SMEs need innovative funding: Report

Small and medium-sized enterprise (SME) financing is one of the three most significant opportunities for financial services firms in emerging markets, according to a report prepared by the World Economic Forum (WEF) in collaboration with The Boston Consulting Group (BCG).

However, only innovative approaches by governments and financial institutions will deliver results, according to the report titled “Redefining the Emerging Market Opportunity: Driving Growth Through Financial Services Innovation”.

Only one-third of SMEs in emerging markets have access to loans or credit, while banks and financial institutions have too little data about SMEs to risk lending to them.

Financial institutions should consider asset-based lending, including factoring, the report says. In traditional factoring, a borrower’s accounts receivable are used as the underlying asset securing a loan. The lender — or factor — purchases the accounts receivable at a discount. The amount of credit is thus linked to the amount of receivables.

Factoring is useful in emerging markets, because the credit decision is based primarily on the quality of the underlying accounts — often large corporations — and not on the quality of the SME borrower.

Yet traditional factoring is not always a viable means of providing SMEs with short-term funding, particularly when timing is tight, as credit assessment and invoice processing take time. Reverse factoring resolves this problem.

In traditional factoring, credit assessment is conducted for all buyers of a particular supplier. In reverse factoring, the lender focuses on one large buyer and finances many SME suppliers of that large buyer, thus simplifying credit assessment and processing.

Equity financing — such as private equity — also needs to be developed when barriers to SME financing exist within the banking sector, the report says.