This is discussion about TREFI ==> scalable SME finance solution without the costs and risks.
My understanding of this product is: Today SMEs take out relatively expensive loans to pay their suppliers before their customers have paid (i.e. working capital). TREFI is a cheaper alternative to borrow this cash. At the same time TREFI is also more profitable for the lender, in particular on a risk-adjusted basis, given its automated credit risk rating. The latter also provides SMEs with automatical early warning signals if one of their customers is likely to go bankrupt.
Question: Next to SMEs and lenders (i.e. banks), could this product be interesting to national governments?; they could integrally roll it out and decrease funding costs across their economy.
Thanks for your message.
You are right, with the solution SMEs have more low cost finance from their suppliers so they do not have to take out an expensive loan at a bank or finance it with funds from friends and family.
With the current solution credit is structurally and sustainably cheaper due to the risk management and cost efficiencies. Real value is created by the solution. This value is shared between the SMEs, the suppliers and the lenders.
You are right, national governments would benefit as it stimulates economic growth. It does not only stimulate by realising lower cost of finance for SME. Since the solution ensures finance is directed to the RIGHT SME through its risk return approach, the economic growth will be stimulated additionally and innovation enhanced.
Various research points out the importance of supplier finance in particular for SMEs.
A research study by Capital Tool Company analysis the top 350,000 companies over the last 10 years in Europe shows that SMEs working capital comes for over 80% from finance from suppliers whereas the top 10,000 companies 40%. The average percentage of working capital covered by finance from suppliers in Emerging Europe is 67% versus 56% in Euroland.
Given the importance of finance from suppliers and the operational, risk and innovation benefits it is logical for national governments to stimulate finance from suppliers where the SMEs are the debtors.
TREFI contains a set of technical tools for managing, monitoring and assessing risk of SME receivables. It uses a web enabled system specifically designed to better manage credit risk and administer SME account receivables. The platform incorporates SME credit bureau information which offers online credit ratings and credit scoring.
* SMEs benefit from an increase in finance terms granted through large suppliers at lower interest rates.
* Corporations or large suppliers also benefit from the reduction of transaction costs, a better administration of credit risk and an increase in the activity of SME clients due to improved access to finance.
The process as a whole generates an enormous economic and social impact which stands as brightly creative solution for any economy.
supply chain financing seem to require the user to install large system applications and then require training and specialist skills to use. How easy is Trefi to impliment? How long does it take? Most SMEs do not have dedicated treasury staff and may not have specialst finance staff - how much training is needed to use Trefi.
Thanks for your message
One of the main advantages of the TREFI solution is that the SMEs need no computers, need no accounting, do not have to be formal and need no education to receive finance under the solution, nor do they need to go to the bank or build relationship with bank employees. At the same time the solution is able to measure risk better by using the information from the suppliers on their SME clients.
As such the SMEs can focus on their core business and prosper more.
If the SME’s want, they can get to the solutions system to download their credit report, review invoices outstanding, register and resolve disputes, approve invoices, make payment agreements and initiate payment.
From the supplier side the solution requires integration with the systems of the supplier. This integration is comparable to typical supply chain finance (reverse factoring) however the extraction focuses on the accounts receivable instead of the accounts payable.
Because supply chain finance relies heavily on invoice approval by the large buyer, the buyer must adjust its business processes to participate. In the TREFI solution there are no such requirements, although if so desired by the large supplier it can use the risk management and collection tools in the solution to enhance the risk management and collections processes.
Some questions about your entry, the answers to which could probably be incorporated into your submission to strengthen it.
- Can you add some specific anecdotal details of your project in Peru - how it works, etc.
- Would this work for multiple sectors/industries or is it specially geared toward those companies that require a steady and significant amount of supplies/inputs?
- Could you provide figures associated with the public sectors potential investment into this solution? First off, do you need investment or guarantees? If either are needed/desired, can you provide figures as to what that investment/guarantee needs to be?
Best of luck.
The process of providing credit to the SMEs has all the aspects that banks take into account in credit provision, however is accompanied by more frequent monitoring, more predictive risk ratings and better risk management due to amongst other the delivery stop.
The process is as follows:
The sales person visits the SMEs to register new orders, inspect the inventory and collect payment.
