As with the global economy, small and medium-sized enterprises (SMEs) provide the backbone of Asia’s economic growth. The Asian Development Bank (ADB) has estimated that SMEs account for over 90% of all enterprises in the region and employ over 60% of its workers. A September 2015 study by the World Bank (WB) found that the majority of formal jobs in emerging markets are with SMEs, which also create four out of every five new positions.
However, it’s no secret that the growth of these crucial organisations is being severely stifled by a lack of financing. The WB study highlighted that over 50% of SMEs are held back by insufficient funding.
A deepening problem
The situation was first exacerbated by the fall-out from the 2008 global financial crisis, and is now at risk of worsening further due to continued geopolitical uncertainty.
Add regulatory developments and tighter control into the mix – for example, the introduction of the Basel III capital adequacy requirements – and banks are increasingly tightening their belts and focusing on big business, their existing, trusted client base.
An SME in Singapore typically needs to have over S$30m (US$22m/€20m) in sales revenue and have been in business for a minimum of three years in order to qualify for a loan for working capital from a bank, unless it falls under a subsidised scheme such as Singapore’s micro loan programme (MLP), which can provide as much as S$100,000 for a period of up to four years.
So in this age of fintech and financial transformation, it has never been more crucial to offer solutions that can feed more SMEs quickly, providing them with the access to capital by which they live or die.
Stepping into a widening gap
This is where alternative finance providers are stepping in. Invoice financing and peer-to-peer (P2P) platforms provide an online marketplace for SMEs to sell short-term invoices to accredited or institutional investors. These invoices are from local businesses, which sell them at a discount to their face value. Investors realise a return when the invoice is paid by the debtor.
Invoice financing is on the rise as it enables companies to improve their cash flow by using their sales invoices as collateral through which to borrow funds, instead of waiting for payment or compromising their credit rating through other channels.
Previously, a company would sell its invoices at a discounted rate through a brokerage, but technology now allows funders to make this investment practice available to a wider audience – and sophisticated algorithms mean that they are able to offer fractional investment easily.
Invoice financing – and specifically invoice discounting – has a number of advantages over other sources of alternative funding. It provides companies with greater flexibility and the ability to raise interim funds, access funds quickly and sell as many invoices as they want. A suppler tool than invoice factoring, discounting allows companies to sell their invoices individually. In factoring, companies sell their whole receivables book.
Companies can now get the working capital that is becoming increasingly unavailable from banks, with their increasingly strict criteria. For example, our own invoice financing platform works with SMEs that can show sales revenue of over S$100,000, have been in business for more than a year and can secure the financing with credible account receivables (ARs).
Also, the capital can be continuously rolled over to use on an ongoing basis without new approvals. So it’s akin to a revolving credit line, helping SMEs to grow and stay in business while creating an environment in which they can innovate and flourish.
Rewarding and protecting investors
The invoice financing model differs from P2P lenders as it involves the selling of an asset; it’s selling the invoice to the investor who then subsequently has recourse over the debtor if it’s not paid. This creates more security compared to loan financing.
The default rates on platforms that make loans are generally much higher than invoice financing, and so the risks are higher for the investor.
Well-run invoice financing platforms evaluate not only the credit worthiness and financial strength of the debtor but also that of the seller, since if the debtor doesn’t settle the invoice within 30 days after the expected due date the seller needs to be able to repurchase the invoice. Aside from evaluating quantitative metrics, our own platform looks at more qualitative elements such as the history of the relationship between seller and debtor. All elements are then put through a scoring system which generates the grade for the invoice.
Investors benefit from annualised returns of 11%-25% depending on the grade of risk of the invoice, during a 90-day investment window. The higher the grade of risk, the higher the returns. Transparency is at the heart of the model, with investors managing the process on the platform themselves and tracking the performance and return on each invoice they invest in.
Looking to the future
The invoice financing marketplace platform model will grow exponentially, further disrupting the banking sector. This is simply because the sizeable gap in the market that banks don’t fill is now being satisfied with a lower-cost, faster and easier funding solution – and investors want the higher returns they can achieve on P2P platforms.
It also appeals – and is relevant – to all sectors and geographies, because there are innovative SMEs around the world which want to grow and achieve success. They all need cash flow to fund their ambition.
Our firm has seen first-hand that Singaporean SMEs are selling quality invoices with low default rates and, crucially, they are reusing the platform. Singapore is a global financial hub, a very attractive growth market, and the Monetary Authority of Singapore (MAS) is supportive of new businesses.
Invoice financing has massive potential to transform the prospects of SMEs across Asia and in turn provide a considerable boost for the wider economy.
Many banks around the world, large and small, continue to experience major security failures. Biometric systems such as pay-by-selfie, iris scanners and vein pattern authentication can help.
The implementation date of Europe's revised Markets in Financial Instruments Directive, aka MiFID II, is fast approaching. Yet evidence suggests that awareness about the impact of Brexit on MiFID II is, at best, only patchy and there are some alarming misconceptions.
Despite all the automation and improvements that digital banking has the potential to achieve, customers and their needs still form the very core of the banking sector.
Banks might feel justified in victim blaming when fraud occurs, but it does little for customer confidence.