Banks are still the main financing source for companies across the globe, yet they are often accused of not doing enough to fill the SME funding gap. Melodie Michel looks at the obstacles they face, and potential solutions to help them increase their support to small businesses.
The International Finance Corporation (IFC) estimates SMEs’ global unmet funding demand at US$1.5tn to US$1.8tn – over one third of the sector’s total access to finance. Regional disparities are significant: two thirds of the gap is in emerging economies.
But even in the EU, SMEs don’t appear to be a priority for banks: according to the Association of Chartered and Certified Accountants (ACCA), loans to small businesses form just 11% of European banks’ balance sheets, compared to 19% for loans to governments and central banks.
The limited bank appetite to fund small businesses could be explained by the fact that in a lot of cases, collateral requirements – made even stricter by increasingly stringent regulations – are incompatible with the very nature of SME loans.
Yet SME surveys regularly place banks high above any other lender as the first institution they approach to raise funds.
“Bank lending is still the most common type of finance raised by our members, particularly on behalf of clients. In terms of day-to-day liquidity, however, suppliers probably provide more credit than banks – although this rarely makes the news. Over time, a combination of capital requirements and other regulation has slowly tilted the business models of major banks away from SMEs, but clearly they are still major players,” says Charlotte Chung, ACCA acting head of SME policy.
Challenges in bank funding
The reasons why banks sometimes struggle to grant loans for SMEs vary between countries and regions.
For example in Sub-Saharan Africa, where 70% of the workforce is employed in agriculture, SME financing in the sector faces complex challenges – the biggest of which relates to land ownership.
Zhann Meyer, head of agricultural commodities, global commodity finance at Nedbank Capital, explains: “The standard calculation in terms of giving security for a loan from a private sector institution like a bank is to have a loan-to-value calculation, based upon the value of the land. In Africa, small farmers do not own the land, they get access to it through a tribal arrangement with a chief, and they don’t have transferrable rights on that piece of agricultural land that they harvest on.
“Because there’s no conventional security being offered in terms of finance, banks need to get their minds around the fact that you need to fund something with the underlying crop as security, and it makes them very sceptical.”
Added to that is the fact that due to lack of access to seed technology and fertiliser, the yield on agricultural land farmed on a small scale is usually around 20% of what it would be for a large-scale commercial farmer – making crops unreliable as collateral.
In the Middle East, banks have traditionally focused on large project finance tickets or restructuring, leading to a very low percentage of SMEs loans in their portfolios – 3% in the UAE, for example.
“This is the situation on the ground in terms of what’s been extended to SMEs, and that’s also because they tend to be far smaller tickets. If you look at the number of loans, the percentage would be much higher, but the amount is relatively small,” Murali Subramanian, head of transaction banking at Abu Dhabi Commercial Bank (ADCB), tells GTR.
At ADCB, two thirds of the wholesale banking group’s clients are SMEs, yet Subramanian estimates that in terms of assets, loans to these businesses represent between 7 and 8% of the bank’s portfolio.
He believes banks in the country have displayed an increasing appetite for financing SMEs, though such financing is confined predominantly to established
and growing firms.
“The approach across banks is to focus on funding gaps and offer solutions in this space and these solutions vary from structured/parameterised products to bespoke solutions that are constructed based on the customers’ current and long-term needs,” he adds, pointing out that the focus is gradually shifting away from being product-centric to being relationship-driven.
In the US, the SME lending culture is one of collaboration between banks and alternative lenders. A 2012 European Bank Federation (EBF) report on SME loans found that around 75% of corporate financing in the EU is obtained from banks, compared to about 30% in the US.
According to Thomas Burr, director of transactional trade finance at Union Bank, the main obstacle preventing banks from funding SMEs is an administrative one. “From my perspective, the usual problem with SMEs is that the mindset of an entrepreneur is to put as much money as they can into product development and sales and less money into financial reporting.
“When banks make their decisions, the stronger the financial report, the higher your chances are at getting money. Most entrepreneurs would rather use that US$10,000 and set up a trade show or go to Singapore to sell the product, and deal with the financials later, and that’s human nature, but then when they start approaching someone else for money it’s a challenge,” he says.
Support systems
Bank financing for SMEs can be made easier by support from governments, multilateral institutions and other private sector lenders, but again the situation varies in different parts of the world.
According to ACCA research, Singapore, the UAE and the UK have the most SME-friendly policies. In particular, Chung points to Malaysia and Singapore’s leveraging of intellectual property (IP) and intangible assets through guarantees facilitating IP-backed lending.
The UK has also announced notable SME-focused initiatives in recent years, including the funding for lending scheme (which aims to boost bank lending by up to £70bn through cheap loans from the Bank of England). Another such initiative is the SME referral scheme by which banks are required to refer rejected loan applications to alternative lenders – a measure announced in the 2014 Queen’s speech but yet to be implemented.
In the US, the business climate is bolstered by strong policies, such as US Exim’s Global Credit Express, allowing accredited banks to refer SMEs they can’t fund to the ECA, which then acts as the lender while keeping the company’s banking relationship intact.
