed several Omani banks and financial firms to cut 2014 dividends from original proposals.

"It continues to be a borrower's market but many believe that market dynamics are changing fast, especially for mid-tier firms. We are getting very close to the tipping point," said Chiradeep Deb, head of corporate finance and syndications at Dubai's Mashreq.-Reuters