Unlocking working capital problem of small businesses

Everybody is concerned about the second wave of Covid-19. Cottage, micro, small and medium enterprises (CMSMEs) have already been affected severely. In a survey conducted by the Bangladesh Bank, 45 banks opined that SMEs were dreadfully affected by the first wave.

The pandemic reduced the supply of products of the SME sector ranging from agriculture to manufacturing by any percentage between 13 per cent and 32 per cent in 2020. In addition, physical distancing and restriction on travel shifted the traditional mechanism of the supply chain process (SCP) with respect to choices, places and techniques of sourcing supplies. 

Buyers are increasingly pressuring suppliers to buy on open account credit terms and getting more credit periods in local and international trade. Further, buyers now usually fail to pay money on the due date and even default in some cases.

Production units in the CMSMEs sector, therefore, are facing tremendous challenges in managing their working capital.  To this end, apart from the utilisation of stimulation package by genuine enterprises, supply chain finance (SCF) might also be helpful. 

The SCF is an evolving financial service using various services such as factoring, reverse factoring, distributor finance, loan or advance against inventory and pre-shipment finance. It enables sellers to get finance for credit sale immediately after delivering products and services at a lower cost with no collateral and minimal documentation.  

In contrast, buyers will get a comfortable credit period to pay money to financiers or suppliers. The finance provided by banks and financial institutions (FIs) under the SCF explicitly depends on the amount of sales and is linked to the quality of a supplier's accounts receivable rather than supplier's overall creditworthiness. It, therefore, allows high-risk suppliers to transfer their credit risk to their high-quality buyers.

The SCF is not a widely used financial service in Bangladesh. It is mostly confined to the urban areas to a limited number of CMSME suppliers. 

The portfolio size of SCF of banks and FIs in Bangladesh is only about $102 million, although the total estimated market size is around $6-8 billion. Around 90 per cent of the market is captured by FIs, and the remaining portion goes to banks' portfolios. Hence, banks and FIs may plan to offer SCF more extensively to all sectors, particularly CMSMEs.

Agriculture and allied fields might be a prospective area for SCF. We need to promote agriculture and agribusiness to fulfil our vast local demand first and if possible, to export. In this regard, the value chain system and the SCF are required to play a complementary role. 

In the value chain system, farmers need to be part of a chain in which everything can be identified to have the right information to tap into the growing urban-based local and global market.

However, buyers' preference, irrespective of local or foreign, to buy on credit creates a severe working capital problem for agri-suppliers as most of them are financially weak. Hence, SCF can assist the suppliers through financing immediate after selling their products on credit. 

It is heartening that a few FIs have started to offer SCF to the supplies of agri-products even in remote areas by securing a guarantee from reputed local buyers. Banks may come up to provide SCF to agri- suppliers by using their huge online network.

The government has launched an online platform for buying food grains and agricultural products. Immediate funds can be given to suppliers for selling products to the government on credit against consent or guarantee letter from the authorities. 

Difficulty relating to collateral and documentation sometimes keeps the CMSME sector away from using traditional banking services for working capital finance like cash credit and bank overdraft. SCF can ease the problem of collateral and documentation with its inherent mechanism. 

Government and semi-government organisations usually go for bulk purchases on credit from agri-producers and CMSME suppliers. SCF can provide instant working capital support to these suppliers by taking consent from the relevant authorities.

The current stimulus package offered by the government and the Bangladesh Bank is mostly for working capital support to producers and suppliers at a subsidised interest rate. Banks and FIs can utilise this fund to finance suppliers belonging to the CMSME sector through the SCF.

In the current predicament situation, we cannot ignore the demands of more credit period of foreign buyers to achieve the export target of $60 billion by 2021. However, the tendency to extend the credit period along with the risk of insolvency of foreign buyers might increase in the future.

At present, we have almost $8 billion accounts receivable in international trade, which is a cause of concern.  Different forms of SCF products utilised in international trade finance like two-factor system, three-corner and four-corner reverse factoring, and back-to-back factoring can be utilised to lessen the amount of accounts receivable.

The Export Policy, 2018-2021 has already recognised factoring as a legitimate international trade financing method. Also, the BB permitted banks to offer export factoring in June last year.

The aforesaid potentials can be accomplished subject to undertaking a few initiatives.

In the virtual world, we are already in the practice of doing transactions electronically. The role of digitalisation becomes even more important amid the pandemic, as dealing with and transferring physical documents is troublesome now. Digital platforms can extend SCF service even to the country's remote areas for domestic SCP and to far-away nations for international SCP with the same level of efficiency and transparency.

Further, a digital platform offers a flawless authentication process of relevant documents, a seamless verifying method of KYC (know your customer) and a simplified information sharing system among relevant parties. Banks may use their own platform to offer SCF. But if they do not have their own platform, they may share platforms of other banks and FIs. 

Furthermore, the Real Time Gross Settlement and the Bangladesh Electronic Funds Transfer Network can be used to pay and send money to the suppliers immediately after the delivery of the products and services.

The cost of funds under SCF services is a vital element for the acceptability of aforesaid services. The BB has given a cap to offer this financial service to exporters (6-month US dollar Libor interest rate plus 3.50 per cent annually) with a view to reducing the cost of exports.

To comply with the cap of the BB, banks now offer international factoring in collaboration with international financiers like Trade Wind.

The BB may consider allowing banks to use the export development fund to provide low-cost post-shipment finance to exporters in the case of international factoring. This will, in turn, pave the way to practice a two-factor system, which is imperative to making international factoring sustainable in any economy.

A conducive legal system and proper policy support are prerequisites to flourishing this financial service in all points of the SCP.

If buyers do not pay bills to financiers on time or do not pay the bills at all, what type of legal action a bank or FI can take is not defined anywhere. Public and private procurement policy might be changed by keeping an option for giving a consent letter to financiers to pay money to banks and FIs, instead of suppliers.

Acceptance of assignment in the legal procedures as the right to own and collect money on behalf of suppliers, uniformity in offering service, and the issue of stamp duty are required to be well-defined by the regulations and policy. A procedural guideline delineating all nitty-gritty of the SCF is also essential to understand and streamline the financial service to ensure more acceptability to the suppliers, buyers and banks, and FIs.

The author is professor of the Bangladesh Institute of Bank Management. He can be reached at banerjee1167@yahoo.com.