SMEs are essential to the global economy, creating jobs and generating new financial ideas. However, they often need help getting the money they need to grow and expand. By providing them with access to trade finance, we can help them grow and create jobs. The World Bank estimates that 90% of businesses and over 50% of jobs are SMEs, generating 40% of national income in emerging economies.
Small and medium-sized businesses (SMEs) are the backbone of many economies, but they can often be limited in their growth due to a lack of access to trade finance. This is mainly due to a need for verifiable information to properly assess the SME’s financial situation. A 2019 IFC study linked credit risk issues to information asymmetry, finding that “a lack of verifiable information to properly assess the SME’s financial situation” makes risk assessment difficult.
One way to help overcome this challenge is through digital identity. A trusted digital identity can help businesses build trust with lenders and other service providers, leading to increased access to finance and other services. In addition, a digital identity can help businesses track their performance and growth over time, giving them a better understanding of their financial situation.
Definition of Digital Identity
Business owners can quickly get a trusted digital identity by registering for an e-Residency card. A government-issued digital identity is one that allows business owners to conduct business online securely and conveniently. Digital identity is a complex term that has multiple meanings.
The definition of financial services should exclude social and personal identity and focus on official identity. FATF guidance says digital ID systems use technology to prove and show identity. This definition explains how only some digital ID system elements must be digital. Some identity proofing and enrollment elements are digital, physical, or a mix of both. Digital binding, credentialing, authentication, and portability/federation are required.
Digital identities are used in a variety of ways to prove identity. These can include online identity verification APIs, platforms, and protocols. Additionally, biometrics can be used to verify identity. This can be helpful in cases where banks need to focus on AML and CTF as well as KYC and CDD to avoid fines and reputation damage.
A Brief on MSMEs’ Struggle to Get Money
World trade is falling short by $3.4 trillion because banks need to lend money to SMEs. Loans are expensive, and MSMEs don’t have a unique way to prove their identity, so it’s difficult for them to get loans. Governments are working on digital identity programmes to help solve this problem.
With the rise of fintech, many players are solving the buyer/seller identity problem. ID4D is a United Nations initiative that assists member countries in adopting the Sustainable Development Goals. Several countries, such as India, Canada, Sweden, and Estonia, are already implementing digital ID programmes. Financial institutions can promote these programmes by driving their clients to use them.
To participate in the global marketplace, MSMEs must establish trust with their customers and partners. One way to do this is by obtaining a Legal Entity Identifier (LEI), a unique 20-character code that identifies an organization. The LEI gives businesses a trusted name, which makes it easier for them to do business across borders.
Also Read: MSME Credit Gap- NBFCs On The Rescue
An Overview of the Benefits & Challenges of Digital Identify
A digital identity provides several benefits for small and medium-sized enterprises (MSMEs), especially in emerging markets. These benefits include:
- Reduced financial institution costs for Know Your Customer/Customer Due Diligence (KYC/CDD) procedures can improve corporate credit terms.
- Fewer errors during KYC document verification
- Improved anti-money laundering (AML) controls can aid supply chain connectivity.
- Banks can offer better products if they consider clients’ changing identities rather than their fixed identities.
- Clients can see when and what information banks share about them.
- Digital identity connects buyers, sellers, and third parties easily and quickly.
However, there are a few challenges with Digital Identity. There are some technical issues that banks need to work out to make it easier and cheaper for MSMEs to do business. One major problem is the need for interoperability between different platforms. This can make it difficult for MSMEs to enter new markets and do business with other companies. Another issue is the cost of adaptation, which can be prohibitive for many companies. In addition, we need to consider the risk of technology failures, which could cost MSMEs more money.
The Bottomline
Digital identities, such as the LEI, will play an important role in trade as it becomes increasingly digitized. We can help close the trade finance gap between developed and emerging markets by streamlining banking operations and compliance. This will make it easier for small and medium-sized businesses in underserved markets to get the money they need to grow their businesses.
MSMEBlog advises MSMEs on how to obtain proper financing and provides information on available funding sources. Find out more about MSME financing at https://www.msmeblog.com/.
