What is de-risking and how does it affect South African SMEs?

What is de-risking and how does it affect South African SMEs?

Banks around the world are under immense pressure from regulators and the public to play their role in the fight against financial crime. All banks must comply with laws that aim to prevent money laundering and the financing of terrorism. As these rules grow more demanding, however, this pushes up the complexity and the cost of compliance.

On a global scale, the financial services industry spent over USD 100 billion on regulatory compliance in 2016 ; and these expenses continue to rise. Additionally, banks face the risk of hefty penalties if their organizations are associated with financial crime or the financing of terrorism, even unwittingly. This not only hurts the bottom line, but also causes reputational damage. This can shake banks’ resilience over the long term.

For these and other reasons, some banks are opting to control their compliance costs and reduce risk by taking a broad “de-risking” approach.

What is de-risking?

Rather than assessing business relationship risk on a case-by-case basis, some global banks are taking a blanket approach and limiting their correspondent banking relationships in certain economies and sectors that they perceive to be “low margin” and “high risk”.

This practice can be dangerous. Why? Because de-risking can lead to increased financial exclusion in emerging and developing markets. As a result, these communities struggle to access the financial services they need to run households, operate businesses, trade across borders and grow local economies.

In this environment, small and medium enterprises (SMEs) often find it very challenging to access banking services and this erodes entrepreneurship and innovation.

How does this affect the SA business community?

While South Africa is not among the most severely impacted countries, de-risking does still shake the stability of our financial system – for example, SWIFT data reveals that South Africa lost more than 10% of its foreign counterparties between 2013 and 2015.

In order to strengthen their relationships with global banks, regulators and law enforcement, local banks are tightening their compliance controls and due diligence processes. Unfortunately, this makes it more difficult for the businesses they serve to access bank finance. This is especially true for smaller companies.

To qualify for bank loans, SMEs must undergo lengthy application processes, as banks review their assets, liabilities, operational histories, overall financial health, cash flow positions, profitability and debt service coverage, among other factors. Any factor that does not meet the banks’ strict criteria – such as a blemish on a credit record (even in a personal capacity) – puts these firms out of the running for bank finance in the current risk-averse climate.

Limited access to finance means that these businesses will struggle to grow and thrive. Without working capital, they cannot hire new staff, invest in new infrastructure or capital equipment, invest in research and development, grow sales or bolster their financial security in an unpredictable economy.

Luckily, bank finance is not the only solution

It’s important for businesses in South Africa to understand that banks are not the only providers of working capital and trade finance. Other financial services providers have emerged to fill the business funding gap that has been created by global trends like de-risking.

One sector that provides an attractive alternative to traditional banking finance is factoring. Factoring companies are specialised financial services providers that give businesses fast and flexible access to working capital by purchasing their accounts receivable and taking care of the invoice payment collections on the businesses’ behalf. This well-established financing mechanism is used extensively across the globe, serving organisations in a wide range of industries across Europe, the UK, the US and South Africa.

Keen to find out more about factoring?

Get in touch with Merchant Factors. Founded 30 years ago to offer growing businesses an alternative to traditional bank loans, Merchant Factors specialises in local and cross-border finance and can tailor its facilities to suit most businesses.

For fast, flexible financing – contact Merchant Factors today.

Finance beyond the Numbers.