Fintech and the funding revolution for small and medium enterprises

Fintech and the funding revolution for small and medium enterprises

With the right approach, fintech lending has the potential to empower SMEs and drive economic growth for years to come

Small and medium enterprises (SMEs) have often faced significant challenges when trying to secure bank loans. Traditional lenders tend to be cautious about providing credit to SMEs due to a lack of collateral, perceived higher risk, and stricter lending regulations. However, the emergence of financial technology (fintech) lenders has revolutionised the lending landscape, bridging the gap between SMEs and traditional banks.

The Role of Fintech in Small Business Lending

A study conducted by Wharton and other experts titled “Collateral Effects: The Role of FinTech in Small Business Lending” sheds light on the symbiotic relationship between fintech lenders, SMEs, and traditional banks. The research focused on France and revealed that fintech borrowers experience an immediate increase in bank credit, peaking at 20% within six months of obtaining a fintech loan.

The French study, which analysed data from 2,000 fintech borrowers and 10 leading fintech platforms between 2014 and 2019, found that this credit expansion translated into an average additional funding of 15,000 euros (or $15,770) for SMEs. These results indicate that fintech lending has the potential to significantly enhance SMEs’ borrowing capacity, making it easier for them to access capital for growth and development.

While traditional banks often shy away from unsecured loans due to regulatory requirements and higher capital adequacy buffers, fintech lenders have found their niche in providing unsecured loans to SMEs. Fintech lenders are willing to extend unsecured loans to SMEs to purchase assets that can then be pledged as collateral to raise additional funding from banks.

One of the key advantages fintech lenders have over traditional banks is their online-based operations. This allows them to tap into crowdfunding and leverage the support of thousands of individual investors to back loans. Even in cases of default, the distribution of collateral or assets among numerous investors remains manageable. This unique business model creates a win-win situation for fintech firms, investors, and SMEs.

Benefits of the Fintech Market

Fintech lenders in France, unable to accept public deposits and not subject to the same regulations as banks, have the opportunity to raise capital from private investors. This capital is then used to provide “junior unsecured loans” to SMEs. In return for the higher risk associated with these loans, fintech lenders charge interest rates averaging 8% annually, significantly higher than traditional bank rates.

Investors in fintech firms, on the other hand, enjoy annual realised returns averaging 5%. Additionally, the platforms that facilitate these transactions collect fees for their role as intermediaries between fintech lenders and investors. This ecosystem allows for the efficient flow of capital, benefiting all participants.

The study revealed some interesting trends in how SMEs utilise fintech and bank loans. The most popular use of fintech loans, averaging 150,000 euros ($157,000), is to acquire assets rather than for commercial growth or business development expenses. However, despite having access to bank credit, these borrowers do not necessarily use it to invest in additional assets.

Instead, SMEs primarily use the additional bank funding to consolidate expensive sources of short-term financing, such as supplier trade credit. By consolidating debt, SMEs can reduce the risk of default and streamline their financial obligations. Supplier trade credit can be particularly costly, with interest rates reaching up to 40% annually.

The study also examined the impact of credit expansion on default rates among fintech borrowers. It found that changes in default rates depend on the financial health of the borrowers. SMEs with low credit risk, even after taking out bank loans, did not become riskier compared to similar firms solely relying on traditional bank loans.

Conversely, fintech borrowers with higher credit risk had higher default rates compared to their counterparts accessing bank loans. These findings highlight the importance of considering the financial health and risk profiles of borrowers when assessing the impact of fintech lending on default rates.

Takeaways for Policymakers

The study’s findings offer valuable insights for policymakers and regulatory bodies. In the case of the French central bank, the research suggests that immediate regulation of fintech lending may not be necessary. The absence of systematic defaults on fintech platforms indicates that the current model of unsecured junior loans is sustainable and does not pose significant financial stability risks.

The study also emphasises the potential of junior unsecured loans to alleviate SMEs’ financing constraints, ultimately benefiting the overall economy. By fostering the supply of such loans, policymakers can encourage SMEs’ growth and productivity, leading to positive economic outcomes.

As fintech lending continues to evolve and gain traction globally, policymakers must carefully consider the regulatory framework needed to support this industry’s growth. By striking the right balance between innovation and stability, governments can foster an environment that encourages fintech lending while protecting the interests of all stakeholders. With the right approach, fintech lending has the potential to empower SMEs and drive economic growth for years to come.

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