By Benedict Shupley, CEO and Co-Founder of Obligate
We have long heard that SMEs are the engine rooms of the economy. accounting for 90 percent business and more than 50 percent employment Worldwide, that’s not an understatement. But what happens when this engine can no longer afford to run?
This is an unfortunate reality for many SMEs. After the turmoil of 2022, which saw rising energy costs, workforce shortage, political instability, inflation and supply chain disruptions, SMEs now also face financial crunch. 60 percent of SMEs Not sure they can secure finance from banks 28 percent Companies reported restrictive behavior by banks in loan negotiations.
This is not a new phenomenon, in fact, much of it dates back to the global financial crisis of 2008, in which major lenders restricted access to credit in an effort to de-risk their balance sheets. This has far-reaching consequences for modern-day SMEs, especially in emerging markets where discriminatory perceptions of credit risk have exacerbated an already difficult situation.
SME Funding Status
in emerging markets, Where SMEs create 7 out of 10 jobs, The funding gap is widening. International Finance Corporation (IFC) Estimate 40% of formal micro, small and medium enterprises (MSMEs) in developing countries have a financial need of $5.2 trillion every year, which is equivalent to 1.4 times the current level of global MSME credit. East Asia and the Pacific region has the largest share (46%) of the total global finance gap, followed by Latin America and the Caribbean (23%) and Europe and Central Asia (15%).
This dangerous financial drought has caught the attention of international organizations and policy makers. OECD recently updated its high-level principles To emphasize on the need to promote non-bank finance on SME financing as well as strengthen SME access to traditional bank financing. while within United Nations Sustainable Development Goals (9.3) it states the ambition to “Enhancing access of small-scale industrial and other enterprises, particularly in developing countries, to financial services, including affordable credit, by 2030.”
In low-income developing countries, SMEs make a significant contribution to broadening employment opportunities, social inclusion and reducing poverty. Improving and providing access to financing is critical not only in fostering entrepreneurship and innovation, but also in advancing the state of the economy and livelihoods of citizens.
Bridging the Financial Gap with SME Bonds
With a lack of bank-backed funding channels, SMEs are already looking to new funding channels from P2P lenders and specialized asset finance companies to invoice or credit card financing. Since the bond market has long been the preserve of institutional investors and high-net-worth individuals, few SMEs have previously considered it a viable option due to lengthy procedures and high costs associated with it, making issuances below a certain size impractical. It happens.
With the advent of blockchain technology powered by smart contracts, we are experiencing a bond renaissance of sorts. By introducing a regulated, traditional instrument on-chain, blockchain replaces the countless middlemen in the old world with a technology that is transparent, decentralized, and secure. For example, integrated smart contracts can assume the roles of issuer and payment agent in the settlement layer of bond issuance, while blockchain acts as both an asset register and trading venue, challenging the existing financial market infrastructure. Unlike the traditional world, this open infrastructure architecture leaves investors ample custody options, ranging from self-custody through blockchain-based wallets to intermediate custody provided by regulated financial institutions.
As a result of moving bonds from traditional to blockchain-based infrastructure, transaction costs associated with bond issuance can be reduced – driven by automation and decentralization throughout the transaction lifecycle – all while complying with regulatory requirements. With bond issuance thresholds lower, SMEs in developed and emerging markets now have access to funding by accessing liquidity directly from a pool of digital asset investors who can hold bonds in tokenized form in their wallets. Using tokenization, they can also provide collateral such as receivables or assets to issue an on-chain bond. This market is referred to by insiders as RWA, an acronym for Real World Assets.
The rise of regulated DeFi
But are SMEs really ready to interact with these innovative financing tools?
Blockchain-based finance, and ‘DeFi’ in particular, has ushered in a new era of financial inclusion. For early adopters, DeFi has already changed the way financial services are consumed, with lending or borrowing through automated lending pools more accessible than ever. It has the potential to create a more open, free and fair financial market that is accessible to all. But at the same time, DeFi has struggled with regulatory clarity that undermines investor confidence and the integrity of the overall market. While the technology behind DeFi is, as mentioned above, compelling, what is missing is legal certainty. It is a challenge that the most proven and standardized debt instruments, With nearly 400 years of historycan solve.
By combining the efficiency and reach of DeFi with the regulatory clarity and trust of TradFi, on-chain bonds have the potential to transform how companies raise money and manage liquidity. As More investors engage with digital assets and big corporates use public blockchainOn-chain bonds could become a blockchain use case that could eventually create value for the real economy, resulting in far-reaching implications for local economies and a more inclusive financial system.
The views and opinions expressed here are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.