If the SME desire finance, the sales person may initiates the credit process which typically has the following steps:
· The SME signs a contract.
· The sales person collects information from the client like identification of the owner, company registration, address verification etc
· The sales person fills in the credit form
· The credit department checks the form and uses the solution to check the credit and the payment behavior and sets a limit in the system.
On each further order the client may purchase on credit, provide the client is within the limit.
Inspectors review the credit limits periodically and when the solution triggers a warning.
Furthermore delivery personnel visit the client to deliver the order. They also inspect the status of the inventory and collect cash if due.
Due to the solution the supplier can give the credit that is reasonably needed by the SMEs because:
· It has low impact on their balance sheet; and
· The risk concerns of the suppliers are reduced.
The product may work in all sectors where SMEs are the clients.
The risk management capabilities of the solution improve with the number of suppliers to an SME tracked by the solution and with the frequency of visits of the suppliers.
In particular the number of suppliers is important since multiple independent reviews of the SME are gathered. Furthermore, when multiple suppliers to an SME are tracked, the willingness to pay by the SME remains high when the supplier goes under because his unreasonable non-payment will immediately have a negative impact on his credit rating and credit relationship with other suppliers.
We note that there is no bank or micro finance institution that gathers multiple points of view on a client to make a decision. Furthermore very little banks visit their client more than quarterly, whilst suppliers together easily have multiple visits a month or even week.
Therefore the ability for the solution to exceed risk management of banks and micro financiers is usually already obtained when a single supplier participates.
Indeed more suitable are suppliers with:
· Regular sales
· Goods instead of services
· Supplying essential product for the SMEs business or a product which is not available from many suppliers
· The goods are not perishable
Public sectors potential investment
Public sector support should be addressed to get the solution to a critical mass. The critical mass will be related to the countries economy size and capital markets price efficiency.
The start of the solution is hampered by a chicken and egg problem. There is need to have lots of SMEs and a number of suppliers participating and at least one financier before it works efficiently. Therefore a funded support at the start, later replaced by guarantee is highly desirable.
Furthermore the form of the support has to be structured to be suitable for the local law, regulation, tax and market practices.
In Peru local tax rules make a guarantee option only feasible in combination with capital markets. Capital market in Peru can only be effectively tapped when the funding reaches about $30m. Therefore funding up to $30m is essential. With further growth this guarantee may then gradually be decreased or focussed on priority sectors or regions.
In the Chinese case a guarantee can be suitably used from the start, since Chinese market environment makes funding easy when a guarantee is obtained.
Since the suppliers provide substantial overcollateralization (typically 25%), the risk taken in a support program by the government can be structured to very low risk levels. For the solution to be effective, it is important that the cost of the support program is in line with the low risk profile. Due to perceived riskiness of SMEs and the currently very low experience with SME receivable finance in Emerging Markets this is difficult to achieve. Development agencies often do have the skills to analyse the risks and can therefore be instrumental in getting the solution started in a country.
In conclusion, since the public will get return for risk for the support, its actually does not have a cost.
It's really important that you incorporate the more detailed version of the process into the entry itself, as the judges will not look at the comments. Also, you might consider incorporating some of the other answers you've given to the insightful questions raised by some of the other commentators.
Remember the deadline is Sept. 5th.
I read your entry with great interest. Could you clarify more how all parties involved benefit from the solution?
Thanks for your question; it is useful to highlight the key benefits again.
The solution creates its value by synergies with the supply process of companies, high automation and enhanced SME risk management methods which are shared between participants as follows:
SMEs benefit by obtaining:
- New finance or additional finance or longer-term finance from suppliers at low or no cost. Note that the finance goes on as long as the SME continues to buy on credit.
