The South African SME finance sector is currently unregulated and the micro-lending space, where a lot of SME funding activity takes place, has been fraught with ethical issues. The South African SME Finance Association (SASFA) was, therefore, established to encourage transparent and responsible lending practices in the sector.
To uphold these responsibilities, SASFA members are compelled to adhere to a code of conduct which serves to protect its customers and safeguard the industry from falling prey to the same pitfalls typically associated with microfinance.
Transparency is one of the keystones to successful lending and borrowing relationships between funders and SMEs. Other than representing a demonstration of good faith and ethical business conduct, transparency empowers SMEs to make informed borrowing decisions that can bolster their development. Similarly, an equal and opposite application of transparency enables SME funders to make accurate and efficient funding decisions which do not become financially burdensome for SMEs during their repayment term.
SASFA is made up of fintech service providers who share concerns that the funding gaps which face the bulk of South African SMEs leave them vulnerable to unprincipled operators, who tar alternative lenders with an unscrupulous brush. SASFA serves as a regulatory body which seeks to redress the extraneous challenges faced by SMEs in securing working capital by providing financial solutions that are fair and transparent. When a client chooses a provider who is a SASFA member, says board member Daniel Goldberg, they are choosing “assurance that they are dealing with an alternative lender that is fully compliant and only wants what is best for their business.”
The importance of transparency for finance providers
When SMEs are considering their business funding options, it’s beneficial to pay attention to markers of transparency which appear during their dealings with prospective funders. There are three especially important areas in which lenders should be forthcoming with details before a contract is signed:
- In disclosing the total amount of funds provided and the total amount to be repaid
- In disclosing all fees incurred by entering into an agreement, including any application fees, interest rates and early settlement fees (if applicable)
- In disclosing if and how a prospect’s data is handled, stored, and distributed amongst third parties
Ultimately, the onus is on SME finance providers to provide complete and transparent information to prospective applicants so that they can make an educated and well-informed financial decision. SASFA members are compelled to adhere to all the Best Practice Principles listed in the Code of Conduct. For this article, we are focusing on the three listed above so that SMEs can identify transparency markers before they are bound to an agreement.
What transparency markers should SMEs be on the lookout for?
So, how can SMEs seeking fair and transparent funding tell if a prospective lender is trustworthy? The following transparency markers are green flags to keep an eye out for:
- They clearly explain how their finance product(s) work in public resources like their website, social media, and blog articles in accessible language
- They indicate how their overarching fee structure works in public resources, and provide specific numerical values in the private contract before it is signed by the SME
- They can demonstrate a track record of robust relationships with other SMEs
- They offer a predictive tool like a business loan calculator which gives an estimate of the total cost of a facility with the provider in question
- They require qualifications from their applicants (usually a minimum trading history and annual turnover) – limitations actually indicate that the finance providers are less likely to take advantage of economically vulnerable SMEs, which is a positive sign
- Their application process entails some kind of investigation into the creditworthiness of their funding applicants
While the attraction of many alternative lending lies in the fact that they do not typically require as many application documents as traditional financial institutions, the absence of any efforts to determine the creditworthiness of an applicant is a red flag. Not only does a credit assessment allow SME funders to set realistic credit limits on their facilities with clients, but it also helps prevent an unethical lending phenomenon recognised as “stacking”.
What is stacking?
Stacking is when a lender provides funds to an SME even when they have outstanding loan balances with other short-term finance providers. If an SME accrues multiple outstanding loans, they can buckle under over-indebtedness. Stacking is unethical because the total repayment amounts accumulated stand to throttle cash flow and cripple the business’s ability to invest in any activities beyond servicing its debt.
While loan stacking is not strictly illegal, it poses a significant danger to the survival of SMEs. In severe cases, stacking can lead to the untimely failure of an SME. SASFA regards the unethical practice of stacking with gravity, and members are prohibited from engaging therein.
SASFA members are beholden to the standards of transparency as laid out in the Code of Conduct, and SMEs are encouraged to conduct themselves according to similar standards to foster ethical behaviour and support continued success and growth in the SME finance sector.
The importance of transparency for SMEs
According to 2022 research by SASFA, researchers at the Banking Association of South Africa have estimated that SMEs constitute 91% of formalised businesses in the country. Furthermore, they employ about 60% of the labour force and their total economic output accounts for approximately 34% of the local GDP.
It’s no question that SMEs constitute the backbone of the South African economy. However, despite contributing so substantially to the local economy, they face a dearth of funding and growth opportunities tailored to their needs. SMEs rely on cash flow and efficient funding solutions more critically than large entities, who can afford to survive the long waiting periods associated with traditional funding routes.
However, in a currently unregulated SME funding sector, this leaves businesses in need of speedy cash solutions in a potentially vulnerable position.
The point of self-regulatory bodies like SASFA is to direct discerning consumers to trustworthy and transparent funding providers. And transparency, like all good business principles, is a two-way exchange.
As the first half of this article outlined, the SASFA Code of Conduct defines clear behavioural guidelines for SME finance providers to follow, to create and sustain industry standards which enshrine best lending practices. This Code also applies to SMEs.
Before applying for a finance product, SASFA encourages SMEs to endeavour to:
- Clearly understand what the SME finance product is and how it works
- Clearly understand the product features as well as the mechanics of repayment
- Clearly understand what benefits the finance product will provide the business with
- Clearly understand if the business is well-suited to the product in question
These guidelines are achievable through the practice of transparency which, for SMEs, entails asking illuminating questions, holding SME finance providers to reasonable account, and upholding complete and transparent access to financial information on their end.
Why is transparency so important for SMEs to exercise when applying for business funding?
As service providers who are upholding the reputation of the rapidly evolving SME finance sector, it is paramount that SME finance providers are transparent in every manner described earlier. However, if the SME finance sector is to flourish, the cooperative transparency of SMEs in the funding process is required.
Daniel Goldberg says:
“Transparency is critical in lending because it allows businesses to make informed decisions about their financial options. And it works both ways. When lenders are upfront about their terms and conditions, it enables borrowers to assess the affordability and sustainability of their loans, ultimately contributing to a healthier lending ecosystem that has longevity.”
When applying for business funding, SMEs need to be upfront about details like their credit history and financial limitations. Depending on how technologically sophisticated a finance provider’s credit assessment process is, this information may be automatically apparent in the accounting and/or financial data accessed by the finance provider.
But in circumstances where more traditional application processes apply, SMEs should take care to disclose their most accurate and up-to-date financial information to their finance provider. This encourages a culture of transparency and sustainability by:
- Ensuring attainable credit limits and repayment terms
- Creating long-term relationships of trust between lenders and borrowers which nurture the sustainable growth of South African SMEs
By being 1) honest and transparent about the information that is disclosed during the application process and, 2) realistic about the amount of funding that an SME requests or accepts from a finance provide, SMEs are contributing directly to a self-regulating industry which protects the best interests of both finance providers and their clients. Together, SMEs and finance providers can positively and profoundly influence the efficiency and accessibility of transformative business funding solutions.
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