Acceptable solution for bringing diaspora into SME finance?

It is the unfortunate situation in Serbia today that small and medium enterprises (SMEs) stagnate in the environment of weak consumer purchasing power, slow and uncertain collection of receivables and almost unworkable funding. Adding to this insufficient business knowledge of entrepreneurs and management as well as often outdated technology available to them, it seems to me that this crucial part of our economy is a long way to become a driving force.

A few years ago I participated in the international conference in Johannesburg on the topic of SME finance with delegates from the International Finance Corporation (IFC), banks from Europe, Africa and the USA with relevant experience as well as other parties. It was to my surprise to learn about the range of assistance – not only funds – that IFC provides to local banks all over the world for setting up a system of SME finance.

Most of the discussions concerned suitable solutions for reducing lender’s risk – in this case, the bank. My second surprise at the conference was to learn from the participating banks that they found lack of business skills among owners and their management teams as the key risk contributor. Interestingly, majority of banks had not insisted on significant collateral (i.e. over 35%), but their focus was on checking references, previous loan history and testing knowledge and business skills of entrepreneurs and evaluating project risk from the business plan. The focus was on finding “cracks” in the business plan and cash flows in order to reach reasonable assurance that the idea can profitably be realized.

The conclusion was that a bank who is in the business of SME finance should, in order to reduce own risk and increase project chances to succeed, get involved and often supervise an entrepreneur by transferring the necessary knowledge and/or mentor her/him until the debt is repaid.

To my knowledge banks in Serbia presently insist on high collateral up to the full value of a proposed loan and, since most SMEs can’t afford this, SME funding i.e. this part of the economy is stacked. On the other hand, this practice doesn’t reduce overall risk for banks either. Adding to that, after some SMEs finally manage to get a loan, the bank will not “bother” to call and check their performance and strategy execution until those enterprises fail to pay installments when it usually becomes too late.

Taking all these arguments into account my belief is that, in order to succeed, banking with SMEs should be practiced separately – through a specialist bank or at least a specialist division of large one.

Therefore, my proposal for Serbia is to establish a new specialist bank. It must be backed by the state but only for smoothing regulation and bureaucracy and to provide insurance for unsuccessful projects – not to manage bank operations and funds allocation. New bank will be financed with capital from EBRD, private investment funds, commercial banks and private investors – foreigners and individuals from Serbia and diaspora. It will be „for profit“ to all investors except the state. „For profit“ investors will set up the board, appoint management and make them accountable. The state will take the knock of nonperforming loans but only after it agrees on the lending procedure and full transparency of the banking process.

Here is another solution. I find American model of “peer lending” quite interesting and probably most acceptable for our diaspora as it would bring investors and SMEs much closer – the bank serves as administrator and doesn’t provide capital although some additional capital from the state and EBRD for example may work as amplifier. It works like a „funding club“. Entrepreneurs seek amounts as low as $2,000 and the lowest investment unit is $25. One good example is Prosper (www.prosper.com) with more than 1.6 million members and over $500 million in loans. As a new project is listed on bank’s website member investors can see the business plan, risk assessment and credit history as well as all about the entrepreneur such as other borrowings, recommendations from friends, business partners and other organizations. Each contribution goes directly to a specific project and when those accumulate in one’s portfolio the overall investor’s risk is reduced (some projects will always fail). This model proved successful in UK too. Read article from MT.

Considering huge untapped financial potential of our diaspora (think $5bn transfer each year, hardly anything for investments) who is primarily distrustful of state institutions when interfering and/or managing their investment money such transparent bank with professional management that is accountable only to its commercial investors may be a winning idea. Our professionals from diaspora are naturally in a better position to make positive contribution to SMEs in a way of improving quality of decision-making, bringing information about new technologies and markets as well as providing crucial business contacts – especially for export. The state would in turn simplify regulations and eliminate 90% of bureaucratic procedures for the registration and management of SME business as well as provide additional tax relief to both investors and SMEs who participate in the scheme (think 3,000 – 10,000 EUR for each new job created!).

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One response to this post.

  1. Reblogged this on SBI Training Solutions and commented:
    This article is really inspiring for Vietnam’s economy also. Thanks for sharing.

    Reply

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