The COVID-19 pandemic has exerted catastrophic pressure on businesses around the world and Asian businesses have not been exempted.
Following unprecedented disruption to supply chains and an economic crisis similar in scale to the Great Depression, many of the region’s SMEs – APAC’s economic backbone and critical to its economic recovery – are struggling to access the finance they need to weather the storm.
However, SME underfunding is not a new issue for the region. Of the US$5.2tn global SME funding gap which existed prior to the crisis, the International Finance Corporation (IFC) estimated that around US$2.4tn of the shortage fell in APAC alone. Without access to capital market products such as corporate bonds, and with private equity and other alternative investment vehicles being reticent to unleash any dry powder they might have, the region’s SME funding gap is only likely to have increased since the outbreak of the virus.
Fortunately, supply chain finance (SCF) represents a solution. Due to increasingly sophisticated digital capabilities in this space, lenders can now securely fund a wider spectrum of Asian SMEs, boost cash flows in their hour of greatest need, and capitalise on the immense growth potential offered by these businesses.
Asian SMEs and COVID-19
Even before COVID-19, a chronic lack of funding meant that a significant proportion of Asia’s start-ups and other small businesses were poorly capitalised and relied on their doors remaining open in order to stay relatively liquid. As COVID-19 spread across the globe, economists rightly warned that the main economic casualty of national lockdowns would be SMEs globally. This is certainly true of Asia.
As a result of the pandemic and resulting lockdown, many of APAC’s otherwise viable SMEs have struggled to survive, significantly impacting the region and its economic recovery. Not only do SMEs represent more than 90% of the region’s businesses, they also employ 50% of its workforce and account for anywhere up to 50% of individual Asian countries’ GDP, depending on their level of development.
While many APAC nations have recognised the plight of their SMEs and injected billions of dollars-worth of SME-targeted fiscal stimulus, these measures are not sufficient to fully plug the current funding gap, or even the US$2.4tn which predates the virus. However, banks and other established lenders can do more to support businesses pivotal to the region’s economy.
Innovation in SCF benefits lenders and SMEs
Beyond the incentive to help SMEs and therefore mitigate the wider economic impact of COVID-19, lenders stand to make a sizeable financial gain from supplying APAC’s high-growth businesses with the financing they need. Asia’s GDP has consistently grown at just under 6% per year for the last five years and the region is expected to account for 60% of the world’s GDP growth by 2030, meaning the region’s SMEs are a potential high-growth asset like no other.
One obstacle standing in the way of banks and other lenders from seizing this valuable opportunity is the risk presented by small or young high-growth businesses and the inefficiencies in out-dated SCF systems, which often adopt an entirely one-size-fits-all approach unsuitable to SMEs.
Yet, with technologically advanced SCF solutions, a large part of the risk involved in funding these companies can be alleviated through enhanced visibility and oversight. Furthermore, increasingly sophisticated digital capabilities have replaced previous manual, time-intensive and paper-based procedures and have made SCF more efficient and, in turn, more accessible to SMEs.
A growing opportunity
As technology has made it much easier for lenders to assess the viability of smaller businesses and to onboard them, factoring (another form of finance that provides advances to SMEs that are secured against their invoices) and SCF have continued to grow in popularity. In the APAC region alone, factoring has grown by almost 300% since 2012, and countries in which SMEs have historically faced the highest barriers to accessing finance are exhibiting the greatest rates of growth. This is a promising starting point for SMEs and the lenders that seek to support them in the wake of COVID-19.
In fact, SCF in the APAC region is expected to increase by a further 10% this year – although this figure is likely to increase due to SMEs’ current liquidity concerns.
And, with McKinsey & Company reporting an estimated US$2tn in secure, readily financeable payables worldwide and a potential revenue pool of US$20bn, there is still significant scope for broader adoption of SCF among lenders and SMEs.
The different benefits of SCF and factoring
Whilst factoring is a well-established form of financing SMEs in the APAC region, SCF, which is also known as reverse factoring, is a relatively novel funding solution. Both factoring and SCF/reverse factoring are solutions that use invoices as the underlying asset in order to help companies optimize their working capital. However – as their respective names suggest – these two solutions solve the problem from opposite directions.
Factoring allows businesses to attain most of its accounts receivable (the money owed by its customers) long before the maturity date of the its outstanding invoices. This is achieved by bringing in a third-party factoring provider – a bank or specialist lender – which would buy the business’s invoices and advance a discounted amount relative to the total invoice.
Whereas the key benefit of factoring is that it provides businesses with immediate liquidity, a central advantage of SCF is that it boosts a business’s bargaining power with the vendors to whom it owes money and gives that business more time in which to generate the money needed to pay off its debts, or accounts payable.
Again, this is achieved by bringing in a third party who, at a discounted rate on the outstanding value of the invoice, immediately pays off the vendors which the buying business owes. The third-party lender then extends the payment period for the buyer granting them more time to earn the amount needed to pay off the invoice.
SCF therefore benefits both vendor and buyer, as it provides the former with quick access to cash and permits the latter to delay repaying its outstanding debts. In this way, SCF solutions encourage collaboration between buyers and sellers, opposing the sometimes-obstructive competitive dynamic that can arise between the two.
A way ahead for APAC
Supplying SMEs with the funding they need has never been more pertinent than during the current crisis which threatens millions of business owners and employee livelihoods. Moreover, thanks to new tech, financing a broad pool of viable but cash-poor SMEs is not only possible for lenders in risk-terms but also quickly and easily achieved and managed.
Alongside the immediate financial benefits of expanding lending capabilities into a largely untapped market, employing the latest SCF solutions provides lenders with a way to drive APAC’s economic recovery at a time when it has never been more critical.
Article written by:
Kheng Leong Lee
Asia-Pacific Representative, HPD LendScape
First appeared on: TRF News