Emerging markets is a term commonly used to describe economies that are in a state of change: from an undeveloped economy to a growing economy.

The chart below shows a few countries that are commonly classed as emerging markets. (The UK and USA are not emerging markets and have been shown for comparison purposes.)

One of the common elements of this market is that there is a significant amount of poverty. If economic growth does not benefit the poor, then there is likely to be political instability or, at least, popular unrest. SMEs play a fundamental role in helping all levels of society to prosper, particularly in rural areas with a lack of infrastructure (e.g., transport, power, education).

Emerging markets cover a diverse group of countries, for example, the Republic of India and the relatively prosperous Republic of South Africa. India has one of the fastest growing economies in the world but it has one of the lowest GNI (gross national income) per capita ($720). A third of its population is below the poverty line (less than $1 per day), according to the World Bank. South Africa has a significantly higher GNI per capita ($4,960) but has one of the highest income inequality measures ('poverty gap'), with a ratio of the richest 10% to the poorest 10% of 33:1.

Source: World Bank. 2005 GNI per capita and growth in GDP at market prices. Turkey 2004.

One of the great social advantages of SMEs is that there are few barriers to entry. For example, approximately 20% of SMEs in South Africa are classed as ‘survivalist’ (proprietor below the poverty line) according to an annual survey sponsored by Standard Bank of South Africa. Mahatma Ghandi, the father of modern India, promoted the ideology of economic self-reliance at village level to generate mass employment that in rural areas with poor infrastructure relies on tiny or small enterprises. The Inter-American Development Bank estimated that 70% of the poorest wage earners are owners or employees of micro-enterprises. So SMEs are a fundamental way in which the poor can directly affect their wealth and are a way in which a country can benefit from people skills that may otherwise be wasted.

The ‘S’ in SME stands for ‘small’ but the combined effect of SME is far from trivial; this sector contributes over 50% of South Africa’s GDP and is accountable for 35% of India’s total exports - an important source of wealth for developing countries.

SMEs need skills and finance to start up and thrive. Cash flow for export business is a particular example where payment is made on delivery. Traditional sources of finance to start up a small business include cash from savings, family and friends or using equity in residential housing or as collateral for loans. Unfortunately, such funds are scarce in many emerging markets, at least amongst the poor. Banks are reluctant to provide finance and generally charge substantially higher rates than for corporate finance, creating an uneven playing field for competition. This is not without some justification:-

• Failure rates amongst SMEs are high, particularly amongst start-ups. SMEs are more susceptible to fluctuations in costs (inflation) and demand than larger enterprises. Banks in India and South Africa have experienced bad rates as high as 10% in the micro-business sector.

• There is a lack of formal sources of information on which to base risk decisions. The majority of SMEs are family owned business with no legal requirement to provide audited financials or make market disclosures; comprehensive data on market share and receivables is not readily available; generally specialised assets (e.g., machinery with undeterminable resale value under distressed sale); often have no or little proven track record; and tend to have a high degree of cash transactions that may not be fully accounted for, allegedly, ('informal economy').

This combination of high failure rates and lack of comprehensive information on which to evaluate risk naturally causes banks some concern. Indeed, the recent period with relatively large amounts of available investment capital and the economic slowdown in many markets affecting exports (e.g. USA) makes credit risk a significant agenda item again.

Experian-Scorex has a recognised tradition of building credit risk ratings for retail bank SME portfolios in developed and emerging markets combining its knowledge of consumer finance, business information and retail banking. Experian recognises the close links between business and personal finance for small enterprises and also the significant unique issues associated with risk rating a business.

The choice of approach and data required for better quantification of credit risk depends on the business event and the type of business. For example, personal data is much more significant for a micro-business sole proprietor start-up scenario than an established company with many directors and significant net worth where annual company financials add greater value; deal size will affect revenues and bad debt that for small transactions may be less than the operational cost of the transaction. But a really significant data for an established, primary banking small business is the data the bank holds itself – account management data, particularly the summarised transaction data from the current account that provides early warning indicators of cash-flow issues and is a usable proxy for affordability assessment. The beauty of this approach is that this type of data is available for businesses for which traditional financial information (balance sheet and P&L) is not a legal requirement.  It supports solutions that create pre-approved exposure limits that can provide a fundamental reduction in operational costs, reduce bad debts and facilitate IRB approach for Basel II retail exposures. It is the strength of these approaches that will help overcome reluctance to lend to micro and small enterprises and provide effective tools for banks to quantify their credit risk in this market.

Nigel Rusby - Principal Consultant, Experian-Scorex

Statistics quoted were obtained from the following sources:

• World Bank
• SME Survey sponsored by Standard Bank South Africa
• Inter-American Development Bank
• SMEIndia.com

Top