They say size isn’t everything, and according to an October report from the World Economic Forum, that’s certainly true when it comes to Small and Medium-sized Enterprises (SMEs).
The report, “The Future of FinTech: A Paradigm Shift in Small Business Finance,” highlights just how significant a role SMEs play in global business. According to the paper, there are around 500 million SMEs and micro-enterprises currently in operation worldwide, of which approximately 200 million are formally registered businesses.
In high-income countries, those formally registered SMEs account for over half of the GDP. Moreover, stats indicate that firms with between 5-250 employees are responsible for close to 70% of full-time employment globally. Between 2002 and 2010, an average of 85% of total employment growth was attributable to small businesses. But it isn’t just as employers and cash generators that SMEs matter. As the report puts it, “Start-ups and entrepreneurial companies drive innovation and technological advances, leading to progress and higher productivity in the long run.”
While these facts and figures point to both the importance and vibrancy of SMEs, they don’t convey the many financial challenges faced by small businesses.
Perhaps the greatest of those challenges is the ability to secure financing. While banks remain the primary source of funding for SMEs, it can be extremely difficult for small businesses to get loans through this traditional channel. Data from 2014 suggests that 44% of SMEs in the United States received “none of the bank credit they applied for.”
In recent years, banks have become more and more risk-averse when it comes to lending to SMEs. Several factors are fuelling this trend. For banks, it requires considerable time and expertise to understand the specific needs of small businesses – making financing less attractive in the face of lower potential returns and greater administrative costs. Small businesses may also simply lack the historical financial data that banks want to see before lending, and are perceived to be a risky proposition. All this, coupled with regulations that impose higher capital requirements for small business loans, has resulted in a fall in SME lending. In the United States, SME loans now represent 24% of all bank business loans – down from 35%.
But don’t go scrapping your plans for that start-up just yet.
While outlining the headaches involved in securing SME financing from banks, the majority of the World Economic Forum report focuses on what it sees as the most viable solution: FinTech.
The report describes FinTech as “a global phenomenon,” and lists the myriad ways in which its rise has altered the landscape for SMEs as they seek to bridge the funding gap created by banking policies.
Outlining the benefits of FinTech for SMEs, the paper leads with the rise of peer-to-peer lending and the way in which it enables small businesses to secure loans with less paperwork, quicker application processing, and data-driven metrics for measuring suitability. Not to mention a less cautious mindset. In China alone, the number of peer-to-peer lending platforms rose from 20 in 2011 to over 1,500 in 2014. Between $60-$70 billion in marketplace lending was distributed globally last year, with peer-to-peer lending figures in the U.S. and the UK expected to double in 2015.
The report also makes special mention of how FinTech innovations are helping to address late payment problems. In 2009, small businesses in the UK alone found themselves in debt to the combined tune of £29 billion as they were forced to await payment from buyers. FinTech services in areas such as e-invoicing and supply chain financing are cited as ways in which SMEs can avoid being crippled by late remittance, and B2B payments solutions that address the complexities of trade transactions unquestionably fall into the same category.
There are many other ways in which FinTech is changing the face of business for SMEs. All are marked fundamentally by a new level of accessibility and driven by data that incumbent institutions are slow to accept as indicators of viability.
It’s no surprise that 68% of banks see their small business lending as being under threat. And although some are responding through collaboration with or acquisition of FinTechs, the World Economic Forum’s conclusion speaks volumes about the possibility for ongoing disruption from new digital players: “While the pace of change is still unclear, the potential magnitude of FinTech as a catalyst for growth is hard to deny. The current momentum is not expected to vanish any time soon.”