Burr says: “Banks like us go find people that meet the minimal underwriting standards, send their information to Washington, US Exim makes the
loan and we keep them as customers. We don’t provide their funds but we provide their international banking services.
“It’s not always that we can’t fund them, but that it’s not profitable to fund them. If you have to do it on an asset-based system there’s a lot of overhead and it’s just not cost-effective for either party. US Exim steps up to the plate, which helps make the company more attractive for banks later on.”
He adds that Union Bank referred five customers through the scheme last year – all of which were approved.
SMEs in the country also benefit from state and federal government-funded small business development centres, which play an educational and advisory role to make them more bankable. One such centre is the Economic Development Collaborative in Ventura County (EDC-VC), which offers free training to help SMEs identify the right financing tool for their needs.
Similar organisations exist in the Middle East. In the UAE alone, there are two government-sponsored funds that support SMEs: the Abu Dhabi-based Khalifa Fund, which provides start-up and growth capital for national entrepreneurs, and the Mohamed bin Rashed Establishment (MBRE), a Dubai-focused programme open to SMEs of all nationalities.
“Right now, MBRE is acting as an education hub and plays an active role in delivering best practice knowledge to SMEs. The organisation has played a vital role in helping SMEs in Dubai get connected and get evaluated which has in turn improved their competitiveness. MBRE is expected to roll out many more initiatives that will boost SME growth during the rest of this year,” Subramanian points out.
Additionally, the UAE government’s SME law was passed last year, including a flurry of support measures for small businesses: exemption from customs tax for equipment, raw materials and goods for production purposes, exemption from payment of bank guarantees companies usually pay per new worker, allocation of 10% of federal authorities’ budgets to SME servicing and consulting, 5% SME quota for contracts awarded by companies in which the government holds stakes of more than 25%… The list is comprehensive.
One of the goals of this legislation is to help raise the contribution of SMEs to the country’s economic output from 60% today to 70% in 2020.
“The law’s funding provisions were among its most important aspects. The Emirates Development Bank [a government lending body set up in 2011 with Dh10bn of capital to promote economic growth] will have to ensure at least 10% of its loans are directed to SMEs. Commercial banks will also be encouraged to lend more to SMEs through technical guidelines on lending to be issued by the Central Bank,” Subramanian adds.
According to him, this encouragement will most likely take the form of preferential terms on supply chain financing (SCF).
It is also worth noting the increase in alternative finance available in the Middle East, with new players like ApexPeak and Tawreeq Holdings looking to leverage the region’s abundant liquidity and favourable interest rates – with a strong focus on SMEs.
In Africa however, a lot more needs to be done to ensure the future of small-scale farmers. Government subsidies are too general, and custom tax disparities between jurisdictions prevent banks from using crops as collateral, as their value changes during transportation.
SCF models in which banks lend money to a large commercial farming or processing company, which then passes it on to smaller agricultural businesses, face many socio-cultural challenges.
Meyer points out: “Processors in Africa are getting involved in backward and forward integration into the supply chain, but they need to be very wary of the fact that if they don’t use a market-related transparent price for the farmer, this model isn’t sustainable – there are many stories of malpractice and farmers being robbed.
“The other challenge for processors is price fixing. The moment a small-scale farmer gets offered a higher price by another processor or trader, he sells his crop there because the initial cost of the input doesn’t get deducted from the purchase price. And because he doesn’t own the land, you can’t even find him, he’ll just move on to the next land and grow something else there. This concept is so intrinsic in the farming community: you sell your crops for the best price you can get and you hope you don’t get caught. It’s a very intricate relationship that needs to be managed very carefully between processors and small-scale farmers.”
He believes land ownership and uniform legislations should be governments’ first priorities, and multilaterals should provide more equity funds to agricultural SMEs to make them more attractive to banks.
Outlook
In the coming years, it is expected that the main way banks will increase their support to SMEs will be through SCF programmes.
ACCA’s Chung tells GTR: “Although SCF remains a very small part of the overall receivables finance market, accounting for less than 4% of global market value, it is now a rapidly growing part of the trade finance product range offered by large, international banks. Eastern Europe, India and China are reported to be the regions with the greatest growth potential for SCF providers.
“Multilateral and state-backed institutions have made the most concerted efforts to harness the potential of discounting receivables to improve cashflow for SME suppliers in developing markets, generally through reverse factoring,” she says.
Alternative lenders are also growing in numbers, though their participation in the debt funding market remains low. In the UK, the alternative finance market grew by 150% from 2012 to 2013 and is on track to grow by 161% from 2013 to 2014 (ACCA).
Crowdfunding and peer-to-peer platforms currently focus largely on providing equity, but it is not unthinkable that someday, they will be a part of the working capital financing mix for SMEs.
“There is growing interest from governments, businesses and investors to explore how cross-border investment activity can be enabled in this alternative finance – however, there is limited data on this. It seems likely that these platforms will find a place in the ecosystem that’s complementary to that of banks and other finance providers, but plays to their strengths as originators of credit or as part of equity investment portfolios for investors,” Chung adds.
