How Fintechs Can Transform Small-Business Lending
Small and medium-sized enterprises (SMEs) play a surprisingly large role in the global economy. These companies and microfirms account for nearly 63% of employment in developed countries, according to the Organization for Economic Cooperation and Development.
But those businesses can thrive only with a steady supply of debt and equity. Those are the lifeblood of established businesses and startups. However, both approaches have downsides.
Lengthy approval processes, risk of high debt and pressure to repay loans at high interest rates can exert enormous pressure on SMEs and compromise growth. Meanwhile, equity financing dilutes control and can disrupt business if the fit is not right.
Although established financial services firms have long-standing offerings for SMEs, fintechs are driving innovation. They are developing newer models for underserved populations, particularly in developing countries. For instance, microfinance is a lending service that provides very small business loans — ones that banks don’t find profitable or perhaps don’t even know how to offer. Fintechs have harnessed mobile channels to tap into this service by providing a seamless user experience and using data to effectively underwrite loans. Some companies report write-offs lower than 5%, a number that would impress most banks.
Another option that has gained significant traction is crowdfunding, where family, friends and the general public donate small amounts to support local SMEs and startups. This model uses social and digital media platforms. Several fintech firms, including Kickstarter, RocketHub and Crowdcube, are already using this approach to provide compelling offerings.
The opportunities for SME lending vary by region. The European Investment Fund found that bank loans and overdrafts were the primary instruments for SME financing in Europe, followed by leasing, equity and factoring. In the United States, online lending companies provided $10 billion in funding to nearly 180,000 small businesses from 2015 to 2017, according to economic research firm NDP Analytics.
Despite its contribution to economic growth, the SME segment is still plagued by inadequate financing. Limited access to finance is among the top-ranked challenges for SMEs in developing countries. SME lending is a high-touch, expensive affair in which banks often struggle to fit small businesses into traditional relationship-lending models.
Here again, fintech startups are changing the game through marketplace (peer-to-peer) lending that features unsecured loans and data-driven credit scoring. These models take advantage of low underwriting costs and automation to deliver competitive interest rates as well as to offer faster and more convenient access to funds.
Other lending barriers include regulatory challenges involving cross-border investments, high personal liability, ineffective budgeting practices and steep overhead. Also, many banks consider loans of less than $250,000 unprofitable. All these factors have led to a decline in external financing for SME lending.
Meanwhile, fintech companies have proven they are adept at using technology to standardize and automate underwriting processes, thereby delivering a superior customer experience. And their low-cost, innovative and flexible solutions can solve a range of problems faced by small-business owners today.
Also, the emergence of online payment platforms is ushering in an era when entrepreneurs can share financial information online and find lenders that approve and disburse small loans for their businesses.
These fintech gains, however, need not come at the cost of the banking industry. Traditional financial institutions can collaborate with platforms that will help optimize their relationships with small businesses. Solutions such as Wave, Autobooks and LendGenius help financial institutions provide services needed by SMEs.
Banks can enable fintechs, either as sources of funds or as partners in reaching underserved SME segments. There is an opportunity to further transform small-business lending by finding underserved markets, appealing to digital natives and using better sources of data to augment underwriting.