Five Reasons to Support SMEs So They Can Build Stronger Resilience to Future Disaster Shocks

Global
July 31, 2020

Djibril’s Story: Djibril lives in Ouagadougou, Burkina and owns a workshop that purchases moringa leaves from a nearby women’s organization. His workshop then fabricates the leaves into tea bags, powder, and so forth for sale in small retail shops. Until recently, the demand for moringa was growing across the country and had a promising prospect for export. Djibril secured a five-year loan with a local bank to upgrade his equipment and to increase his workshop’s productivity.

But COVID-19 has changed everything. To contain the pandemic, his city is under lockdown with travel limitations and closures of shops and markets. The women’s organization greatly reduced his supply of moringa leaves as a result of transportation disruptions and social distancing measures. Sales are at their lowest, and to cope with the situation, Djibril decided that his workshop will temporarily scale back production. If there is no positive outcome in four weeks, he won’t be able to afford operating costs and salaries for his employees. His challenge is further compounded by damage and losses from heavy rains.

Tam’s Story: Across the world in Hoi An, Vietnam, Tam and her family friends face similar challenges. They occupy homes that reflect a rural style of living and that provide accommodation services for tourists who visit this heritage town. In 2017, the town experienced heavy floods that resulted in damage to residents’ properties and disruptions to their businesses. Although the residents are more familiar with floods or typhoons, which visit the area every year, Tam and her friends found that COVID-19 presented an unprecedented disaster beyond their experiences.

Photo courtesy of Nguyen Thanh Tam. Her home was flooded in 2017.

As the country went under lockdown, most of the town’s businesses were closed except for those serving guests who were stranded because of travel restrictions. Tam and the town’s people were lucky because Vietnam was able to contain the first wave of the pandemic quickly. However, their businesses will continue to undergo difficulty with the global travel industry now under paralysis and with revenues quickly declining. While coping with the consequences of the pandemic, Tam and her friends are bracing themselves for yet a resurgence of COVID-19 and another season of floods and typhoons. 

As policy makers worldwide examine shocks caused by future disasters and crises, the critical and debilitating effects on small and medium enterprises (SMEs) as illustrated in the above case studies present compelling reasons as to why and how support measures can be better delivered to this sector.

Reason #1: SMEs are the lifeblood of economies and face mounting challenges from COVID-19 and from growing disasters and climate shocks.

Djibril’s and Tam’s stories are similar to those of millions of SME owners around the world who contribute to more than 50% of the world’s employment[1]. Globally, more than 436 million[2] enterprises face high risks from serious disruptions caused by COVID-19 in sectors such as wholesale and retail, manufacturing, accommodation and food services, and real estate. About 75 percent of SMEs surveyed by the International Labour Organization (ILO)[3] are experiencing or expecting a decrease in revenues with one-third of them expecting losses of more than 50 percent of their incomes. As a result, nearly 9 out of 10 businesses surveyed are already experiencing a shortage in cash flow, and income losses will range from US$860 billion to $US3.4 trillion.[4]
 
Reason #2: Access to finance in emergencies is critical for SMEs to weather the storm.
 
A common denominator for SMEs’ financial resilience is an often low buffer of cash to survive such an exogeneous shock as COVID-19, not to mention surviving compounded shocks. As shown from historical disasters such as the 2011 Thai floods or the 2011 Tohuko earthquakes, what SMEs need in the short term is a quick injection of liquidity to keep them afloat. Indeed, the damage from the 2011 Thai floods was estimated at US$46.5 billion, and the needs for reconstruction were estimated at US$50 billion, whereas 90 percent of damages and losses of Thai floods was borne by the private sector (US$41.8 billion), and their reconstruction was approximately US$37.5 billion. However, not every SME will be lucky enough to access liquidity at the required speed and volume. SMEs’ credit profiles are likely weakened—together with damage to properties and inventories—in the case of a disaster and associated losses of revenues. In addition, banks’ risk aversion tends to increase when there is an often-uncertain outlook following large-scale catastrophic events that will exacerbate the challenges faced by firms.
 
Reason #3: The World Bank can support governments to reduce the negative impact of disaster and climate shocks on SMEs, and helps to relieve the relievable from this coronavirus crisis.

Following COVID-19 and past natural disasters, governments were quick to ramp up existing support measures or to introduce new support packages so firms can have access to quick liquidity. Failures in firms’ access to finances could potentially lead to bankruptcy, loss of jobs and income, and transmission into the banking sector, all of which could eventually fall on governments’ liabilities. As of mid-April 2020, the World Bank recorded 723 policy measures in 113 countries to support firms in response to the COVID-19 crisis. The number of measures reflects the scale of the impact. Such measures focus on access to finance, financial sector prudent measures, tax relief, and employment support, among other needs. Similar measures such as tax relief, bridge loans, and credit guarantees were also found in the wake of past natural disaster events.

