Home » Industry » Checklist for Potential Informal Sector Funding Sources [opinion]

The financing of informal sector has been a subject of great interest – both to policy-makers and informal sector players – because of the significance of informal sector in today’s commerce. Given the heterogeneous nature of the informal sector as it includes a wide range of businesses, which differ in their dynamics, technical aancement and risk attitudes.

Many small businesses are relatively stable in their technology, market and scale, while a few others are more technically aanced, filling crucial product or service niches. This makes their financing of great interest to financiers such as banks.

What are the potential sources of funding for Informal sector?

Informal sector players should understand that banks have a comparative aantage in credit information processing and intermediation, and continue to play an important role in funding the informal sector segment.

A more diversified mix of funding options than those currently available would represent would be more sustainable in the long run in the country’s current financing environment. At the national level, a range of policy actions have to be put in place which aim to create a more diversified set of viable funding options.

Therefore, before any informal sector player decides to approach a bank, they should develop a checklist of their potential sources of financing.

It is always important that they continuously evaluate to check on the proportion of their working capital and new fixed investment that has been financed from some of the following sources during their subsistence bearing in mind that financing innovation and small businesses requires a funding system that sustains entrepreneurship and drives job creation. These potential sources of financing would include:

Internal fundsretained earnings

Borrowing from local private commercial banks

Borrowing from local State-owned banks

Loans from familyfriends

Money lenders or other informal sources (other than familyfriends)

Trade credit from suppliers

Trade credit from customers

Leasing arrangements

Non-bank financial institutions

Non-governmental organisations

Venture capital is also an important part of such a framework

Is Diversification away from banks good?

Diversification away from reliance on bank funding is very desirable. It is important that policy-makers mitigate the risks accruing to small firms merely because they are turning to other underdeveloped and costly forms of financing due to an inability to access bank credit. Policies must aim simultaneously to stimulate the flow of bank credit and to create well-developed markets for a range of alternative financing sources to complement the role of banks in financing the informal segment.

There is need for increased coordination amongst various, and often disconnected, stakeholders interested in sustainable informal sector financing. Institutions whose objectives are to stimulate and promote private capital for poverty alleviation and promotion of sustainable development could be used as platforms for a coordinated mechanism for various stakeholders including investors from public, private and philanthropic institutions, active in informal sector financing and seeking synergies with players from complimentary sectors.

Against all odds, the existence of marked informational asymmetries between small businesses and lenders, or outside investors the intrinsic higher risk associated with small-scale activities and the existence of sizeable transactions costs in handling informal sector financing are some of the inherent challenges faced by institutions that have an appetite to finance informal sector.

It is therefore important that policy frameworks governing the operations of these informal sector should be able to proffer potential solutions so that these factors ceases to be the scaring factors for those with the appetite to finance this group of entrepreneur’s.

It has been observed that the majority of the small business sector players only apply for loans from banksonce they find business opportunities.

They ask banks to offer loans as soon as possible in order to organize materials and realize transactions in time.

However commercial banks have to follow strict procedures and operational standards before issuing loans. though necessary from a Banks point of view, these standard procedures sometimes do not satisfy the urgent needs for financing of small businesses.

It is in light of this urgency that the informal sector players end up resorting to other sources of financing so that they don’t jeopardise their business deals.

Although bank loans will certainly remain the dominant source of financing for economic activities, long-term investments are better financed by equity capital.

In particular, share capital is preferable to foster innovation and growth in businesses with uncertain results and pronounced information asymmetries.

While banks can count on guarantees and long-term relationships with firms to reduce the information asymmetries, equity capital enables investors to benefit in full from the returns to successful innovation.

The author is an economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe.

Source : The Herald