Tuesday, September 7, 2010

Small enough to fail - alas

I had never heard of ShoreBank until I read this article in The Economist. The Economist titled its article – Small enough to fail. I add an “alas” to my post header.

ShoreBank , according to The Economist article, thrived for 35 years on a business model of a small community bank that targeted lending to poor people in poor neighbourhoods. It actually had higher repayment rates and lower delinquency,  as any careful micro lender will tell you.  But then the recession struck like a tsunami. In the neighbourhood in  which it operated, the recession has been brutal and most people lost their jobs. Despite very good payment records in the past, they couldn’t keep it up.  Unfortunately its location in Chicago and therefore the association with Obama made it a political lightning rod. No way it could be bailed out. Alas, it had to go.

This article set me thinking on the risk quotient for small businesses. By definition, small businesses cannot be diversified in terms of risk. They will be dependent on either a small market, or a small set of suppliers, or a particular technology or a single currency, or whatever. Even if they are an extremely well run business, they can be vulnerable to a violent swing in risk parameters over which they have no control. Exactly what happened to ShoreBank.

It must be remembered that some 90% of all businesses in the world are small businesses. They are, by far, the largest employers in the world.  Are they fundamentally vulnerable ?  And therefore at a fundamental competitive disadvantage over big businesses ?

Traditional risk mitigation strategies involve either hedging or taking insurance.  Both don’t seem to be attractive options here. Can small businesses pool together and hedge together ? Can some intermediary create a product that can help make this happen ?

These days, I am working with a small entrepreneur whose business has gone bad. What he and his family are going through has to be seen at close quarters to be appreciated. Risk is an esoteric term in economics text books. When it hits lives brutally, it stops being a concept and starts to become something frighteningly real. Small businesses face it every day , in ways  that big businesses would not even comprehend.  And yet, risk mitigation seems that much more difficult for small businesses.

This is a muse, without a point of view. I just wonder if risk management products must be evolved for systemic risks faced by small businesses. And just one other thing. The next time you delay a payment to a small guy, or squeeze him in a negotiation, just pause and spare a thought.