Supply Chain Frontiers #51 :: Bridging the Finance Gap for Asian SMEs

Supply Chain Frontiers issue #51

Large banks represent a weak link in the financial supply chain for small and medium sized (SME) enterprises in Asia. The problem also hinders the physical supply chain in that SMEs are key drivers of business growth in the region. The Malaysia Institute for Supply Chain Innovation (MISI) has developed a framework for helping banks to become more actively involved in SME financing.
  The framework is included in a new working paper published by MISI for the SWIFT Institute, the Belgium-based financial services research organization. SWIFT sponsored the research that MISI carried out for the paper.
  A lack of collateral and limited access to venture and growth capital are some of the obstacles that SME owners face when seeking finance for their businesses. Cash flow shortages caused by long or delayed payment cycles exacerbate the problem. On the supply side, a number of issues including high transactions costs, inadequate information about borrowers, and weak governance deter large banks from developing SME lending portfolios.
  In the absence of bank lending options, many Asian SMEs turn to other sources of finance such as unregistered money lenders that charge high interest rates.
  However, local lenders are accessible and understand the SME business model. They are also able to keep a tight rein on costs and have developed ways to make sure that investment funds are used by borrowers for profit-making purposes.   Case studies created by MISI show that in the dairy industry, for example, SMEs borrow money to buy animals and the lender makes the payments directly to the seller to ensure that the funds are used correctly. In addition, SMEs can arrange for their customers to pay the lender directly so the loan is serviced as agreed.
  Banks generally lack this type of expertise and local knowledge. In addition, they often perceive SME customers as too risky, lacking in transparency, and poorly organized.   Yet there is huge demand for financing from the SME business sector in Asia. MISI identified nine areas of demand for capital, including funds to pay for fixed assets and raw materials, to pay for seasonal periods of low demand, and to underwrite the ramping up of operations ahead of product launches.
  In addition to money lenders, typically SMEs use eight types of financing options, according to MISI. These include family and friends, micro finance institutions, and owner’s equity. There are also various government schemes to help SMEs secure the financing they need. However, the research shows that these programs only reach a relatively small fraction of the total population of businesses.
  The lack of affordable financing options stymies the growth of SMEs in Asia. Take, for example, the plight of banana growers in West Bengal, India. The banana is considered to be a high-value crop that is produced in three fruit-bearing seasons in a two-year period. Yet farmers are unable to secure loans for growing the crop because it is considered to be susceptible to strong winds during the monsoon season. There are no insurance plans available to offset the risk, even though other crops can be insured.   MISI suggests that banks in the region need to redesign their lending portfolios so that they are better able to evaluate and manage SME loan applications. To help clarify the risks, the working paper offers a grid that shows how the different sources of SME financing are weighed in terms of the so-called 5 Cs: capacity, capital, character, collateral, and condition.
  The banks should adopt more innovative ways to analyze SME loans and gain a deeper understanding of how these enterprises fund their supply chains, recommends MISI.  This does not necessarily require a complete overhaul of current practices; financial institutions can tap into the SME market by learning to work within current financing systems.   To this end, MISI describes 11 key devices that can be leveraged to catalyze the lending process. For example, Joint Liability Groups comprise farmers with compatible businesses who come together to borrow from financial institutions. Group members can borrow individually or collectively by offering mutual guarantees for each other.   Technological advances such as the growth of internet banking and electronic funds transfers can also be harnessed to facilitate SME lending. New standards released by organizations such as SWIFT are helping to unlock these IT-related advances in banking.
  As MISI points out, creating a viable market for SME financing benefits both the financial institutions and enterprises involved. Regional and global supply chains also benefit, in that there is an increasing need for sustainable and financially viable SMEs in Asia.   SWIFT Institute working paper No. 2012-002, Financing the SME Value Chains, by Asad Ata, Manish Shukla, and Mahender Singh, is due to be published in the fall of 2013. For more information on the paper please contact Asad Ata.