Breaking down barriers: The Significance of Financing Reforms for Small and Medium-Sized Enterprises
Small and medium-sized enterprises (SMEs) might not always make the headlines, but they are the unsung heroes of economies worldwide. From bustling metropolises to remote villages, SMEs play a pivotal role in driving economic growth, employment, and export revenues, especially in emerging markets.
Picture this: a local family-owned bakery in a quaint town, a tech startup in a bustling city, or a handicraft workshop in a rural village. What do they have in common? They’re all SMEs, and they’re all contributing significantly to their respective economies.
In a recent survey across 20 key Asian countries, SMEs emerged as dominant players, constituting 96% of all enterprises and provide employment to 62% of workforces across these 20 countries and contributing an average of 42% to gross domestic product (GDP) or manufacturing value-added. This assertion also holds true in Malaysia whereby 97.4% of businesses fall under the category of SMEs.
A closer look at the Challenges Faced by SMEs in Accessing Financing
SMEs are vital to Malaysia’s economy, driving employment, innovation, and growth. Nevertheless, they encounter substantial barriers that impede their progress and growth, as accessing essential financing is not always straightforward for them. Let’s delve into the specific challenges faced by these enterprises in Malaysia.
Limited Collateral
The insufficient collateral among SMEs not only leads to higher interest rates on loans but also poses a significant barrier to expanding SME credit. Traditional financial institutions, such as banks, often require collateral to secure loans, yet many SMEs struggle to provide tangible assets or property, especially during their early stages. This limitation severely limits their ability to access loans and lines of credit, hindering their growth potential.
In stark contrast, multinational companies encounter a much lower rejection rate , with only 7% of their financing requests being declined. This discrepancy underscores the challenges SMEs face in securing financing compared to larger corporations.
Businesses Are Deemed Too New
The youthfulness of a business often becomes a hurdle when seeking traditional financing, as SMEs are frequently informed that their venture is too new. Banks typically mandate a business to have a minimum operational history of two years to be eligible for loans. This requirement stems from the necessity for a business to demonstrate its potential for success and sustainability over a defined period. Establishing a track record of success is vital, as it signifies profitability and reduces the perceived risk for lenders.
Figure: New SME and total Business Lending Annual
However, this poses a dilemma for new businesses in need of capital to kickstart their operations. Figure 1 illustrates the disparity between the required total business lending and the actual amount lent to new businesses. Obtaining loans from banks as a small business proves challenging, underscoring the importance of seeking alternative funding avenues.
Regulatory Barriers
In many developing nations, banks often lack robust internal ratings-based models due to data scarcity related to SME exposures. This leads to SMEs receiving unfavourable external credit ratings, resulting in significantly higher financing costs compared to larger enterprises. Credit rating models employed by agencies tend to treat both large companies and SMEs similarly, despite SMEs’ constrained financial depth and individualised corporate governance structures. This discrepancy significantly inflates the cost of funds for financial institutions, as risk weights for SMEs can climb to 100% or higher, compared to a manageable 20% for higher-rated borrowers. As a result, SMEs face a substantial financial burden, hindering their ability to compete effectively in the market.
Another significant concern arises from the implementation of liquidity and leverage requirements in the financial sector following the global financial crisis. Post-crisis financial regulations demand high-quality assets, posing challenges for SMEs due to their low credit ratings and underdeveloped capital markets in emerging economies.
Insufficient Use of Information Communication Technology in SMEs
In today’s dynamic business landscape, the integration of information and communication technology (ICT) has become more than just a choice – it’s a necessity. However, despite its undeniable importance, many businesses in Malaysia, particularly those in rural areas, still lag behind in adopting ICT. This presents a worrisome scenario, especially for SMEs that overlook the adoption of digital technologies. Without embracing ICT, SMEs risk limiting their visibility to larger markets and jeopardising their long-term sustainability. According to studies, the detrimental impact of limited ICT access on SMEs are hindering their ability to innovate and thrive in today’s competitive business environment in Malaysia.
Facilitating SME Financing Through FinTech and Government Support
Given the pivotal role of SMEs in Asian economies, it is imperative to explore avenues for ensuring their access to stable financing. The emergence of FinTech has brought about a transformative shift in SME financing, introducing groundbreaking solutions that simplify procedures and offer seamless access to capital. Platforms such as peer-to-peer lending, invoice financing, and crowdfunding have revolutionised the landscape, empowering SMEs with new avenues for funding. By leveraging these digital platforms, SMEs can overcome traditional barriers to finance and access capital more efficiently.
Numerous government and donor programs have been established in many countries. Among these initiatives is the credit guarantee scheme (CGS), designed to bridge the disparity between SME finance supply and demand. This public guarantee scheme serves as a strategic tool to alleviate the challenges faced by SMEs in accessing financing.
Bank Negara Malaysia, established in 2009, oversees the Credit Bureau managing the Central Credit Reference Information System (CCRIS). It regulates financial institutions to ensure stability, advocating for prudent credit policies and professionalism in credit risk management. Providing CCRIS data to banks facilitates quicker, informed lending decisions, promoting responsible lending and strengthening Malaysia’s financial system. This strategy fosters a healthier and more robust financial ecosystem in Malaysia, supporting economic growth and stability.
The Bottom Line
The increasing reliance on digital platforms for financial transactions has significantly driven the adoption of online lending and digital banking services, enhancing SME financing accessibility and efficiency. Governments globally have introduced policies like loan guarantees and tax incentives to facilitate SME financing. However, the success of reform strategies depends on assessing the financial system and economy’s readiness. Tailored initiatives are crucial to address specific challenges and opportunities, fostering a dynamic and inclusive economic landscape, and strengthening SME growth and resilience.
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