A major hurdle on the road to success for Small or Medium Enterprises (SMEs) is being able to access the capital they need in order to cultivate their business. In theory, banks and other financial institutions should be primed to step into the void and provide financing and assurances, so that an SME can feel intrepid and secure. In practice, these provisions are sporadic because they are subject to perceived risk and fluctuations in local and global markets. Is this likely to change?
When turmoil ensues and economic markets are impacted, and when it comes to trade finance, SMEs tend to be the first and hardest hit. Banks’ and associated entities’ penchant for risk becomes – at best – diluted, and the finance needed by SMEs to continue their trading dries up. Before a global pandemic arrived on our doorsteps, the 2008 financial crisis was the last time global trade finance contracted with the inevitable more widespread rejection of the humble and vulnerable enterprise (in that crisis, it is estimated export markets reduced in size by around 50%). It is pertinent to consider that according to The International Finance Corporation, 65 million businesses in emerging economies have an unmet financing requirement of $5.2 trillion each year, with East Asia and the Pacific carrying the highest burden. When it comes to trade finance, SME’s get pushed and shoved in all directions by the whims of the global marketplace.
Through the Bank’s Eyes
Banks and their associated entities are inclined to look for, and adopt, new technology as it emerges. They do this to increase efficiency and profits. They cannot be faulted for this, certainly. In the world of business, the mantra adapt or die reigns supreme. Invariably, with the new technology, the criteria by which SMEs are assessed becomes more stringent because lenders want to implement their new-found efficiency. Equally, the lending of money itself comes with a transactional cost and it is more expensive to have to analyze and audit more susceptible – and therefore riskier – businesses, whose profit is less of a guarantee than that of a larger and more established company. According to Trade Finance Global, there are various criteria that give rise to questions requiring satisfactory responses when successfully applying for financing (see figure 1).
Figure 1: Criteria requiring satisfactory responses to obtain finance
Coupled with reduced profitability, the risk of lending to SMEs in comparison to large organizations is greater: through the possibility of defaulting and bankruptcy. Even more than this, the very nature of a smaller business means it cannot provide as much collateral: it is smaller and therefore has limited assets. Broadly speaking, security for the financing entity is lessened, and the wholesale attraction of the business as a worthwhile investment suffers.
Playing the Game
SMEs don’t play the game properly. For a start, they do not necessarily have an understanding of the finance marketplace and will retreat with tail tucked between legs on the first rejection. According to research conducted by Close Brothers, financial entities can reject SME applications because they do not understand the sector, or they do not have any knowledge regarding the specific needs of the borrower. Obviously, it behooves the SME attempting to get finance to identify an organization that understands the line-of-work it specializes in. Moreover, UK Government research indicates that 80% of all trade finance relationships of SMEs go through the largest four banks. This does not mean there aren’t any alternatives, but rather that SMEs are disinclined to look. With larger institutions’ stricter stipulations on financing, and what with an SME’s tendency to quit at the initial ‘no’, it is no wonder that many of these businesses struggle to get the support they need.
Why Bother?
Well, according to the World Trade Organization, SMEs account for 90% of businesses globally, and over 50% of all employment. They are critical to the development of emerging economies and raise the quality of life through job creation. The WTO estimates 600 million jobs will be necessary by 2030 to integrate the global workforce. Also, it is important to note the concept of transition. Many organizations seen to be the titans of industry today will once have been a fledgling business casting around for financiers to supply credit and investments. Now embedded in our social consciousness and culture, it is not known how many of these enterprises will have otherwise failed without the crutch of trade finance. It could be argued there is a moral responsibility for governments and the trade finance sector to provide financial support to impoverished regions and companies that are commercially adrift. They are the lifeblood of a thriving economy.
Finding a Path
One of the most promising ways in which SMEs might break the cycle of erratic financial support is through digitalization. COVID-19 has laid bare the weaknesses of relying on paper systems. This has been especially impactive for supply chain trading. Where the pandemic has imposed tight restrictions on travel and logistics, business-to-business trade has adapted and become more digital. But SMEs are still bringing up the rear when it comes to widescale adoption of digital business practices. To aid the recovery of SMEs and developing economies in the aftermath of COVID-19, encouraging and supporting digitalization is becoming ever more important.
Digitalization enables benefits such as data collection and assessment (to rate credit risk for example), as well as improve the efficiency of KYC processes. This may seem to be beneficial only to financing entities, but those viable SMEs that take part digitally in free data transfer will be able to communicate their worthiness for investment more quickly and comprehensively. With data availability comes the capacity to employ people better placed to analyze it and make informed decisions. Data collection for all parties enables easier short term tactical, and longer-term strategic, decision making.
Digitalization begets automation, and automation removes the fallibility of human beings to make mistakes, not to mention it also increases speed. Data collecting in this culture is more accurate, more available, and processed quicker. Applications by SMEs for credit will not just be faster but will also see less disruptions due to error and reprocessing. KYC data of SMEs could be communicated to expanded financial audiences where specialists in certain types of financing and credit could be identified and brought on board – circumstances that would be impossible to achieve in a paper-based system. In the first instance, the digital centralization of data through e-documentation and portals would be desirable, providing access to specialists. Beyond this and into new technological horizons is the decentralization of data where it can be owned by everyone (as occurs in cryptocurrency).
A recent news item by Scoop World provides a glance into the possibilities for technological enhancements in trade finance and hope for SMEs struggling to find financing partners. Di Muto and OPAL are coming together to develop payment services on the Di Muto platform – a hub for blockchain technology. Through their partnership, these firms intend to transform the way in which payment and finance occurs in the agrifood trading sector. Their intention is to utilize OPAL’s international payment expertise, digital currency ‘wallets’, and financing solutions, as well as marshalling Di Muto’s broad network of agrifood clientele, digital trade technology, and their ability to harvest asset-driven information. The partnership is an example of how technology and innovative thinking can conjure new business opportunities as well as streamlining traditional ones.
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