In KAVILASH CHAWLA’s 2016 comments on the state of SMEs and entrepreneurship within the global Islamic finance industry, he laid out an expectation that, in 2016, we would continue to see the development of SME and entrepreneurial clusters, but at an accelerated pace from 2015. In this article, he continues from where he left off and invites us to dive in together to see how 2016 unfolded.
Review of 2016
If there was one word I would choose to characterize 2016 it would be ‘uncertainty’. From macroeconomics to geopolitics, 2016 was a year of surprises. Markets, as a rule, don’t like surprises. In finance, markets operate on the logic that higher risk activities require, and should generate, a higher return to compensate for that risk. As financiers, successful engagement within the SME and entrepreneurial space comes down to one’s ability to accurately price and mitigate the risks associated with the space.
Even at the best of times, pricing risk is more of an art than a science, and in 2016, we were in a gallery surrounded by abstract rather than figurative art. This resulted in a flight to quality. Whether it’s assets, partners or customers, in uncertain times, markets and market players seek to find certainty in the known and in the quantifiable, and 2016 for the SME and entrepreneurial space was no different.
With this context in mind, 2016 still turned out to be quite remarkable when it comes to the acceleration of the disruptive forces I commented on in 2015. Before turning to these, however, it is important to also highlight the significant negative impact the uncertainty of 2016 has had on the SME sector. Firstly, 2016 saw a marked increase in accounts receivables and a continuing deterioration in average terms of trade, and in some markets the deterioration has been as pronounced as going from 45 days to 200 days-plus for average payment terms. This means that SMEs are not only having to compete on price, but are increasingly having to compete on their ability to operate without getting paid. The second impact has been a deterioration in access to both trade and growth-related finance, as financial institutions (both Islamic and conventional) have tightened their internal requirements for extending finance to SMEs.
While deteriorating terms of trade and a broadly negative cash flow outlook for SMEs may, from a financial institution perspective, justify the tightening of internal requirements, it leaves SMEs with a very real cash flow shortage issue that they need to solve to remain viable.
In returning to the forecasted acceleration of disruptive forces in the SME and entrepreneurial space for 2016, as anyone who has been involved in the Islamic or conventional financial markets in 2016 can attest, the fintech industry is now part of the global financial landscape. In 2016, we saw every element of fintech, from blockchain and payment systems through to capital-raising and social finance, surface within Islamic finance. Many of these platforms and businesses were at the seed stage in 2015, and 2016 saw both growth and the beginnings of the institutionalization of these disruptive businesses into the Islamic finance landscape. As aforementioned, the Islamic SME and entrepreneurship space in 2016 was not immune to the broader flight to quality brought about by global macroeconomic and geopolitical uncertainty. The flight to quality led to a concentration of investor capital into high-quality entrepreneurial ventures and platforms, pushing lower quality assets out of the marketplace. Having capital and support focused on high-quality businesses and assets has facilitated the acceleration of disruptive businesses into the marketplace (eg Finocracy) in 2016.
Simultaneously, the flight to quality has driven the recognition by both private and public sector players that the long-term, successful development of the SME sector and entrepreneurship requires an ecosystem approach. To develop high-quality investable assets, government, industry, civil society, education providers and a host of other stakeholders need to work in concert within a productive framework and environment. In 2016, we saw the realization of an ecosystem approach start to manifest with the emergence of incubators, accelerators and other SME and entrepreneurial communities within the Islamic finance space.
Preview of 2017
2017 is going to continue to be a year of uncertainty, but perhaps less so than 2016. If there was one word that I would use to describe the expectations for 2017, it is ‘scalability’. For the SME and entrepreneurship space, the flight to quality of 2016, with all its positive and negative impacts, will continue, but with two big differences. Firstly, 2016 saw high-quality SMEs and entrepreneurial ventures within the Islamic finance space attract capital and support. In 2017, we will see some of these start-ups scale and move on to successful series A and B fundraising rounds. 2017 will deliver a successful track record of businesses built off of these disruptive forces, and will better capture what is resonating and succeeding with investors and consumers alike. This sets up 2018 for the mainstreaming of disruption.
The second big difference between 2016 and 2017 is the acceptance of the ecosystem approach. Whereas 2016 was about accepting and starting to invest in an ecosystem approach, 2017 will be about growing and scaling the ecosystem. To be sure, an ecosystem approach is time-consuming and complicated, as it requires disparate stakeholders to cooperate around shared outcomes. But the commitment by many OIC economies to diversify their economies by investing in entrepreneurship and SME development provides fertile ground for carrying the ecosystem approach forward.
SMEs and entrepreneurship are the engines of economic growth. While traditional wholesale banking, capital markets and retail finance will continue to dominate the Islamic finance landscape in 2017, the SME and start-up space represents the future of the industry. 2017 will help to determine which innovations from 2016 will create the new architecture of global finance, and 2018 will determine if, and how that architecture can contribute to economic diversification, economic growth and a shared economy.