Learn how industry innovations are working to level the playing field for access to cash, though historical inequities continue to persist.

May 18, 2022
By Taulia
By Taulia

Much has been researched and written about the global trade finance gap. In 2018, Taulia estimated that $14 trillion in working capital was locked up in global supply chains. In a post-pandemic world, this figure may approach an amount that is three times higher.

Small-to-medium enterprises (SMEs) particularly feel the impact of the trade finance gap. Lack of access to capital means these smaller businesses face recurring cash shortages that limit their ability to meet demand or even threaten ongoing viability. To counter tight credit access in the supply chain, large corporate buyers have sought out innovative fintech solutions for supply chain finance (SCF) to provide a reliable, cost-effective source of cash to SMEs.

But before we can appreciate how SCF helps SMEs, we need to understand why the gap in trade finance has not only persisted but also ballooned over time:

Risk appetite

Prior to lending, financing entities like banks need to assess the risk of an arrangement by finding answers to questions like the following:

  • What is being financed?
  • How will the borrower pay back the money?
  • What recourse is available if the borrower fails to pay in full?

Without the relevant responses to these and other questions, financiers are locked out. And since the data for making financing decisions must be current and reliable, SMEs in emerging markets where data of this caliber tends to be scarce are especially vulnerable.

“It all comes down to accurate information,” said Ali Ansari, Managing Director and Product Lead for Taulia’s payables solutions. “If that’s not available or if it doesn’t meet certain standards, the risk appetite of the financing entity dramatically decreases.”

Capital consideration

Since capital is limited, financiers have to consider which assets are worthy of their investment. Ansari, who spent 12 years managing trade and supply chain finance on behalf of banks, said financing entities prioritize their investment decisions on the expected return from the assets. It’s no surprise that higher-performing assets also get the lion’s share of the capital. This is especially true in a stressful economic environment when capital flies toward higher-quality assets. At the other end of the spectrum, SMEs require greater capital consideration because they carry a higher financial risk. On a global level, SMEs end up fighting for the scraps.

“Poor financial infrastructure or governance maturity of some regions makes the cost of acquiring and servicing SME customers prohibitive,” Ansari says. “When you take everything into account, lending only happens at high rates and with terms that are too hard to stomach for a lot of SMEs.”

Domestic liquidity

Even when risk appetite and capital considerations are not blockers, SMEs can face problems borrowing due to domestic liquidity constraints. These constraints develop whenever a local currency is under pressure, especially when a significant, negative trade balance in an emerging market exists (such as when Egypt had to devalue its currency by 48% to meet the demands of a $12 billion International Monetary Fund loan).

The mismatch between liquidity pools for domestic and cross-border trade, which is mainly denominated by a few foreign currencies, can be a major blocker for SME access to credit. Cross-border financing for SMEs requires the additional consideration of financial exchange movements, payment controls, and reliance on financial institutions located in a handful of international markets.

SCF frees SMEs from the credit crunch

Now that we’ve seen how SMEs on the global stage face practically insurmountable challenges in obtaining traditional financing, let’s turn our attention to how SCF brings in capital and liquidity at attractive rates for SME financing:

Technology that sources credibility

Financing through SCF relies on information provided by a larger buyer, which is generally considered to be an independent and credible source by financing entities like banks. The provisioning of this information from a buyer’s ERP, for example, validates the financier’s business case and reduces risk.

What’s more, because the program is underpinned by the buyer’s obligation to pay, SMEs are not required to sign any complex collateral documentation — which also benefits the lender because the contract with the buyer is easier to enforce.

“Innovative SCF solutions have the added benefit of technology that makes the repayment flows transparent and easier to control for the financier,” said Ansari.

Capital that’s used optimally

Since better risk profiles require less capital overall, SMEs can receive optimized financing through SCF. You see, the risk of repaying the financier is tethered to large corporate buyers, which provide confirmation of payment on a set due date.

One of the reasons this arrangement works so well, according to Ansari, is because funding to SMEs through SCF can come at attractive rates without negatively impacting the capital return requirements of the financing entity. The effectiveness of SCF in pumping up supply chain liquidity is the major reason the U.S. and U.K. governments encouraged some of the large enterprises in their respective countries to launch SCF programs as opposed to more traditional financing through banks during the downturn of the Great Recession.

“On one hand, these governments were asking the banks to reinforce their own balance sheets, but they also wanted more lending directed towards SMEs,” said Ansari.

Cash flow without borders

SCF allows for financing of cross-border transactions to SMEs of emerging markets without difficulty. The local cross-border payment controls that could pose problems in such economies is blunted by the way in which SCF programs can leverage the repayment by foreign buyers, based in a financial hub or a more developed market versus getting money back from suppliers in emerging markets.

Ansari says SCF does more than provide a hedge against these cross-border challenges: “It actually unlocks more liquidity for SMEs,” he said.

The future of unrestrained cash flow

Though SCF is making substantial progress in removing barriers to shrinking the credit gap for SMEs, Ansari points out that more could be done in the public sector to support the effort. “Governments need to recognize that technology is the great socio-economic equalizer of this century,” he said. “Investments in infrastructure have changed the landscape of financing in many markets, but that needs to continue.”

Policymakers have taken some steps in the form of digital business registries for more transparency into capital needs or requirements for SME financing. As governments team up with innovators, Ansari hopes finance can become truly digital by addressing information access, risk management, and our ability to pair liquidity with the right needs.

“We need to make finance available in places where trade happens, embedded within the ecosystems of buyers and sellers,” Ansari said. “SCF has made great progress in doing that; there’s still a long way to go.”