A recent study, based on interviews with emerging leaders in the fintech sphere and traditional money lenders has revealed that expectations of an enhanced borrower experience will force significant changes in small business financing in the years to come.
The main objective of this study was to identify the challenges faced by the bank and financial institutions during the process of lending and define a future vision for making the system more efficient and profitable.
Challenges in Small Business Lending
The process of small business lending at a majority of the banks today is completely manual and carried out across multiple unintegrated portals that renders it totally inefficient and expensive.
Even after all the relevant information is collected, credit managers spend even more time in reconciling the data obtained from all the sources.
Again, once the lending decision is made, a gap between monitoring of documents and portfolio performance remains which causes further delays.
SMEs themselves are at the receiving end when it comes applying for credit through banks. Very few small businesses are aware of their business credit risk and ways to improve their rating.
The inconsistent requirements of banks with regards to data and documentation doesn’t help either. Finally, lack of expertise in the SMEs makes it difficult for them to maintain accurate financial reports which form an important part of the lending application.
Implication on SMEs-Analysing The Financial Gap
While SMEs are vital for economic growth and development they face many hurdles in securing “online” business loans. As more and more banks have started retreating from SME financing, these enterprises seek out new sources of funding from private equity and other sources.
In fact, first loans have started declining in developing countries and have stagnated in the US and UK since the global economic crises. As a result, a huge financial gap in trillions of dollars can be observed for SMEs in emerging markets.
Prior studies have revealed that SMEs confront limits on borrowing mainly because of their weak financial structure and low levels of production.
SME insolvency and bankruptcy are some of the indicators that the business is suffering due to payment delays resulting in declining liquidity. These market signals term them as unfavorable borrowers who in turn have to offer high quality collateral to prove their creditworthiness.
Further as the SME sector is extremely vulnerable to external market shocks, it has affected the short and long term financing to them.
Data from Organization for Economic Co-operation and Development (OECD) shows that in some countries SMEs are paying an average interest rate of 20.8% per annum, which will seriously impact the growth of less profitable firms.
This significantly high interest rate, coupled with reduced lending, makes it all the more important to study the financing gap which ails this sector.
Emerging Trends in Small Business Lending
Since small businesses have started to get a lukewarm response from traditional banks in accessing loans, alternative platforms have started to emerge at a feverish pace to grab a piece of the pie in SME financing.
As a result, SMEs have started to recognize the benefits of these new sources of lending, as these fintech companies offer cheaper loans, low cost transactions and faster process of disbursement because of digitization of their services.
Soon the financial institutions will begin targeting the digital-first population and accommodating these new generations of customers will become a challenge. Some of the lending trends that will shape the industry in 2021 could be:
- End-to-end digitization
- Use integrative microservices
- Adopt new business models
- Improve conventional scoring systems.
- Incorporate machine learning and artificial intelligence.
- Install block chain technology
Technology and data will dominate the future of the small business lending industry. While the complex compliance issues are likely to remain, the need of the hour is digitization to simplify the process and change the lending business lifestyle.
Borrowing From Fintech Companies
Fintech companies have garnered all the limelight in recent times as individuals are fed up with banks and bureaucracy.
Chances are that if you need financing for startups you would approach fintech for immediate transactions rather than fill out papers and wait for days for a response.
Moreover, fintech companies cater even to those SMEs which banks have refused over and over again because of bad credit ratings.
A fintech company, for example, may offer small business loans to women, something which traditional banks may refuse as a calculated risk. On the other hand, the fintech company may approve the loan taking into account the challenges faced by women in starting a new venture.
The downside to these personalized services is that the alternative funding source doesn’t have a proven track record as that of a traditional institution and can come and go in a blink of an eye.
Again if your business is healthy, you may get a favorable interest rate, but if it is considered high-risk then get ready to pay interest in double digits.
How Digital Lenders Are Disrupting Finance?
Unlike traditional banks which lend only to existing customers, fintech lenders offer online business loans, both to unbanked and underbanked customers.
These digital lenders, today, are disrupting the banking financial sector by offering payment solutions, lending, credit and much more, and forcing the once fool-proof business models to join hands with the fintech companies or find their own solutions.
This is forcing the financial institutions to create better consumer experiences, if they want to keep abreast with the competition.
From payment technologies like PayPal to lending solutions like Avant and OnDeck present day technology disruptors are giving the traditional financing industry a run for their money.
While these fintechs are unlikely to wipe out the banks completely, they will surely force them to rethink how to serve the financial needs of a customer better. While data leaks and cyber attacks may pose some risk, they will have to adopt these digital technologies if they want to stay on top.
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Author: Abdul Mateen