Much has been made of increasing access to credit for the SME business sector as part of Covid-19 relief strategies.
Governments are even funding schemes themselves, either directly or through traditional banking channels. It sounds great, a positive "hand up" rather than hand-out for the business sector. But isthat the reality? Will small businesses really be able to get new funds? Sadly, in many countries, the answer is no.
The problem lies with the standard banking model. Worldwide most banks still use outdated collateral requirements which rely heavily on traditional real property, i.e. the business owner's home or office building. In the bank SME financing sector it is rare to find other collateral used in a meaningful way.
As a consultant for the World Bank and Asian Development Bank for several years, in multiple markets, I have seen this problem first hand.
The World Bank data shows that on average 78 per cent of SME business assets are movable assets such as inventory, machinery and receivables while only 22 per cent is land and buildings.
But in developing markets about three quarters of all bank loans are secured by property1.
Fortunately there has been a huge push in recent years by the development banks and others to change this model and introduce improved legal frameworks for movable asset finance. Never has this new model been more needed than now, in a Covid-19 world.
Even in my home country of New Zealand, which has one of the best practice Secured Transactions frameworks in the world, the banks are primarily offering new Covid-19 loan schemes as an extension of existing credit limits only, where the SMEs already have property mortgaged, and that is despite an 80 per cent Government Guarantee on the new loans!
What about adding genuine new credit based on movable assets? Where is Purchase Order Finance – financing stock orders so that businesses can re-stock, or Contract Financing, Inventory Financing, and Accounts Receivable Finance/Factoring? Have banks forgotten how to do these well proven financing products or have they decided the administration and risk management is too hard?
Any change to the old banking model cannot come without a change to risk assessment.
Banks have been operating on a remote control points based credit scoring system that relies on the traditional client assessment criteria – 3 years of historical financial data, good payment and credit history plus a weighted value mortgage collateral over land.
It is a numbers game, simplified down so that credit decisions are easy. But of course only a few SMEs qualify. Movables-based finance, on the contrary, looks at the business cycle assessment first.
The loan repayment comes directly from the sale of the goods being financed, not from some theoretical long term profit projection. The question being asked is, does the client's business model work, can the assets we are financing be sold within the reasonable timeframe to repay this finance and can I track and control the funds through that cycle?
That is not a difficult process if the bank is open to trialling new products and new risk methodology, the type that IFC and ADB have been demonstrating to financiers and for which the legal systems have been strengthened.
Many banks around the world are already developing new products and lending capacity in the movable finance space but it has still been too slow. The old model is hard to move away from when Credit Committees and Boards are familiar with traditional property lending.
But right now is the time! This is a call to all banks to accelerate your product development work and move immediately into expanded movable-based finance products.
- Simon Thompson is an international specialist in Access to Finance for the SME sector.
