Broader access to SME funding key to economic growth
• Banks, lenders struggling to serve this crucial segment of the economy
As the South African government struggles to stimulate economic growth due to various structural challenges, small to medium-sized enterprises (SMEs) will play an increasingly important role in SA’s economic development.
Yet micro-enterprises and the SME sector face numerous challenges. According to the World Bank Group’s 2018 International Finance Corporation (IFC) report, there are an estimated 5.78-million small businesses in SA, but only 14% are formalised.
Worryingly, the sector only grew by 15% between 2008 and 2017, which reflects the low survival rate and almost stagnant growth. This is largely attributable to the difficulties SMEs experience when attempting to access finance, with 75% of credit applications rejected, while only 2% gain access to bank loans.
According to Nick Tuttelberg,
Global Consultant at Experian, banks struggle to serve this crucial segment of the economy due to difficulties in assessing SME creditworthiness.
“Demonstrating cash flow remains a challenge for smaller businesses. Many receive small, frequent bank deposits, which makes it difficult for a lender to verify loan ‘affordability’, and many may not have audited financials to share at the application stage.”
“Credit bureau information on local businesses, in particular SMEs, has also been limited,” says Guy Hosking, chief financial officer at Retail Capital.
“As such, SMEs remain underserved and offer a significant untapped growth market.”
These circumstances have created opportunities for alternative lenders and, increasingly, fintech startups to meet the demand.
“However, problems can arise when new entrants aren’t headed by bankers, or those who have experience operating in markets where it can take up to five years to recoup money from defaulters,” says Gary Palmer, CEO of Paragon Lending Solutions.
“Where banks focus on serviceability to judge eligibility, some newer and more cavalier lenders take a purely assetbased view. In some cases, even when solid assets back a deal, business owners are charged high interest rates — often in
excess of 36% per annum — even where the loan should attract more favourable rates.”
Palmer says he has not seen financing deals structured like this since 2008, and warns that there is significant risk in the current lending market. As such, lenders and business owners must be cautious.
Accordingly, the need for comprehensive scoring and vetting processes to assess customer credit risk has never been greater.
“Fortunately, the digital age provides various data sources that can help to rate credit risk, with much of this data now available in real time. This empowers alternative lenders to expedite applications and approve loans in hours or days, rather than the weeks typically taken by traditional banks,” says Hosking.
With the right solution, Tuttelberg says lenders can also assess payment behaviour for expenses like rent, utilities, transport and salaries, which can boost approval rates.
“Categorisation can offer real-time insights on aspects like other accounts, business interests, foreign income and even fraud.”
Providing SMEs with various loan repayment options that match the business’s ability to service their loans is also vital to their sustainability, adds Darren Abrahams, CEO at Transaction Capital Business Solutions.
“Providing solutions like invoice discounting and other lending products that cater to their unique funding requirements throughout the working capital life cycle is vital for the country’s underbanked SME sector.”
In this regard, Abrahams says it is paramount to assess SMEs on an individualised basis. “Every business has unique working capital requirements, which is why credit assessment teams must apply innovative structuring and credit risk management to craft bespoke solutions based on the client’s specific needs.”
Transaction Capital leverages its database of more than 12,000 SMEs when vetting credit applications, which it overlays with aggregated credit bureau data and additional digital channels to obtain relevant financial information.
“We also partner with numerous institutions that provide assistance when lending to qualifying businesses that lack collateral to secure the loan,” adds Abrahams.
And introducing new and more appropriate data sources is also helping to broaden access to finance through traditional banks.
“There are many forms of alternative data that could help build a financial footprint,” explains Tuttelberg.
This access to richer data sources is driving the open banking trend globally, which paves the way for banks to offer new products and services to consumers and businesses, including SMEs.
“Open banking means that applicants are able to authorise and grant permission to their banks to share their account transaction history with other vendors,” says Tuttelberg.
“This can assist entrepreneurs to demonstrate affordability, even if their credit history or data provided does not reflect the criteria desired by the finance provider.”
CLEARER PICTURE
It also gives financial institutions a clearer picture of a company’s cash flow and its individual cyclical circumstances for a more sophisticated and accurate assessment.
“In this way, open banking data has the potential to fuel not only SME growth, but also enable credit lenders to be more competitive.”
Ultimately, if local banks, lenders and commercial institutions prepare early to embrace open banking, and are agile enough to harness open banking data through technology, they will be better positioned to make the right credit decisions and ensure clients never have to shop around for alternate offers,” says Tuttelberg.