Why Small Businesses are Vital to Building Urban Resilience

By Arzu Culhaci, Mercy Corps East and South Asia

Why Small Businesses are Vital to Building Urban Resilience

A record-breaking 272 mm of rainfall fell on Chennai, India on 1 December 2015, leading to a two-week flood which displaced 1.8 million, claimed over 300 lives and caused well over $7 billion in economic losses. Due to the flooding, some 14,000 individual Micro Small and Medium Enterprises (MSMEs) experienced a total of $250 million of damage. In a city like Chennai this can have serious implications: MSMEs here make-up a vibrant manufacturing industry that employs 360,000 people and contributes over 3 billion to the city’s Gross Domestic Product (GDP), 3% of the national total. After the floods, many small businesses were forced to shut down, either temporarily or permanently.

Rapid urbanisation across Asia is altering the natural environment and combined with climate change is leaving areas dense with people, infrastructure, and assets exposed to flood risks. In Chennai, the encroachment of development onto flood plains, inadequate drainage infrastructure, and poor coordination among city institutions were major contributors to the extreme levels of flooding that affected MSMEs. But a recent study by Okapi Research and Advisory conducted with the support of Mercy Corps shows it was the business environment – and particularly financing options for small firms- that determined which businesses did relatively better, and which ones were worse off after the floods.

We found that reliable cash and credit flows helped reduce the impacts of the December 2015 floods on small businesses, whereas slow or insufficient capital severely amplified the effects. Financing streams and insurance options, however, are severely constrained for MSMEs in India and almost 67% of MSMEs are excluded from the formal financial sector. The Chennai floods revealed just how dependent firms were on informal capital, with 19 out of 35 firms interviewed self-financing their recovery and 13 relying on loans from family, friends and money lenders. These informal sources were perceived to be quick, more flexible sources of capital for restoring assets and reconnecting with supply chains after an emergency.

Insurance was also a dismal performer for small firm recovery and covered only a small fraction of losses. The few firms that purchased independent insurance policies recovered only an average of 31.5% of their claimed amount. Most firms, however, held insurance as part of bank requirements that bundle insurance policies with loans products. In this case, firms received a mere average 16% of the claim amount. Insurance claims also failed to consider labour losses. In fact, insurance companies and their surveyors demonstrated limited knowledge about the industry and assets they were meant to protect.

The state of financing support for small firms in Chennai in the wake of the floods reveals a major challenge for balanced and resilient urban development. As current urban growth patterns in Asia continue, climate and other disaster risks will continue to threaten small business, businesses that are essential to a vibrant, inclusive economy. Given the status quo, and to protect economic gains in urban areas, MSMEs will need flexible and fast financing options. Access to insurance must become simpler and more relevant for small business needs.

Chennai’s situation is not unique, and must be a call to action. Development actors must work jointly with policy makers, industry associations and the private sector to support a better business environment for small firms that can help them mitigate disaster risks. A strong starting point is partnering with financial institutions and insurance providers to develop and test innovative, inclusive financing solutions for small businesses. These solutions should not only contribute to small business growth, but also their resilience and rapid recovery as they face climate and ecological risks. This will require bridging the knowledge gap and connecting financial service providers with small businesses to better understand their needs, and helping financial institutions recognise the business opportunities in more effectively working with small business clients.

There is money to be made on both sides, but the social impact of resilient small business that enhances employment and supports local economies can go a long way in making sure urban resilience is good for everyone.

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