- A credit rating that may be used to obtain additional finance through other sources at no cost and without the need to do anything
Suppliers benefit by:
- Increased sales to SME clients because SMEs will favour suppliers with better credit terms, but also because of the growth of the SME clients resulting from the credit
- Ability to reduce operational cost by optimizing delivery cycles and easing payment methods for supplied goods (see also the comments under the question “”)
- Improved risk management of clients, reducing credit losses and variation of credit loss, reducing capital costs
- Improved timeliness and willingness to pay by SME clients (although later than before)
- Without negative impact on the receivable balance
Governments benefit as the solution:
- Stimulates an efficient new source of working capital for SMEs increasing competition and therefore reducing price and improving overall efficiency in SME working capital provision
- Enhances activity and innovation in the SME sector of the economy
- May benefits a large number of SMEs fast and at low cost
Investors in capital markets benefit from:
- Access to perpetual highly diversified well-managed SME backed investment opportunities
- High transparency and quality daily risk reporting
Financiers benefit by:
- Having additional risk ratings to manage credit on SMEs
- Reducing risk and cost in receivable finance solutions
It seems that TREFI is combining advanced risk, structured finance and IT technology. Not only should the solution provide new and better SME risk ratings, but it should also provide tools to manage and furthermore to refinance credits provided to SMEs on an integrated basis.
Delivering all these functions in a single solution is substantial and I am not aware of any other similar such integrated SME finance
How do you manage such complexity and does it not become too complex for the supplier, SME users and financiers?
You are right. The solution uses and improves over advanced methods in credit risk management and structure finance and uses high performance, secure computing technology. Furthermore local laws, taxes, regulations and trading customs may complicate matters further.
Yes, we knew it was going to be hard and yes it was even harder.
As we knew from the start that we would have to cope with the complexity we did the following to cope with it:
From the perspective of the SMEs it is very simple, just ask your supplier for more finance; nothing more.
From the suppliers perspective, its starts simple, check the credit of the customer, comply with the rules of the platform and get refinanced. However the supplier can also make sophisticated use of the platform by tightly integrating the solution into the sales and collection processes of the company.
From the suppliers perspective, we can compare the solution with driving a car: nowadays everybody drives a car, however little people know how it works on the inside. When the first cars were made, nobody wanted to drive. The few who dared first wanted to know how it works on the inside.
From the financiers and investors perspective they have to get comfortable with the investment risks. We have comprehensive trainings and reporting to make investors comfortable by explaining the risk mitigating features of the structure in comparison to alternative working capital products. As the solution is pretty new, it takes substantial time to get investors comfortable. But as we standardize and are transparent, we believe that over time this will ease. We have highlighted that government and development institution support can help in this matter.
To get my head around this: what % of a GDP is needed for financing customers while they have already received the product, but not yet paid? What kind of decreasing in funding cost/interest could result from such an approach if it were to be applied nation-wide? and a tricky one ... what would companies do with the extra money, now that they pay less on their loans? We're not talking impacts like for micro credit, are we?
Dear Lucas, an excellent question, however this is difficult to estimate. But let us try to estimate order of magnitude:
Size of the market
Lets get an idea of the order of magnitude of receivables outstanding:
- The top 15,000 companies (of which we have complete annual reports available) in 2009 in the Netherlands have €185 billion in receivables outstanding. The top 15,000 companies probably represent 50% of GDP. Dutch GDP is about €600 billion. So in Netherlands the receivable balance is about 60% of GDP.
- Similarly Belgium has €56 billion with top 11,000 companies with a GDP of €350bn with the same rules would result in 32% of GDP.
- Similarly Spain has €168bn with top 25,000 companies at a GDP of €1005 bn is about 33%
If we assume receivable balance is about 40% of GDP with a global GDP in the order of $65 trillion there should be in the order of $25 trillion, 50% of which are with SME (Data sources CIA factbook, BVDEP).
For comparison, the total amount of micro finance outstanding in the world is in the order of $45 billion (www.mixmarket.org). We note that most microfinance credits are like receivables of a short term nature.
Cost of funds
In our entry we already discussed reductions of operational cost and risk cost that may be achieved. This operational cost is in the order of 2% for SME in developed markets and 25% in developing markets for micro credits plus the reduction in risk costs.
If such solution could reach $45bn like microfinance achieved, a savings in the order of $12bn per annum is achieved compared to if those funds would be provided by micro finance methods. We note however that the current solution, although financing in principal is perpetual, strictly covers working capital needs. The method is not meant for the financing of capital goods, vehicles and property.
If solutions such as the current would be applied nationwide substantial efficiencies may be reached.
What would the SMEs do with the funds
If the SMEs pay lower interest and improved access to finance they will use it to grow their business, increase product quality and improve the income or the owners and staff. In developing markets SME’s are more likely to employ the poor. As a result entrepreneurs will flourish and may relieve themselves and their staff from poverty.
