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SME guide to financial institutions

There are different types of financial services for SMEs. It is very important to identify the supplier that best fits the needs of the firm. Selecting the right type of credit provider for your company's needs can generate substantial savings.

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Published by ConnectAmericas

Large or medium sized, with many or few employees, importers or exporters, with or without credit history. No firm is like the other, nor do they all have the same financial needs. Because of this, before choosing a source of financing, it is advisable to learn about the different types of credit entities and the financial services they offer.

“Some sources of financing are accessible, while others are more costly; some offer a single financial service option, while others offer specialized services; some require collateral security while others do not,” reports the International Trade Centre.

Commercial Banks 

Most SME (small and medium sized enterprises) owners usually resort to commercial banks for their financial needs. The size varies considerably: some are huge multinationals; others are large but domestic, and there are also small or niche banks. 

Multinational Banks

As explained by the Organization for Economic Cooperation and Development (OECD), the private multinational banks comprise the largest group of financial institutions in most countries of the region. Capitalization tends to be greater and they offer extensive banking services. They include trade financing transactions, for example, that are ideal for SMEs seeking to internationalize. 

Multinational banks generally enjoy the advantage of being recognized all over the world, something that is very useful when financing trade. According to the Guide to International Trade Center Exporting SMEs, most of these entities "accept bills of exchange and issue letters of credit as well as discounts and negotiate IOUs.”

As the OECD explains, the disadvantage of SMEs regarding large multinational banks is that transactions are subject to strict risk analysis processes and procedures such as credit ranking. In many cases, SMEs lack adequate financial history to be included on the list.

Domestic Banks

The disadvantage of working with domestic banks is that they are not internationally recognized. For example, working with international logistics providers may require another bank to confirm the credit card issued by the local bank, rendering the transaction more expensive. 

The offer of domestic commercial banks is more limited in services but SMEs might find it easier to operate with them because, as specified in a document prepared by the Economic Commission for Latin America and the Caribbean (ECLAC), “they tend to be more flexible, offer more favorable conditions, and are more expeditious in their decision making.

Development Banks

Financial development institutions offer medium and long term credit, generally in projects contributing to a country's growth. According to ECLAC, several of these institutions, such as BNDES in Brazil, “are beginning to contribute short term credit to strategic sector SMEs, namely in the aeronautical, software and telecom industries.”

Multilateral development banks are like national development banks but have a much wider scope. As the International Trade Centre points out, “they are usually a good source of financing because of their favorable conditions but they do not usually provide financing services retail to individual SMEs but rather through governments and associated banking entities."

Export and Import Banks 

Export and import banks (EXIM) often receive support from governments, multilateral development banks and industrial associations. They are present in most countries of the world and their objective is to provide financing support for the export of products and services from the country of origin to international markets.

These banks assume the risk of the country in addition to the credit risk that private entities are not willing or able to accept. For example, they provide short term credit at favorable conditions and take on risks that other private financial institutions would not. Moreover, they issue guarantees and insurance on purchases of goods and services by foreign buyers who are unable or do not wish to accept the credit risk. They are also useful for providing guarantees required by SMEs to obtain financing in the most demanding commercial institutions. Hence they are an ideal resource for SMEs.

Factoring

These entities buy accounts receivable at a discount. SMEs can use their services without having to worry about guarantee requirements normally involved in commercial bank loans. The main consideration is that the client (selling accounts receivable) be solvent. The advantage of this financing tool is the speed with which the entrepreneur obtains the cash requested. Usually, a liquidity injection is obtained in 24 hours.

The disadvantage of using factoring is the cost (or discount) at which accounts receivable are sold. According to Bloomberg in Businessweek magazine, a commission of 2% to 5% is charged for this service for the first 30 days exceeding the term of the payable account. After these 30 days, other commissions are added for each additional day. Therefore, if payments exceed a longer period this type of financing can quickly become expensive.

Leasing

These firms transfer assets under a leasing regime, namely commercial goods, machinery or vehicles. This tool helps to free up capital through multiple lease payments instead of a single disbursement for the total amount of an important purchase. For start-up firms, this type of service can be a solution for growth.

Non-bank financial institutions

Non-bank financial institutions (NBFI) provide bank-related services such as establishing common funds against risk, and investment and brokerage services. These institutions include insurance companies, credit cooperatives, pawn shops, foreign exchange companies and microfinancing entities. 

Export loan guarantee and insurance firms provide coverage against commercial risks in exchange for payment of a premium. The guarantees and insurance provided are very useful for obtaining favorable financing from commercial banks. According to the OECD, “many of these entities are sponsored by the government and were created mainly to promote exports.” The premium charged for their services is often tied to the perception of risk in the country where the goods will be exported. If the risk is too high, it may not be advisable to opt for this export coverage. 

Credit Cooperatives

These are financial institutions involving groups of people with common interests. According to the International Trade Centre, “the members of credit cooperatives put their assets in a common fund to grant loans to each other and provide other financial services.” SMEs can easily obtain financing from the cooperatives of which they are members but the services offered are very limited. Generally, they do not deal with international banking and commercial financing. However, credit cooperatives are a good source for short-term loans.

Government Sponsored Loans

Governments attach considerable importance to exports because they generate income and boost the national economy. This is why government agencies introduce policies and promote programs and incentives to encourage and motivate exporters. The funds are usually processed through banks so the firms are advised to ask the head entity about the existence of these loans.

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