One of the biggest obstacles to getting smaller firms to grow is a lack of financing. The gap between demand and supply is significant. A 2017 World Bank study suggested that 65 million micro, small and medium sized enterprises (MSMEs) were credit constrained. This is probably an undercount of the problem.
Smaller firms are not well served by traditional credit financing schemes, even in markets where a range of potential solutions are available. For example, companies participating in our Asia-Pacific MSME Trade Coalition (AMTC) frequently report that the only available financing is tied to the use of land as collateral for lending. As many MSMEs have no land resources, especially those run by women, they are simply unable to scale up.
Instead, smaller firms typically finance operations by borrowing against their own personal savings, the savings of family and friends, or by using cash from ongoing operations when it is available. Most have not even bothered to try to tap traditional sources of financing, such as banks or credit institutions, because they know they will be denied access.
As might be imagined, the disruptions caused by Covid 19 have been particularly challenging to navigate. Some AMTC firms have made no sales or extremely limited sales for months at a time and have gone further into debt. Even an overall economic rebound might be too little, too late for a wide range of companies that had been managing operations well prior to the pandemic.
Of course, the fact that MSMEs have limited access to financing is not an unseen problem. There are a wide range of potential solutions, including a growing history of providing microcredit loans. However, to really scale up a business, most microcredit options are too small, with frequent or weekly loan repayment terms that do not work for managing businesses.
Discussions on financing gaps then often turns to a particular slice of financing—trade finance. The creation and extension of trade financing for business operations can be a key source of revenue and enables small business participation in regional or even global supply chains.
There are a range of excellent reports on the issues related to trade financing. The ICC has just released a new set of suggestions for addressing these gaps. Their recommendations would provide a welcome shot of liquidity into firms aiming to rebound from pandemic challenges.
Many of the ICC recommendations involve updating antiquated processes. Trade finance transactions are unnecessarily complex with, as the report shows clearly, complicated shuffling of mostly paper documentation. Firms attempting to work in multiple markets also face regulatory disconnects with unclear processes. To add to the mix, there are three primary product categories for trade financing with different demands and requirements for each: documentary business, supplier-side financing, and buyer-led financing.
While unraveling these complex processes would be helpful, with significant gains available, it does not go far enough in providing basic financing to the millions of MSMEs that are currently underserved by the market.
What is needed is a new approach that leverages a range of new technologies to reconceptualize the way that small businesses are evaluated and pull in new financing providers. By starting with an MSME-first approach, it is possible to reimagine the provision of capital and start to unlock and unleash the potential trapped inside small firms.
The ICC report (full disclaimer—I was part of the conceptual team to help develop recommendations) begins to sketch out some of the conditions for a new ecosystem to support financing for MSMEs in the near term.
What is new is the creation of an interoperability layer that brings together digital trade enablers, trade finance interoperable foundations, and a set of guiding principles. The report, of course, covers this in greater detail.
What is particularly of interest here is the idea that financing for MSMEs should draw on a much wider set of potential market players than traditionally considered.
For example, many MSMEs are not part of a credit system at all because it is not possible for them to have a recognized identity, particularly in multiple markets. The lack of clear company identifiers makes it difficult for financing institutions to perform important checks starting with Know Your Customer (KYC) rules. Getting convergence around just this one point could dramatically improve the prospects for smaller firms to enter financing markets.
Firms are often hampered by documentary requirements and demands for information in differing formats. It should be possible for companies to provide a wider range of information on corporate operations than previously possible and to input this information digitally. A wider use of documents may also help smaller firms by providing alternative forms of collateral for consideration by lending companies.
The system described in greater detail in the ICC report also brings in additional market actors, going well beyond traditional lenders to tap on additional financial resources. Alternative financing operators could find MSMEs an attractive new market, particularly if potential lenders had access to a wider and more transparent range of information that could help assess risks in trade transactions.
Some of the knock-on benefits to scaling up financing for MSMEs will flow to other industries, including logistics operators or platform providers that could access new firms, products and services which have been locked out markets.
Of course, it is one thing to suggest that a new interoperable layer is needed to support MSMEs. It is another to make it happen. This is partly why it is so important that the ICC has taken the lead in promoting the concept. Bringing together such a wide range of potential participants with governments requires institutional capacity that few organizations possess. The ICC has suggested a likely roadmap to the creation of such a capacity.
This is the sort of practical, grounded initiative that has the potential to really transform business opportunities for millions of MSMEs globally. It deserves to be widely read, considered, debated, and implemented. Effective recovery from Covid requires new ways of thinking about old problems.
***This Talking Trade was written by Dr. Deborah Elms, Executive Director, Asian Trade Centre in Singapore. Congratulations to the ICC, to Fung Business Intelligence, and to McKinsey for crafting the final document.***