Cash And Trade Magazine For Cash and Trade professionals in the Middle East
Facilitating trade finance for new businesses is paramount to nurturing continued growth in the Middle East. Small and Medium Sized enterprises (SMEs) are proliferating in the region and creating an increased demand for bespoke and flexible financing, which is not being met by the region’s banks. Chris Ash, Managing Director of ExWorks Capital UK, describes the challenges and opportunities in Middle Eastern trade finance.
Headwinds to progress
Businesses in the Middle East have much to contend with. They face a range of economic perils such as unstable currency exchange rates, fluctuations in demand, and insufficient margins, all of which could mean, at best, disruption of the balance sheet, and, at worst, financial ruin. With such adverse variables, the balance between risk and reward is precarious. The survival of many SMEs is dependent on whether they can access the bespoke financial solutions they need to weather these storms. But international regulation and risk management requirements are shrinking some banks’ appetite for lending, forcing them to be more risk averse in deciding where they deploy capacity. Consequently, many SMEs in the region are facing a funding deficit.
The regulatory pressures that banks are increasingly exposed to have had the dual effect of driving up the costs for all parties involved in a given transaction, and impacting on the degree of financing that banks can profitably offer to their clients. As soon as capital constraints present themselves, banks are forced toreassess their portfolios, and often end up offering less funding to heavily leveraged and higher risk borrowers in order to protect their interests. Stringentrisk management and capital reserve requirements have resulted in a visible withdrawal of capacity from the trade finance space in the Middle East by banks and insurance companies. And any remaining capacity naturally comes at a higher cost, with more imposed conditions and restrictive covenants, which smaller enterprises that lack the necessary accounting capabilities often struggle to satisfy.
In the region’s current business environment, the traditionally inflexible approach adopted by most banks towards payment default has been shown to beoutdated. Local exporters have historically either favoured secure trade products provided by banks, chosen to operate on an advance payment basis only, or simply minimised their own risk by taking modest orders. But these cautious measures strangulate potentialgrowth. The increasing costs around compliance and financial crimeprotection measures add to the litany of financial pressures that local businesses are exposed to.
A move towards structured finance solutions to mitigate risk has been a positive approach adopted by some banks who see the financial potential in the region as too great to leave untapped. But smaller firms, by virtue of their very size and maturity, are often precluded from accessing these more sophisticated forms of financing, or find that such financial architecture is not suited to their individual funding requirements.This leaves very little option besides bank overdrafts or account receivables-based financing, both of which are unattractive and expensive alternatives for SMEs. Banks can withdraw or demand repayment of overdrafts at any time, constituting a new element of uncertainty for the client. And account receivables-based financing, both recourse and non-recourse factoring, can prove problematic in that the creditworthiness of the customer isdetermined on an inflexible andprescribed basis, by an assessment of upfront liquidity. This is oftendetrimental to businesses, like most Middle Eastern SMEs, whose balance sheets predominantly carry inventory. As such, this has proven to be an inadequate solution.
The remedy
This perfect storm has created a funding vacuum that alternative lending parties are starting to fill with more innovative trade finance solutions. With efficient due diligence and a more flexible approach, providers such as ExWorks Capital can offer supply chain financing to customers whose balance sheets are already fully leveraged. Short-term funding in the form of bridge loans are invaluable for smaller businesses that have won an order and require working capital to fulfil it, yet have insufficient funds to open a Letter of Credit.
The role of the bank is not obsolete in these transactions, however. Alternative providers often lend in tandem with existing banks and gap-fill where the latter fall short. This allows clients the freedom to deviate from the usual operating patterns acceptable to a typical trade finance facility, if their businessesso require. Providers are frequently required to offer letters of credit (LC)that permit the client to extend more credit to their customer base. Here again, non-bank finance providers can add tangible value for local exporters, mitigating costs by adopting a flexible and tailored approach to repayment to suit the client’s business, and ensuringthat any additional costs are absorbed as much as possible by strategic restructuring of transactions.
Yet progress requires innovation on the behalf of these financial providers. At ExWorks Capital, we often look to advise clients on their transaction chains where there is already an established relationship between trading parties. Value can be added to clients by streamlining processes for cost efficiency purposes, such as circumventing the use of a trader and instead directly engaging with the originator to obtain a better margin. This kind of innovation will be the future of trade financing, striving to make the process ever more cost efficient and therefore available to all. Non-bank entities, less fettered by reserve and regulatory restrictions, are well placed to serve in this capacity for businesses, and can gap-fill the shortfalls left by banks to make financing available to all worthy candidates with a view to nurturinggrowth in the region.
About the author:
Christopher Ash is Managing Director of ExWorks Capital UK, a leading provider of domestic, import, and export trade finance products.
