Small and medium-sized enterprises (SMEs) contribute substantially to the global economy. They now make up 90% of businesses and 50% of employment worldwide. In emerging markets, SMEs are propelling development by introducing new products, processes, and competition. Although it is difficult to gather and track data about informal companies in emerging economies, SMEs that are registered add as much as 40% to national income (GDP) and provide 80% of the jobs.
Despite their valuable contributions to the global economy and emerging markets, young companies are facing many challenges. The current COVID-19 pandemic is only fueling one of the primary difficulties for SMEs – a lack of access to credit. Nearly 70% of small companies already lack access to credit, which has created a finance gap of $5 trillion in emerging markets, compared to the $4.2 trillion in lending.
This lack of resources exists worldwide, with the most substantial finance gap in the East Asia and Pacific region, followed by Latin America and the Caribbean. SMEs in emerging markets need alternative methods to secure the financing necessary to sustain their businesses.
What are the alternatives?
Traditionally, formal financial institutions provide loans to businesses. However, bank loan processes are known for being bureaucratic and lacking in transparency, with long wait times and strict requirements. For small companies that lack human resources and funds, the time invested and money foregone to complete these processes are more than they have to spare, especially considering that about 50% of small business loans get rejected. Digital lending fintechs offer convenient alternatives, with faster digital applications and real-time review processes.
Crowdfunding is another popular option for micro, small, and medium enterprises to get funding. Crowdfunding platforms around the world are currently waiving fees to help small businesses. A crowdfunding campaign raises money through many small contributions, usually made online. Often, companies presell their products or services as part of the campaign, bringing in the capital ahead of delivering their goods.
Peer-to-peer (P2P) lending is another common financing option for individual consumers and businesses. P2P platforms connect individuals seeking loans with those offering funds. Lenders join for the opportunity to receive better returns than they would get from a bank savings account. Borrowers often lack formal credit history or merely want lower-interest loans. The platforms set the rates and processes the transactions between parties.
Business-to-business (B2B) lending operates similarly to P2P, but for business loans only. Many P2P platforms are adjusting loan limits and terms to help businesses mitigate the effects of Covid-19 on their operations. What’s more, some P2P software companies are opening up licenses so that others can set up lending platforms quickly. P2P platforms are the second most popular funding option for SMEs seeking capital, and allows small companies to find opportunities with suitable terms and requirements for their needs. In contrast to banks, B2B lenders often offer smaller loans, more flexible terms, and accept informal credit history.
Assessing credit risk and providing faster funding
Lending platforms and funding options are increasing access to funding, but the challenge of determining credit risk quickly remains. One option, cited by the World Bank as a solution to the lack of credit available to SMEs, is the use of alternative data. Lenders may review bills and payment transactions, public records, and even more informal data like emails or social media to determine credit risk.
Evaluating such a variety of information is a complex process that requires cutting-edge technology that most banks do not currently have. Artificial intelligence (AI) is being developed and used for alternative data analysis because it can learn without being programmed based on exposure to mass amounts and varieties of data. AI also works in real-time, decreasing the time required in the evaluation process, and helping SMEs access financing faster.
Invoice financing is another option that gives SMEs quick access to cash. Small companies often lack liquidity and may find themselves with unpaid bills that, if left too long in volatile times like these, can ultimately bankrupt their operations. Invoice financing allows them to sell those invoices to investors at a discounted rate, providing them with immediate cash flow. When the invoice is eventually paid, the investor who bought the invoice receives the payment.
Bank-Fintech partnerships are a necessity
Many banks recognize the need to digitize their services, and 82% of top bank executives said they plan to partner with Fintech companies in the next few years, but there is little time to wait. Although the banking industry has extensive experience with managing risk, loan servicing, and monitoring, fintechs have an advantage in speed, customer service, and personalization. When banks and fintech combine their efforts, they can provide faster financial options that are flexible to a small business’ most immediate needs.
Andrés Abumohor, Co-Founder and COO of OmniLatam, a neobank that provides financial services to small- and medium-sized businesses in Latin America.