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Financial Institutions today faces numerous challenges and increasing pressure from competitors and regulators respectively. Moreover, the systems lagger with manual processes and rigid legacy systems resulting in high opportunity costs and loss of market share. Furthermore, Small and Medium Enterprise (SME) business lending at most of the banks is highly manual and lacks systems to assess business risk.

Due to increasing competition, changing regulations, technological improvements and evolving customer expectations, Banks are required to digitalize and transform their lending processes in order to conduct seamless lending activities and provide a superior customer experience. Digital access to information and services is now a baseline expectation.

SMEs are building blocks and the major contributors in the GDP of many countries around the world. SME also represents a massive demand led opportunity in terms of long term and short-term credit that can be leveraged by national and international banks alike.

However, SME lending also poses risks and challenges for Banking institutions. Banks require data on many fronts to assess the creditworthiness of the SME but due lack of structured data, Banks lack the quality and quantity of data that is required fully understand their business which increases risk and makes it difficult for banks to operate a profitable lending business.

In emerging markets, a loan decision takes 6-8 weeks on average, whereby 80% of the time is spent on data collection. Manual processes, re-entry of data at multiple points and preparation of financial analysis for the credit officers consume huge amounts of time and manpower. Additionally, rejection rates of more than 50% make SME lending even more challenging.

SME financing gap

There exists a huge disparity in access to finance for small and medium enterprises. Many SMEs find it difficult to have adequate and timely financing vis-à-vis larger established enterprises. This fact is especially true for microenterprises and SMEs in middle- and low-income countries.

According to report, access to financing is usually one of the top constraints on doing business for SMEs. In several regions, access to financing is the single most- important constraint. The resulting credit gap that SMEs face is about $1.5 trillion. Including informal SMEs, the gap widens even further, to around $2,6 trillion

Around 55% of formal SMEs in emerging markets are either unserved or underserved

Furthermore, a 2019 study by Fedsmall Business analyzing American companies with less than 500 employees found that 64% of employer firms faced financial challenges in the prior 12 months. More than two-thirds addressed these challenges by using the owners’ personal funds and 54% of small employer firms that applied for $250K or less did not receive the full amount of sought-for financing. Especially young companies at five years old and less, had a 63% rejection rate. 42% of SMEs with low credit risk got rejected, and that 42% of profitable companies got rejected.

Challenges Faced by SME/MSME Financing

Small and medium-sized enterprises (SMEs) are the backbone of all economies, supporting the largest sectors of employment in most developing and developed countries. However, access to finance is often problematic or difficult for small businesses compared to the multiple financing options available to large corporations. There are several reasons why small businesses are struggling to get financing.

Both supply and demand factors may explain why SMEs have a why SMEs have very low access to banking services. Market imperfections, such as information asymmetries or weak creditor protection. can make it difficult for financial intermediaries to evaluate creditworthiness of SMEs, monitor their assets and make repayments. A demand-side problem exists when SMEs are not creditworthy. In this case, unless lending is subsidized, creditors will not extend credit because they would incur in losses. Although demand-side problems occur, supply-side constraints are much more prevalent.

There are many obstacles to SME loans. Small businesses tend to be more opaque than large businesses because less information is available regarding their business in the public domain. As a result, banks may find it more difficult to assess the creditworthiness of small businesses thus discouraging lending to them. The lack of transparency has forced banks to better utilize relationship lending when dealing with small businesses. This means that lenders rely more on “soft information” gathered by loan officers through personalized contacts. The nature of a small business can also be a barrier to access financing. SMEs tend to be young and banks typically require at least two years of accounting records. As banks are reluctant to lend to unknown sectors, SMEs face various financial constraints involved in the innovation sector.

Furthermore,

• SMEs believe that banks don’t understand their needs or support them well (only 1 out 5 SME loans get approved by banks)
• Banks still focus on traditional service and sales models, and which are unaligned with today’s SME needs.
• Many big banks simply refer their SME customers to their costly small business credit card products for low-value loan request.
• SMEs spend over 25 hours simply on their loan request paperwork and have to approach numerous banks with their applications.
• Successful loan applicants have to wait for weeks, or even months for the funds to get approved by the banks

A study from the Asian Development Bank found the following four main reasons for rejecting the loan applications of SMEs[1]:

• 29% KYC concerns
• 20% not suitable for financing
• 21% need more collateral/information
• 15% low bank profit