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Unlocking the Small Business Working Capital Problem



Everyone is concerned about the second wave of Covid-19. Cottages, micro, small and medium enterprises (CMSME) have already been seriously affected. In a survey conducted by the Bangladesh Bank, 45 banks estimated that SMEs were severely affected by the first wave.

The pandemic has reduced the supply of products for the SME sector ranging from agriculture to manufacturing by any percentage between 13% and 32% in 2020. In addition, physical remoteness and restriction of movement have changed the mechanism. traditional supply chain process (SCP) in terms of sourcing choices, locations and techniques.

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Buyers are increasingly putting pressure on suppliers to buy on open account credit terms and obtain more periods of credit in local and international trade. Additionally, buyers usually don’t pay the money by the due date and in some cases even default.

The production units in the CMSME sector are therefore faced with enormous challenges in managing their working capital. To this end, besides the use of the stimulus program by real companies, supply chain finance (SCF) could also be useful.

SCF is a scalable financial service using various services such as factoring, reverse factoring, distributor financing, inventory loan or advance, and pre-shipment financing. It allows sellers to obtain financing for the sale on credit immediately after delivering products and services cheaply, without warranty and with minimal documentation.

On the other hand, buyers will have a comfortable credit period to pay money to financiers or suppliers. The funding provided by banks and financial institutions (FIs) under the SCF is explicitly dependent on the amount of sales and is tied to the quality of a supplier’s accounts receivable rather than the supplier’s overall creditworthiness. It therefore allows high-risk suppliers to transfer their credit risk to their quality buyers.

SCF is not a widely used financial service in Bangladesh. It is mainly confined to urban areas to a limited number of CMSME providers.

The size of the SCF portfolio of banks and FIs in Bangladesh is only around $ 102 million, although the total estimated market size is around $ 6-8 billion. About 90 percent of the market is captured by FIs, and the remainder goes to bank portfolios. Therefore, banks and FIs may consider offering SCF more widely to all sectors, especially CMSMEs.

Agriculture and related fields could be a potential area for CFS. We need to promote agriculture and agribusiness to meet our vast local demand first and, if possible, export. In this regard, the value chain system and the SCF are called upon to play a complementary role.

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

However, the preference of buyers, whether local or foreign, to buy on credit creates a serious working capital problem for agro-suppliers as most of them are financially weak. Therefore, SCF can help suppliers by financing immediately after the sale of their products on credit.

Encouragingly, a few FIs have started offering SCF for the supply of agricultural products even in remote areas by securing a guarantee from reputable local buyers. Banks can offer SCFs to agro-suppliers using their huge online network.

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

Difficulties with guarantees and documentation sometimes prevent the CMSME industry from using traditional banking services for working capital financing, such as cash credit and bank overdraft. The SCF can alleviate the problem of guarantees and documentation through its inherent mechanism.

Governmental and semi-governmental organizations typically make bulk purchases on credit from agricultural producers and CMSME suppliers. SCF can provide instant working capital to these suppliers by obtaining the approval of the relevant authorities.

The current stimulus package offered by the government and the Bangladesh Bank is primarily intended to support the working capital of producers and suppliers at a subsidized interest rate. Banks and FIs can use this fund to finance suppliers belonging to the CMSME sector through the SCF.

In the current difficult situation, we cannot ignore requests for a longer period of credit from foreign buyers to achieve the export target of $ 60 billion by 2021. However, the tendency to extend the period credit as well as the risk of insolvency of foreign buyers could increase in the future.

Right now we have almost $ 8 billion in international trade accounts receivable, which is a concern. Different forms of SCF products used in international trade finance, such as two-factor system, reverse three- and four-corner factoring, and back-to-back factoring, can be used to reduce the amount of accounts receivable.

The 2018-2021 export policy has already recognized factoring as a legitimate method of financing international trade. In addition, the BB authorized banks to offer export factoring in June of last year.

The above-mentioned potentials can be realized provided that some initiatives are taken.

In the virtual world, we are already used to doing transactions electronically. The role of digitization becomes even more important in the midst of the pandemic as the processing and transfer of physical documents is now problematic. Digital platforms can extend the SCF service even to remote areas of the country for the national CPC and to distant countries for the international CPC with the same level of efficiency and transparency.

In addition, a digital platform offers a seamless authentication process of relevant documents, a transparent KYC (know your customer) verification method, and a system for streamlined information sharing between the parties involved. Banks can use their own platform to offer SCF. But if they don’t have their own platform, they can share the platforms of other banks and FIs.

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

The cost of funds for SCF services is an essential element for the acceptability of the aforementioned services. The BB has set a ceiling on providing this financial service to exporters (6-month US dollar Libor interest rate plus 3.50% per annum) in order to reduce the cost of exports.

To respect the BB ceiling, banks now offer international factoring in collaboration with international financiers like Trade Wind.

BB could 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 in turn will pave the way for the practice of a two-factor system, which is imperative to make international factoring sustainable in any economy.

A conducive legal system and appropriate political support are prerequisites for this financial service to flourish in all parts of the SCP.

If buyers do not pay bills to financiers on time or pay bills at all, the type of legal action that a bank or FI can take is nowhere defined. Public and private procurement policy could be changed by retaining the possibility of giving a letter of consent to financiers to pay money to banks and FIs, instead of suppliers.

The acceptance of the assignment in legal proceedings as the right to own and collect money on behalf of suppliers, uniformity in the service offering and the issuance of stamp duty should be well defined by regulation and policy. A procedural guideline delineating all the details of the SCF is also essential for understanding and streamlining the financial service to ensure greater acceptability for suppliers, buyers, banks and FIs.

The author is a professor at the Bangladesh Institute of Bank Management. He can be contacted at [email protected]



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