By Samuel White, Regional Director Asia and Middle East, Creditinfo Group
Over the last twenty years, small and medium-sized enterprises (SMEs) have underpinned the growth and development of economies, creating jobs, contributing significantly to innovation and technological developments, and helping to alleviate poverty around the world. This is especially the case in developing countries where SMEs they represent around 90% of businesses and more than 50% of employment opportunities. In today’s competitive market, access to additional finance is crucial to helping SMEs to expand and grow their businesses.
However, despite its steady growth and contributions to the economy, the sector is still experiencing challenges when applying for loans. It is estimated that 65 million firms, or 40% of formal micro, small and medium enterprises (MSMEs) in developing countries have an unmet financing need of $5.2 trillion every year. Without financial support from banks, many SMEs are forced to look to personal funds, friends, and family for financial help to support their businesses.
Barriers to SME lending
Lending of any type always comes with a certain level of risk, whether that be overdrafts, credit cards, short or long-term loans. Traditional banks have always been cautious, especially when it comes to lending money to smaller and supposedly less stable businesses. One of the main reasons banks are so reluctant to grant loans to SMEs is because it’s difficult for them to evaluate their level of risk in the same way as more established businesses can, since these smaller businesses don’t usually have the solid accounting systems and necessary data.
The complex nature of assessing a business’ creditworthiness often impacts the bank’s ability to provide affordable credit. Without the option of taking a loan from a traditional bank, most SMEs turn to alternative solutions to get the financial support they need, for example, expensive credit lines that charge eye-wateringly high interest rates. This is not an affordable or sustainable option for small businesses that need to maintain a steady cashflow.
Times are changing for SME lending
SME lending demands a faster, more agile, digital approach. While traditional banks have tried to create new solutions to bridge this gap in SME lending, they’ve not been able to provide a solution that fully meets the specific needs of SMEs.
This is where alternative solutions come in. Unlike traditional banks, fintechs and other modern financial services are not held back by legacy systems and have the expertise to provide a solution. Fintechs can leverage data and technology, such as a digital decisioning platform, to quickly assess an SME’s entire data footprint and provide tailored financial solutions. For example, in Africa, such a platform has been used to assess the credit risk of an SME by looking at real-time data from multiple sources, including data from e-wallets, credit bureaus and credit scores.
This kind of data, also known as alternative data, is abundant. For example, every time SMEs and their customers use digital services, carry out a bank transaction, make or accept digital payments, use their mobile phones, or manage their receivables and payables through a digital platform, they create alternative data. With this real-time and verified data, it’s easier for lenders to determine both capacity and willingness to repay loans on a case-by-case basis
In addition to alternative data, specific SME assessment methodology can be applied. For example, small companies often have a greater level of owner-centricity. Therefore, it’s possible to combine business and personal data to develop highly predictive blended scorecards that utilise the payment patterns of business owners and managers alongside company credit data to produce a more complete risk assessment.
Tapping into alternative data opens a window of lending opportunities for SMEs but this alone isn’t enough. Central banks must play their part and continue to support the SME sector wherever possible. On a global scale, central banks are implementing mandates for all banks to lend a set percentage of their credit portfolios to SMEs. These changes are meant to facilitate the flow of cash in the economy and reduce the high cost of credit to a sector that is regarded as a growth driver for these economies and a key player in our financial ecosystem.
New opportunities on the horizon
Internationally, we’re seeing a shift towards digital lending solutions as a way to overcome traditional barriers to SME lending. Reimagining lending methods and facilitating access to finance will enable SMEs to grow their businesses and strengthen their presence in their respective markets. As an underpin of financial ecosystems globally, it’s crucial that the sector’s needs are met, so SMEs can continue to thrive both now and in the future.