UAE's small and medium business financing could do with some change

It’s a perennial chicken-and-egg game in the world of business lending.

The better a SME performs, the more it has access to vital working capital. And the more it has access to capital, the better positioned it is to ride short- and long-term shocks.

In a world of increasing credit crunch, SMEs need more than just incumbent solutions to tide over. The contribution of SMEs to UAE’s economic growth cannot be discounted in any way. While personal remittances play a significant role, trade remittances have long held the ship steady.

Unfortunately, in the face of threats arising from migrant exodus and abrupt business disruptions, access to funds is no longer a prerogative small businesses can take for granted. Adherence to strict compliance and regulatory proceedings, tools to track a business owner’s financial footprint and better forecasting of the market landscape have in one way or the other put a brake on the lending spree of traditional financial institutions.

While recent developments may well justify this prudence, there are other ways to maintain liquidity for SMEs to thrive. One such impactful solution is Supply Chain Financing (SCF), a model that puts the onus of repayment risk on the buyer, instead of the SME who may have initially taken the loan to service a guaranteed invoice.

SCFs have been around for a good part of the last three decades, but has gained traction in recent years, especially with international trade getting more complex and multi-dimensional. In fact, a McKinsey report pegs the SCF business at $2 trillion, with most programmes catering to sectors such as automotive, manufacturing, retail, technology and capital goods.

Take on recessions

Let us consider an example to better understand how SCF can be a recession-buster for SMEs.

In the UAE, a furniture merchant will traditionally approach a bank for working capital to procure and supply goods to a vendor. The merchant absorbs the entire risk of loan, under the assurance of being paid by the vendor within a stipulated period, of say, 60 days.

In the event that he is not repaid within this duration, the interest on the loan piles up, affecting his credit score, and subsequently his ability to acquire more working capital to service his other orders. Such scenarios are common, and small firms often wind down due to issues arising from late payments and bad debts rather than dip in sales.

A structured SCF programme will allow the merchant to recover the entire invoice amount as soon as possible, albeit at a discounted price, while banks and investors work with the merchant to get the invoice fulfilled within a mutually agreeable period.

Such a hassle-free environment permits the smooth flow of working capital for subsequent transactions, allowing SMEs to do what they do best - run the business. Without being bothered about invoice recovery or financial crisis arising from erratic vendor payments.

Several economies in Europe and Asia-Pacific region have long adopted alternate structured programs such as SCF to tide over working capital issues faced by SMEs.

Spread it around

The primary intention is to provide a holistic, cross-regional financing solution for global supply chains, by tackling credit crunch through timely honoring of invoices and reduced risk of default.

Understandably, SCF carries an element of major risk and can derail the delicate balance at which traditional lenders operate. But modern fintech-driven SCF platforms, have made this possible. Modeled on algorithms that consider multiple data points and minimal consumer touchpoints, they enable SCF propositions to exist through easy-to-use digital tools and onboarding processes.

This allows financial institutions and investors to plug into an interlinked system remotely. As one of the most innovative economies, the UAE has made the right moves so far towards embracing SCF commercially. In its pursuit to becoming a financial hub, a creative structured proposition such as SCF will usher in much-needed foreign funds and allow local companies to access the liquidity offered by international investors and banks.

The government can give a further fillip by playing the role of a facilitator - leading information campaigns and deploying SCF for direct and indirect projects of its undertaking.

This will not just reduce the strain on the local banking system, but ultimately achieveg financial inclusion in its truest sense. Of removing credit friction and reducing transaction costs, for all stakeholders of an ecosystem.

Be it be for individuals, or for underserved SMEs that form the backbone of a modern, financially healthy society.

- Adeeb Ahamed is Managing Director of LuLu Financial Holdings and Chairman of LuLu Capital.