SMEs are a crucial contributor to post-pandemic economic development, but continue to struggle to access financing. With the right approach and partnerships, supply chain finance could provide them with the support they need, writes Kevin Day, CEO of Lendscape.
Even before the global pandemic, many emerging markets and developing economies were struggling to achieve growth and economic security.
A frequently cited Asian Development Bank study performed in 2019 estimated the global trade finance gap had reached US$1.5tn, and on the eve of the world going into lockdown in 2020, the World Economic Forum estimated the gap would reach US$2.5tn by 2025.
A little over a year later and the pressures and impact of the pandemic have only widened the inaccessibility to trade finance in emerging markets. While SMEs have struggled to access trade finance in the past, technology and innovation have helped businesses in emerging markets to build momentum and offer the promise of high-growth potential relative to their size.
According to the World Bank formal SMEs “contribute up to 40%” of GDP in developing economies – this percentage is “significantly higher” when informal SMEs are included. More than ever, SMEs are a crucial contributor to post-pandemic job creation and economic development. As we head into a post-pandemic world, we should be thinking about how we build back stronger and with greater sustainability in mind, and financial institutions must be ready to unlock critical finance to stimulate activity in these markets.
Recognising and addressing challenges
Establishing the financial ecosystems able to provide financial support to businesses in developing economies does not come without challenges. Banks may be present in these markets, but do they have the tools and the know-how to realise the potential of businesses and enable growth? Under the surface, one might uncover a lack of expertise, technology constraints, and a limited depth of data to support products or solutions.
Assessing and establishing the credit risk of the borrower is another challenge, particularly in countries where credit information is in short supply. While no lending is without risk, it will be vital for financial institutions to have confidence that when they lend money it will be repaid.
An International Finance Corporation report on the importance of trade finance notes that new regulatory challenges may also emerge. In the long term, the report notes the “most successful outcome will occur if the cross-stakeholder ecosystem of regulatory activity, which was in nascent stages before Covid-19, can continue to improve transparency, clarity, and frequency of communication”.
Success in the post-pandemic period will hinge on the adaptability of financial institutions as market dynamics evolve, and these changes will more than likely be accelerated to address funding and risk-sharing for trade. Those slow to move or adapt could very well lose business as future growth in the long term will be driven by digital innovations and technology.
There are few industries where the pandemic has not compelled some form of innovation, and technology solutions could not only bolster the health of the overall supply chain by helping buyers but also address common SME cashflow challenges by providing affordable and timely access to funds for suppliers.
Supply chain finance to support SMEs
When considering the financial products that can best serve these markets, buyer-centric supply chain finance (SCF) programmes are a good starting point. Larger domestic or foreign corporates can provide the credit quality to support the financing of invoices from their suppliers. The risk of default on approved payables for a large corporation should be much lower than funding the supplier directly using other more conventional banking products.
Buyer-centric SCF programmes offer several advantages for both the buyer and the suppliers, particularly in that it deals with the issue of poor credit ratings or data pertaining to the suppliers. Establishing SCF programmes can be on a local or on a cross-border basis, but in both cases, they can provide much-needed working capital to suppliers using the product.
It is important to note that SCF programmes are only the first step in the funding of SMEs in emerging markets. Once established, SCF programmes can create an ideal market for cross-selling additional financial tools. These include factoring, distributor finance, inventory finance, and other products which unlock the balance sheet assets – creating more working capital for a business to fund growth and success.
Governments and banks around the world are aware of the opportunity of these financial products, but it can still be a daunting challenge to launch such initiatives. However, these products are proven to work and can be a real force for good to support both fledgling and established SMEs. Now, more than ever, SMEs will be vital to driving economic growth, providing employment opportunities, and developing a more dynamic marketplace.
Local banks and other funding providers need to meet this challenge and be proactive in their support of their clients, and there are many global organisations such as the IFC, EBRD and FCI who are working hard to provide the assistance required. These organisations can provide advice, training, and support interaction with government agencies to unlock doors and remove any legislative barriers.
The right technology and partners
Technology can be used to create a solid and secure platform, supporting one or multiple banks in a country to launch supply chain finance initiatives. Our Lendscape product has an inherent best practice approach to enable the development of the necessary skills, although this can of course be augmented as part of the implementation process.
We have successfully achieved this in several markets, most recently in the UAE in support of an initiative launched by the Emirates Development Bank, supported by the IFC.
Building internal technology solutions will always have the benefit of being designed and built for your unique situation. However, hefty upfront investment costs, lengthy developmental phases, and specific software dependencies can quickly become a burden and frustration given the specialism required for this niche form of lending. One should also keep in mind the defensive elements of maintaining software – these include the constant evolution and increase in cyber threats and regulatory framework changes.
It is important to avoid a costly and time-consuming approach that fails to deliver value and carries an increasing risk of failure the longer the project continues to run. Often, there are already large corporates eager to be involved and can help to drive momentum.
Time to market is often a crucial component of strategy and off-the-shelf solutions enable programmes to be launched quickly. In our experience, an agile methodology should be employed to focus on delivering a minimum viable product and have the product available quickly. This is then followed up with later phases which enhance the financial service as it begins to scale up.
Working with an established technology provider has the additional advantage of continued investments and a clear product roadmap, ensured by the existing and future user base. This will become increasingly important as the pace of technology accelerates and financial institutions desire to be at the forefront of innovation.
Taking the first step
With the advent of cloud deployment and pay-as-you-go pricing models, it is possible to establish solutions based upon world-class technology at a cost that makes economic sense. At Lendscape, our approach is about developing long-term partnerships and we are passionate about bringing the best technology to both established and developing markets.
Emerging markets and developing economies have many challenges to face in the months and years ahead.
The importance of SMEs in these markets cannot be overstated and financial institutions must get creative about their use of technology.
One thing is for certain, a business-as-usual approach will not work to address the significant trade finance gap in a post-pandemic environment. With the right approach and partnerships, SCF can be a first step in these markets to support these businesses and get much-needed working capital into the hands of the firms that need it most.
Article written by:
Kevin Day & Iain Gomersall
First appeared on: GT Review