Supply chain financing: An effective way for development banks to support small entrepreneurs
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All businesses need financing either for investment or as working capital for daily operations. Working capital is employed to purchase the input materials for production, to finance inventory, and to bridge the time until customers pay their invoices. That’s why access to suitable instruments to manage working capital requirements is key in global efforts to reduce the finance gap for small and medium-sized enterprises.
Due to its unique structure, SCF enables suppliers to larger customers to receive faster payment of invoices raised via a finance facility that is supported by using the strength of the buyer’s business as security for the lender, making it a win-win situation for all parties.
But while SCF has gained popularity in many parts of the world, financial institutions in many emerging economies find it challenging to offer these products due to a lack of financial infrastructure, technological capacity, resources and awareness.
A fertile ground for development banks
As the world struggles to find funds to meet the Sustainable Development Goals, and economies work to mend supply chains affected by the COVID-19 pandemic, development banks can be instrumental in narrowing this funding gap.
To support SME finance, development banks around the world already use partial credit guarantees while letting private lenders originate, fund and collect on credit. Development banks can also play a catalytic role in providing funding, reducing risks and building capacities of financiers to help foster SCF initiatives. Among other things, development banks can support legal, regulatory and policy frameworks, provide technological platforms, supply-level advisory, and demand-level awareness building.
Multinational and national development banks can use SCF to leverage public sector resources to mobilize private sector funding to support new investments around the world. They could also kickstart dialogue with regulators and policy makers to develop the enabling framework for SCF, and advise and support commercial banks in developing new products. This may include supporting the development of secured transactions and factoring laws, publicity systems and public registries, enforcement of rights transferred via purchase/assignment of receivables, e-invoicing strategies, e-signatures, know-your-customer compliance processes, and clear guidelines for SCF multi-funder programs.
In addition, they could develop and operate multi-funder, blended finance platforms to incentivize the participation in SCF of lenders who may otherwise be unable or unwilling to develop their own SCF program. Development banks can indeed be the central stakeholder to launch SCF initiatives, facilitating and promoting the SCF ecosystem more efficiently in their countries.
“There are literally trillions of dollars in late payments, and trillions more in missed opportunities for SMEs worldwide in supply and distribution chains, yet little formal financing is provided, except for the larger, Tier 1 suppliers closest to the anchor buyer or seller in the chain”, said Matthew Gamser, CEO of the SME Finance Forum, a global alliance working to expand access to finance for SMEs. “Extending reach used to be difficult because of information asymmetries and transactions costs. New technology now makes this extension not only possible, but also an enormous undeveloped business opportunity,” said Gamser, adding that development finance institutions have a role to play in making the financial sector more aware of this opportunity—and more capable of pursuing it.
Local initiatives demonstrate viability
Several countries already have a state-owned institution undertaking SCF-related interventions in collaboration with the private sector, with the purpose to foster and boost financial development. For instance, Mexico’s Nacional Financiera (NAFIN) was a pioneer in offering reverse factoring services to SMEs through a public sector-led online platform and its “Cadenas Productivas” financing initiative.
Similarly, Argentina’s Bank for Investment and Foreign Trade’s (BICE) “e-Factoring” product aims to foster integration between SME suppliers, large companies and financial intermediaries, strengthening long-term links by creating productive chains that improve competitiveness and the development of national economic sectors. Another initiative is Reserve Bank of India (RBI)’s new Trade Receivables Discounting System (TReDS). RBI acts as the authority to grant the necessary licenses to providers of technology platforms, which both public and private sector lenders can leverage to provide financing to MSMEs. NAFIN, BICE, and TReDS showcase different approaches to public-private sector collaboration in the area of SCF. At the multilateral level, IDB Invest, a member of the Inter-American Development Bank Group, has also unveiled a joint effort with the Mexican Business Council that seeks to develop reverse factoring lines of credit for up to 30,000 small and medium enterprises affected by the COVID-19 pandemic.
Figuring out where and how to intervene is not a simple matter for development finance institutions. Making the right choices requires thorough planning, market sizing, a strategic framework and business model, legal and regulatory reforms, technological and platform development, and implementation. There is not a one-size-fits-all solution, so tailoring to local conditions will be vital. However, there are several international experiences on which to build in designing a strategy for development banks seeking to create or grow the SCF market, depending on the specifics of each particular economy. This would pave the way for the private sector´s ability to provide SCF, ultimately benefiting small businesses
A Guidebook on Supply Chain Financing through Development Banks and Public Sector Entities, recently launched by IFC, describes different business models or approaches for supporting small and medium-sized enterprises through supply chain finance. Such initiatives must be aligned with local conditions, mandates of development banks and the participation of the private sector.
Supply Chain Financing (SCF) no doubt is the way to good for development banks especially if those in the developing and the emerging economies. A working SCF template can be replicated in Africa to address the ever-widening fund gap and risk adverse nature of many lenders operating in the continent.
With the current collateral challenges in emerging economies like Africa, SCF acts as one of the solution to address majority of SMEs financial needs. Commitment to both government's and private corporate entities is the key towards building sustainable solution to lenders as delays in payment and syndicated fraud has led into increased non performing facilities.