By Joseph Cherian, Deputy CEO of Asia School of Business

In today’s dynamic economic landscape, small and medium-sized enterprises (SMEs) play a pivotal role in many nations’ economies. They serve as the engines of growth and innovation. As we navigate unprecedented geopolitical and supply chain challenges, such as those arising from the recent global pandemic, it has become increasingly evident that SMEs require robust financial support systems to thrive. With SMEs contributing significantly to the national economic fabric, fostering their resilience demands a coordinated and comprehensive approach.

Singapore provides a good case study with its all-of-government approach to supporting SMEs, epitomized by institutions like Enterprise Singapore (ESG) and the Economic Development Board (EDB). ESG’s multifaceted support, ranging from development grants, upskilling and talent development, productivity enhancements to international networking, sales, and marketing, illustrates the comprehensive manner of assistance provided to its SMEs in order for them to thrive. Moreover, initiatives like EDB’s venture fund (EDBI), which invests in promising SMEs in technology and select high growth industries, demonstrate the government’s commitment to fostering innovation and growth within the SME ecosystem.

During times of crisis, such as the recent global pandemic, the coordinated efforts of these government agencies become paramount. ESG’s role in channeling subsidized bank loans to vetted SMEs showcases the importance of a streamlined and efficient support system. Fragmented or siloed approaches risk diluting the impact of assistance, which may leave SMEs vulnerable to unanticipated economic shocks.

Drawing parallels, the U.S. Small Business Administration (SBA) also offers a plethora of support mechanisms for American SMEs, underscoring the importance of a diverse toolkit. From concessionary loans to counseling, training, upskilling, and networking sessions, the SBA takes a multifaceted approach necessary for SME resilience, especially for minority and women-owned businesses.

Private initiatives like Alignable in the U.S., which fosters online networking among SMEs and functions like a conjoined LinkedIn and Facebook for SMEs, demonstrate the potential of leveraging technology and business-focused social media platforms to enhance collaboration and resource-sharing within the SME community, especially in areas such as information-sharing, continuing education, and thought leadership. Establishing a similar platform in Malaysia can facilitate knowledge exchange and business referrals, fostering a supportive ecosystem for SME growth.

Moreover, capital market solutions, as exemplified by the Securities Commission Malaysia’s five-year roadmap for SMEs, offer these enterprises access to diverse funding mechanisms. These solutions not only stimulate economic growth but also create employment opportunities and enhance market liquidity.

Historically, many SMEs do not have access to local capital markets. They usually rely on government support, concessionary loans and grants, bank financing, or are simply owner-financed. Most government support to SMEs during crises is in the form of loans and debt channeled through the private sector at concessional rates, which eventually have to be repaid.

To mitigate negative economic and social consequences, to save organizational capital, especially organization-specific human capital, alternative financing schemes are necessary. Capital market solutions, particularly those involving tradeable funding vehicles, that partner with both the public and private sectors (PPP) to fund large-scale infrastructure and green projects around the world, and which include a credit enhancement component, are especially useful and illustrative in the current context. This type of financing mechanism is referred to as “Blended Finance.”

The Managed Co-Lending Portfolio Program (MCPP) by the International Finance Corporation (IFC), the World Bank’s investment arm, is a good vehicle structure to replicate in Malaysia for public-private financing of its SMEs. The Managed Co-Lending Portfolio Program (MCPP) is a syndication lending structure with credit enhancement, specifically designed for infrastructure projects. It allows the IFC to co-invest in a diversified portfolio of loans for due-diligence projects, attracting institutional investors from both the public and private sectors. The Swedish government or the IFC de-risks the MCPP portfolio through a first-loss guarantee, a.k.a. credit enhancement. The IFC recently announced the launch of its MCPP One Planet (climate change) facility, which comprises a portfolio of Paris Agreement-aligned emerging market senior loans.

A corresponding example is the IFC/Amundi Green Cornerstone Bond Fund, which channels capital from institutional investors into anchor investments in sustainable bond issuances from corporates and financials in developing countries. Fund proceeds are primarily used to buy green bonds issued by banks in developing countries. Blended Finance in this case helps unlock private capital with the aid of public or MDB capital with the same first-loss warranties via equity participation.

Equity investment can effectively leverage public money. Case in point is the IFC-Amundi structured fund that attracted 16 times as much private investment into the funding vehicle! Good due diligence by a trusted institution coupled with proper credit enhancement from a long-lived sovereign authority could encourage asset owners sitting on trillions of dollars in assets to participate in sustainable finance-related investment vehicles. This is due to the first loss warranties available, which makes the structure akin to investment grade.

Malaysia can draw on its strengths and comparative advantage by considering utilizing credit-enhanced Islamic Blended Finance vehicles for innovative SME financing, which by construction are ESG compliant.

Quasi-equity financing can also emerge as a promising avenue, especially during times of crisis, by offering SMEs an alternative funding mechanism to traditional debt financing. By providing first-loss protection for lenders and enabling flexible repayment structures, quasi-equity schemes mitigate financial risks for SMEs while promoting sustainable growth.

My essay on quasi-equity financing, combined with a simple financial economic model, which first appeared in an article I wrote for the Nomura Journal of Asian Capital Markets in Fall 2021, illustrates that in equilibrium, quasi-equity combined with concessional loans economically dominates a pure concessional loan scheme2.

All the innovative financing schemes for SMEs mentioned here are Pareto-optimal — i.e., at least one party is better off, with no one worse off. These structures:

• Free up the bank’s capital for further lending (asset recycling),
• Disintermediate and mitigate the risks that risk-averse banks face when approving risk-taking SME entrepreneurs’ loans (risk management),
• Improve the credit quality of the funding portfolios such that asset owners like pension funds can now invest in them (credit enhancement).

In conclusion, fostering SME resilience demands a holistic and coordinated approach that encompasses financial assistance, technological innovation, and regulatory support. By emulating successful models and embracing innovative financing mechanisms, we can build a resilient ecosystem that empowers SMEs to thrive in an ever-evolving global economy.

As we look towards the future, it is imperative that the government, financial institutions, and industry stakeholders collaborate to create an enabling environment where SMEs can flourish. By prioritizing SME financial support and fostering a robust, all-encompassing, technology-driven ecosystem of innovation and resilience, Malaysia can pave the way for sustained economic prosperity and inclusive growth.

Originally published by The Exchange Asia.