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Why SMEs should consider trade financing over legacy banks in this region

Why SMEs should consider trade financing over legacy banks in this region

Many SMEs do not have access to bank borrowings, purely because banks are generally reluctant to provide funding to companies that have smaller balance sheets

Different Arab money

We are living through exceptional times. Things are changing at a dramatic pace for businesses across the country and beyond. This is the time where legacy banks are arguably lagging behind when it comes to providing financing versus a factoring company.

There are several reasons for this. Given the need for finances, especially in these testing times, a quick turnaround is helpful for SMEs as cash flow can make or break a business. This is the first advantage for trade finance companies as they can expedite the assessment and decision-making process thanks to their specialised and focused approach.

Since legacy banks have various revenue streams and cross-sell opportunities, this means they are not particularly concerned about attrition rates when it comes to their clients. This brings us to favourable accounting treatment and enhanced balance sheet management.

Let’s look at a bank-borrowing scenario. If a client discounts their receivables, they typically witness an increase in cash-in-bank, while creating an increase in short-term bank borrowing, which is essentially a zero-sum game.

However, if SMEs look at a factoring arrangement, they stand to get cash-in-bank, while the receivables are removed from their balance sheet. This results in improved leverage for the company giving them room to grow. Naturally, this results in accelerated cash flows without the burden of associated debt.

Furthermore, this offers non-recourse options. So, in case of eventualities, a legacy bank would conduct collections on recourse, and sometimes even on a dual-recourse-basis. Essentially, the bank pursues both client and their buyers for payments should this situation arise.

However, some factoring companies offer solutions on a non-recourse basis. What this effectively means is that if there is an issue with payment, an insurance claim is made against the buyer, and the client need not pay. What’s more, the risk of the buyers is in fact, transferred to the trade finance company. This is not something that would occur with a legacy bank.

Then there is risk-concentration management – where certain clients are unable to secure additional funding from banks due to their inability to provide additional fixed assets and collateral. This is where a factoring company comes in, and provides financing without any securities. This approach is beneficial for SMEs, enabling them to grow, enter new markets, and continue to sell outside of their internal credit controls, as the risk assessment and management is carried out by the factoring company.

Additionally, factoring companies provide cross-border support, which is not necessarily the case with some local legacy banks, whose main focus tends to be on domestic market alone.

So, there are several reasons why trade financing is better than a financing from a legacy bank. Many SMEs do not have access to bank borrowings, purely because banks are generally reluctant to provide funding to companies that have smaller balance sheets. Then, if such a company might be able to overcome the hurdles to be considered eligible for financing, they are often subject to months of review and reams of paperwork. Following which they have to adhere to – and agree to – a vast list of terms and conditions which must be met before allowing for them utilise the facility.

Trade financing companies, on the other hand, provide proposition flexibility driven by the client’s business needs. And importantly, unlike legacy banks, which focus more on the client’s balance sheet strength, a factoring company’s primary focus remains on the buyer’s balance sheet, which is a great differentiator.

One might wonder what also happens in case of buyer insolvency. This is where the benefits of trade finance companies come into play – they file an insurance claim against the buyer. They provide the insurance, or the client can choose to assign their insurance to their trade financier.

All in all, trade finance companies are altering the financing landscape for SMEs and beyond, providing them with the opportunity to grow their businesses, without the constraints they would generally face if they seek financing from a bank. It’s no secret that the backbone of any economy are the SMEs and with trade financing, they can grow unfettered.

Peter Maerevoet is global CFO and senior executive officer for Tradewind Finance

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