What is Financial Inclusion and Why Do We Need It?

The global economy thrives because of the work of small and medium enterprises (SMEs) who make up the majority of businesses worldwide. SMEs create jobs and develop a range of innovative services that contribute to global economic development. Given their huge contribution to the economy, SMEs don’t get the financial inclusion they deserve.

When I talk about financial inclusion, I mean access to finance and financial services. The World Bank found that access to finance was the second most cited obstacle to SMEs when trying to grow their business in emerging markets and developing economies.

SME’s receive a disproportionately small share of the credit from the financial system, a trend that exists in developing and developed countries alike for a few reasons.

  • Financial institutions find SME loans less profitable, even when charging higher interest rates to account for greater risk.
  • Banks find it harder to monitor and assess credit risks for SMEs. This is partly because SMEs will have less frequent and lower quality financial statements.
  • More appropriate levels of funding for SMEs such as; equity finance and corporate bonds are underutilised by SMEs. Perhaps because there is a lack of awareness about these options.
  • The assets that SMEs are seeking to borrow against are increasingly intangible such as the value of a brand or user base – rather than physical assets.

These problems are compounded for SMEs that have no financial history and untested business models. It stands to reason that banks would be hesitant to finance companies they cannot track. As much as 50% of economic activity can be sourced back to unregistered businesses in developing countries. It could be as simple as not having a business bank account which puts them in this position but makes them a bigger risk to lenders.

The Global Legal Entity Identifier Foundation (GLEIF) said:

“The lack of a trusted identity which can be linked to key business information and provide transparency, prevents many companies and individuals acting in a business capacity from participating in global trade and money flows. Successful trading and financing conditions rely on absolute confidence that transactional partners are known to each other and that their identity can be verified. A bank or financial institution will not lend money to an unknown or unverified business, in the same way that the average person would not usually loan a significant sum to a stranger they meet on the street – the associated risk of not recovering the investment is just too great.”

Lending Starts With Trust

A digital transformation initiative is nothing without trust. What I mean by this is simply that you cannot start a transaction online without knowing who you are doing business with. Verifying we are who we say we are is the first step in transactional trust and a prosperous global economy.

Current KYC processes aren’t fit for purpose and fraud is at an all-time high so it is important to give lenders a broader set of information on which they can make credit-based decisions. The Bank of England’s Mark Carney stated:

“To make real inroads, SMEs must be able to identify the data relevant to their businesses, incorporate it into their individual credit files, and easily share these files with potential providers of finance through a national SME financing platform.”

This is where the work of the GLEIF comes in. Born out of the 2008 financial crisis, Legal Entity Identifiers were created to fill in exactly this gap of digital understanding when it comes to business: “who are you and who owns you?”.

LEIs are a 20-digit unique code that holds data on a company’s identity and hierarchy. Every business can only register once and the data can be mapped to other identification data such as BIC codes and ISIN numbers.

ISO 20022 now requires Real Time Gross Settlement Payments to be tagged with a LEI and it looks like this may be extended to corporate payments in the future which means this payment data could be included in a portable credit file and used by lenders to identify risk.

If you’re new to LEIs, read more about them here or if you’d like to apply for a Legal Entity Identifier, you can register in under 2 minutes with ManagedLEI.

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