SMEs Financing Needs More Dynamic Approach

Jan 22 , 2022
By Asseged G. Medhin

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Bank lending is the most common source of external finance for many small- and medium-sized enterprises (SMEs) and entrepreneurs, which are often heavily reliant on traditional debt to fulfil their start-up, cash flow and investment needs. While small businesses commonly use it, traditional bank financing poses challenges to SMEs, particularly to newer, innovative and fast-growing companies with a higher risk-return profile. Countries like Ethiopia, where the economy is not financialised enough to adequately reach lower income households and rural areas aggravate the availability of financing.

Capital gaps also exist for companies undertaking important transitions in their activities, such as ownership and control changes, as well as for SMEs seeking to deleverage and improve their capital structures. The growing need for finance following the supply gap as SMEs move to industry, the long-standing need to strengthen capital structures and decrease dependence on borrowing has become more urgent because firms continue to fish in troubled waters.

Broadening and diversifying financial tools will thus create a competitive landscape for SMEs and grow the rate of return for financiers as they will be supporting the creation of sustainable businesses.

We have observed new banks and insurers coming to the sector. The capital market is also in the process of becoming operational. Such new developments should not mirror the traditional tools, which are full of policies, procedures and directives significantly deviant from dynamism. It does not mean that banks, financers, and insurers should not be stringent towards financial, management, and loan management. But since SMEs are highly dependent on bank financing and insurers, there is a broad concern that credit constraints will become the “forever normal” for them. It is necessary to broaden the range of financing instruments available to SMEs and entrepreneurs to enable them to continue to play their role in investment, growth, innovation and employment.

The supply of insurance and finance needs to be somehow related to the best interest of “mutual breakthrough,” the greater performance of SMEs will, in turn, kick off the target of both bankers and insurers. A more progressive perception towards SMEs considers that it benefits both parties. The goal can be achieved by encouraging discussion among stakeholders about new approaches to create innovative policies for SME and entrepreneurship financing.

We need to have a new broad range of external financing techniques, including “asset-based finance,” “alternative debt,” “hybrid instruments,” and “equity instruments.”

The techniques should map the financing modalities, the profile of eligible firms, enabling factors, trends and policies for tools within these categories. It includes analyses that highlight the different degrees of uptake by SMEs of these instruments and the potential for broader usage by certain categories of firms.

Asset-based finance is widely used by SMEs for their working capital needs and, partly, for investment purposes. In Europe especially, the prevalence of these instruments for SMEs is on par with conventional bank lending. Through asset-based finance, firms obtain funding based on the value of specific assets, including accounts receivable, rather than on their own credit standing. In this way, it can serve the needs of young and small firms that have difficulties in accessing traditional lending.

Policies to promote asset-based finance relate primarily to the regulatory framework, which is key to enabling the use of a broad set of assets to secure loans. Across OECD countries, active policies exist to support asset-based finance for businesses that are unable to meet credit standards associated with long-term credit.

While asset-based finance is a useful tool in the SME financing landscape, alternative forms of debt have had only limited usage, even within the larger size segment, which would be suited for structured finance and could benefit from accessing capital markets, to invest and seize growth opportunities. In Ethiopia’s experience, this approach creates a very stringent attitude on the performers in relation to securing the loan with collateral. Venture capitalists or innovators are not interested in coming along the way.

To foster the development of alternate financing, such corporate bond markets for SMEs have especially targeted transparency and protection rules for investors to favour greater participation and liquidity. In some countries, public entities participate with private investors to fund the SME bond market, with the aim of stimulating its development. Such initiatives and programmes should be encouraged in Ethiopia.

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PUBLISHED ON Jan 22,2022 [ VOL 22 , NO 1134]

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