By Devaprakash Ramakrishnan
Though Agriculture and Micro, Small and Medium Enterprises (MSMEs) are growth areas for banks, the perceived risks associated with them, along with inadequate collateral-comfort from financing institutions, have resulted in lending to these sectors remaining unattractive. Unfortunately, non-real property assets are outside the consideration of banks for loan negotiation. This is because they are presumed to be untenable and unworthy of covering up the loan delinquency, with the security transaction framework considering only land and building-based collateral.
Ratio of capital stocks
A survey by World Bank enterprises points out that capital stocks owned by firms distributed less on land and real estate (22%) and more on vehicles, machinery and equipment (44%) and account receivables (34%). A mismatch was created, with collaterals taken traditionally by banks being skewed in favour of land and real estate, (73%) instead of moveable assets (27%). Therefore, there is a need to turn the balance upside down for adequately diversifying the credit risks for banks. With the security markets not being well-defined, financing tends to take the form of debt, rather than equity. Banks are constrained by balance sheet woes, poor returns to equity and stressed assets. This deters them from continuing the credit cycle with MSMEs and agriculture, which are the growth engines in most countries.
Impact of Fintechs
The growth of Fintechs in recent years has brought some solace, with their algorithm-based score card driving aggressively to fill the finance gap. However, their reach has not been very appreciable to have a large-scale impact. This is obviously due to their inability to break through the right scaling strategies by working through partnerships with mainstream banks. The marketplace-lending accounting for over a third of the AltFin (Alternate finance) market, was a mere 0.08% of the $96 trillion global corporate and household debt that was outstanding in 2015. Movable finance, referring to financing on the strength of moveable assets as collateral, has the potential to alter the inequitable financial balance that hinges on an informal economy. It does this by overcoming the discrepancies and uncertainties in the legal frameworks and governing security rights.
Prospects for movable finance
The SME finance gap for the formal sector is estimated by the IFC and SME finance forum to be $5.2 trillion. Added to the demand of informal MSMEs, it can bloat to nearly four times of what is estimated for formal sector. Closing the credit-gap for small businesses at average lending spreads and adding fee-based services could generate about $270 billion in additional revenue for banks. Moreover, including unbanked adults into the formal financial system could generate another $110 billion, according to Within reach, a study jointly conducted by Accenture and CARE International.
The unmet demand for the smallholder segment of the global agricultural finance market is estimated at approximately $417 billion out of a total estimated market demand of $450 billion ($225 billion in short-term finance and $225 billion in long-term finance), according to Dalberg, 2012.
What movable finance can promise
The jump in asset stress for banks is the fall out of weak collateral management framework. Over-evaluation, multiple-dip and biased documentation continue to plague many economies due to the absence of technology-enabled centralised database on collateral. These can give a better handle on the monitoring of collateral and the detection of misuse and fraud. Moveable finance, besides blurring the shadow economy by bringing scores of informal businesses and agricultural activities into the formal financial system, also cuts down loan delinquency, and strengthens the rating of the financial system. Apart from this, there is even evidence of it bringing down the cost of credit, as in Albania in 2001.
The biggest benefit it can have on the economy is in increasing credit to women-owned businesses and family-farms, where the title for the property is skewed against women. Movable finance market can unveil opportunities for a host of new-generation products, like inventory financing, account receivable, invoice lending, factoring, farm input financing, equipment financing, and contract finance to reach scale.
Outcome of a movable registry
There has increasing evidence regarding the positive impacts on formal finance that were brought on by enabling provisions on secured transaction reforms in small business and farm sectors. As a result, there is all the more compulsion for more economies to follow suit. It would be interesting to learn from the best practices from China (84%), Mexico (45%) and Afghanistan (90%) and many African economies, including Nigeria, where a centralised collateral registry is on the vanguard of igniting a revolution in bank lending. While in China and Afghanistan, the figures of small business finance catching fire is mind-boggling due to the magic created by the movable registry, the transformation was more pronounced in the farm sector in Mexico.
Challenges faced by movable finance
In some countries where movable finance is yet to take off, the banks, despite being blessed with a moveable registry, hesitate to unlearn the habit of favouring male clients to reap collateral advantages. Some countries do face the challenge of banks being unable to imagine movable assets, other than vehicles, that are worthy of being pledged. This is due to poor liquidity or resale value for other movables. Moreover, some regulators are still grappling with manual-based collateral registries to enable consolidation. It will have to wait for its own time to show kindness on movables as tradable commodities.
The shift to movable financing continues to be bogged down by conventional thinking and lesser capacities of stakeholders. It misses the priorities of a sizeable number of emerging economies and is mired in outdated secured transactions, with an inability to give comfort to asset-stressed banks.
Moving forward
Having given due regard to the several issues faced, the secured transaction regime is a foundational brick in the legal framework that can enjoin, amongst others, increased access to capital. This can help in bringing down costs in the long-run. More importantly, it has the potential to give life to movables, which are otherwise construed as dead capital. Moveable finance, if handled well, can fill the growing credit-gap in small businesses and farm-lending. At the same time, other enablers like favourable eco-systems and understanding stakeholders are equally essential.
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