Do you have any other ideas how to make an estimate?
Hi Lucas, check out the answer to Irene Hewletts question below!
The Dutch government has recently set up a facilty for SMEs to acquire capital at an interest rate of about 9%. Can you give an indication of what the cost for SMEs would be, if the TREFI platform would be utilised for this purpose in the Netherlands?
As described in the entry suppliers can save operational cost in providing credit. It is rare that SMEs would be charged any interest for being able to buy on credit, however it may be that the price of the product or service is slightly higher.
Using a similar methodology as in the First World Bank study “Supplier Credit to SMEs An attractive investment opportunity” we can estimate the all in cost of providing the finance.
There are four costs involved:
- Operational costs
- Expected loss
- Capital cost
- Funding costs
As discussed in the entry the operational costs for providing SME credit by suppliers is insignificant. In many case costs will be lower by providing credit as a result of delivery and money-handling efficiencies. Further benefits are achieved as a result of the risk management provided as part of the solution. We therefore assume that this cost is zero.
We need to add the cost of the infrastructure. For developed markets we estimate this to be 0.5%. The handling costs in SME finance provided by banks in Europe are in the order of 3%.
In Peru it was found that suppliers get paid much better than banks, even though suppliers provide credit to companies with a higher risk profile. The solutions risk methodologies help to reduce this further.
Expected Loss in the SME portfolios of Dutch banks are in the order of 1%. Like in Peru we assume this figure is reduced by 50% to 0.5%.
Suppliers in the TREFI structure will typically enhance the receivable portfolio by over collateralisation to AA level. To estimate the capital cost we assume that the portfolio is financed for 8% by capital like a typical average bank portfolio. The cost of capital may be put at 18% pre tax. The capital cost is 8% * 18% = 1.5%. We note that additional capital will have to be held for dilution risk, however to be able to compare to bank lending this has to be taken out. As the solution has risk management benefits, ultimately the capital allocated should be half of those of banks at 0.75%.
Once the solution would reach critical mass funding cost should be similar to those of banks in the interbank market. Currently the interbank market for 90 days is at about 1%. Some costs for raising funds would apply which would be in the order of 0.5%.
The all in cost to provide the finance to SME in the current market = 0.5% [Operational costs] + 0.5% [Expected Losses] + 0.75% [capital cost] + 1.5% [Funding costs] = 3.25% on an annual basis. This figure is to be compared with the 9% of the Dutch program you are referring to.
If this would be on 60-day invoices the cost in relation to sales is 0.5%, just a small percentage of each sale, but very important for the SMEs financial position.
Given that a funding bank would hold AA assets, under Basel II IRB senior securitisation treatment capital in the order of 1% would be all what is needed. However banks are not willing to provide the financing or only at prohibitively high cost.
A (mezzanine) government guarantee on the finance can resolve this. With such a guarantee of up to EUR 100m critical mass can be reached in Europe, which is about €1 bn. From that point the structure may go to capital markets and achieve similar cost of funding not far from those of large banks.
The effect of such guarantee on economic activity may be more substantial than the almost E1bn of guarantees on SME loans that the Dutch state provides to banks and much less risky for the government since the suppliers absorb most of the risk.
On October 27, 2010, the judges reviewed entries for the Changemakers G-20 SME Finance Challenge competition and would like to pass on the following feedback for your entry (below). Thank you for applying and for your hard work in the field. We are excited to archive your entry to serve as a leading solution for the worldwide community of innovators. We wish you continued luck with your innovative, sustainable, and socially impactful initiatives.
All the best,
The Changemakers Team
TREFI addresses the various barriers to access for finance for SMEs, and has a positive track record. Since it is a web platform, it has the ability to move quickly into new areas and can be scaled up.
The empirical evidence presented is very encouraging. A concern is that the solution seems to require too many parties to cooperate in order to remain viable on a scaled-up basis. Overall, it is another intriguing idea with the potential to bring SMEs and financing together.
The TREFI solution needs the same number of parties to participate as alternative financiers like banks.
However, in the TREFI model the parties are named and there are procedures to replace parties in case of insufficient quality.
The effect of this is that there is better segregation of duties than in banks and a better process for managing quality.
This will ensure that also on a scaled up basis the quality can be maintained.