Photo courtesy of Nguyen Thanh Tam. Tam, third from right, and her local staff members at their An home in Hoi An, Vietnam.

Reason #4: Credit guarantee schemes can play an important role.

Credit guarantee schemes can act as shock absorbers during crises and can help SMEs to weather the storm. Many countries around the world have established credit guarantee schemes that support SMEs such as Djibril’s or Tam’s businesses. Those schemes provide access to finance for response and recovery following COVID-19, as well as after large-scale disaster shocks. Given the significant uncertainty about the length and scale of the outbreak, a public credit guarantee scheme (CGS) is considered by countries as an important instrument to unlock firms’ access to finance. Worldwide, CGSs amount to an estimate of US$1.8 trillion.[5]

Following the 2011 Thai floods, while the established portfolio guarantee scheme which had a mandate to cover disasters had a capital of THB2 billion (US$64 millions), commercial banks extended up to THB100 billion (US$3.2 billion) in new loans to flood-impacted SMEs. Given firms’ needs to access quick guarantees so they could gain quick liquidity for short-term response and long-term borrowing for recovery after disasters and crises, CGSs must be able to respond to both. However, not all of them can mobilize capital in a quick enough manner to respond, especially public CGSs that rely on the limited fiscal support of governments. In addition, CGSs are often not protected against pandemics and other disasters in most countries although those events could significantly undermine the quality of banks’ underlying loan portfolios that would, in turn, increase the vulnerability of the credit portfolios that the CGSs are protecting.
 
Reason #5: Can governments do more to support SMEs more rapidly during emergencies? Create shock-responsive credit guarantee schemes.

Can governments apply the principles of disaster risk financing to help CGSs work more quickly and effectively as “automatic” shock absorbers? By understanding risk in advance, establishing the right systems, and pre-arranging finance, CGSs could be enhanced to act even more quickly to support SMEs.

Catastrophe risk solutions could strengthen the resilience and the sustainability of CGSs against future disasters and crises; this pre-arranged finance would be released in an emergency to “power-up” the CGS and to enable it to support more SMEs. Then the SMEs would be able quickly to access the finance they urgently need to recover and would have much greater certainty, thereby reducing the long-term negative impacts.

The World Bank’s Disaster Risk Financing and Insurance Program is working with wider financial sector specialists to embed such innovations as part of the COVID economic recovery. Practically, catastrophe risk-sharing enhancements are embedded into the existing credit risk-sharing arrangement of the CGS in order to (a) protect the current loan portfolios against credit losses caused by pandemics and other disasters and (b) secure additional economic capital for guaranteeing new loans in the aftermath of pandemics and other disasters. This approach will increase CGSs’ financial capacity to (a) reimburse banks for the CGSs’ share in the catastrophic losses of their current portfolio, thereby reducing banks’ nonperforming loans (NPLs) and freeing up the banks’ capacity to underwrite new loans to SMEs; and (b) allow CGSs to offer new guarantees to SMEs in the aftermath of pandemics and other disasters. This arrangement also has the benefit of crowding in private capital and of limiting the fiscal exposure of governments.
 
With this type of arrangement in place and with support created by the five reasons, MSMEs and entrepreneurs such as Djibril and Tam will be able to invest in the future with greater certainty and can be confident in their ability to weather future storms.

 

 

[1] The World Bank. Small and Medium Enterprises (SMEs) Finance. Improving SMEs’ access to finance and finding innovative solutions to unlock sources of capital. https://www.worldbank.org/en/topic/smefinance

[2] ILO. April 2020. ILO Monitor—Covid-19 and the World of Work, 2nd edition. https://www.ilo.org/global/topics/coronavirus/impacts-and-responses/WCMS_740877/lang--en/index.htm.

[3] ILO. May 2020. “MSME Day 2020: The COVID -19 Pandemic and Its Impact on Small Business.” https://www.ilo.org/empent/whatsnew/WCMS_749275/lang--en/index.htm.

[4] ILO. March 2020. ILO Monitor—Covid-19 and the World of Work: Impact and Policy Responses. 1st edition. https://www.ilo.org/wcmsp5/groups/public/---dgreports/---dcomm/documents/briefingnote/wcms_738753.pdf.

[5] World Bank Blogs. May 2020. “Boosting Credit: Public Guarantees Can Help Mitigate Risk during Covid-19.”  https://blogs.worldbank.org/psd/boosting-credit-public-guarantees-can-help-mitigate-risk-during-covid-19.

 

Photo Credit: Photo courtesy of Djibril Ouedraogo, owner of the factory showing the new equipment.

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Disaster Risk Finance | COVID-19 Blog Series

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