Credit constraints for SMEs particularly in the emerging markets is fast becoming a new norm. SMEs from Poland to Zimbabwe are facing liquidity gaps and remain mostly reliant on bank debt to run their business, ensure cashflow and fund investments. Yet, due to the inherently high risk involved for banks to lend money to SMEs, many still lack the finances they need to grow.
This is worrying given that SMEs form the back-bone of many emerging markets. According to the World Bank, most formal jobs in the emerging markets are in SMEs and they create 4 out of 5 new positions, but 50% of SMEs do not have the access to finance they need.
Traditional bank lending remains the main form of financing for SMEs but they are inherently ill-suited for many smaller companies, particularly newer and fast-growing ones that rely on intangible assets that banks cannot consider as collateral. Their profits and future growth are difficult to forecast and they often lack sufficient credit history. Banks have had to contend with relatively lower revenue per client compared to a corporate client, higher risk of credit losses because of SME sensitivity to economic downturns, and the need to have a physical presence to lend to SMEs. This has meant higher interest rates for SME lending because banks cannot determine their credit risk as easily as with bigger companies.
In recent years, there have been new financing options aimed at bridging the gap existing in the markets. Microfinance, a Nobel-Prize winning concept that started in Bangladesh, tackles high risk of default with community monitoring, but remains insufficient because of its short-term nature. Venture capital options are also less forthcoming because of the lack of potential high returns in most SMEs. Crowdfunding has been on the rise since the 2000s, but remains limited because it aims to fund very specific goals or projects and are ill-adapted to meet the diverse and dynamic needs of SMEs. Underserved SMEs remain but they represent an even bigger market opportunity in emerging markets. With many banks looking for new areas of growth, SMEs represent a huge profit opportunity to expand quickly and unlock profits.
According to McKinsey, banks cite poor data and business cases as one of the main constraints of SME lending, with three-quarters of banks listing poor business cases as critical reason for credit decline. More particularly, emerging market SMEs tend to use tools that could capture useful information for scoring more unevenly. More meaningful information needs to be collated about SMEs to unlock bank lending in a scalable way.
Some banks have tried to reap the potential in this area. For instance, a bank in Indonesia set up a subsidiary targeting ‘mom and pop’ stores using a community model where they engaged relationship managers from the local area to service clients within a three-kilometre radius. These managers had close ties with local retail clients and became the key source of information about a client’s character, cash flow and sources of borrowing. However, this lacks the scalability needed to quickly collate data about SMEs on a larger-scale. Information is collated haphazardly and locally and does not enable a real transformation in credit financing.
Another solution is harnessing big data to collect insights about how a client is using technology. In emerging markets, business software for SMEs have yet to penetrate the market and there is still a huge gap for entrepreneurs to leverage. Through providing business software solutions targeted at emerging market SMEs, data can be collected on a uniform platform in a more consistent fashion. This data can be pieced together to form a clearer picture of SME. The data collection becomes seamlessly integrated into the workflow of the SME, making it a much more sustainable solution. More importantly, it actually empowers the SMEs to do business more efficiently, as they themselves can benefit from the IT-enabled solutions and access their own business data to make more informed decisions. The market potential for emerging markets is particularly huge given that many businesses have not integrated more advanced IT software into their business workflow.
