Holland Fintech is presenting a monthly series of informational articles – Navigating The Fintech World – about the ever-changing world of fintech, delving deeper into a new topic each month! This month, read about how SME Finance is being redefined within the fintech sphere!
Small and Medium Enterprises (SMEs) are the backbone of most economies, particularly in developing countries. According to the World Bank, SMEs play a pivotal role in job creation and global economic development, making up approximately 90% of businesses worldwide and contributing to over 50% of global employment. They also account for up to 40% of national income (GDP) in emerging economies. However, as per the World Bank’s estimates, SMEs face a substantial financing gap, with 40% of formal micro, small, and medium enterprises (MSMEs) in developing countries having an unmet financing need of $5.2 trillion annually. This challenge is even more pronounced in regions like East Asia and the Pacific, Latin America, and the Caribbean, where SMEs often struggle to secure the capital they require.
Challenges in SME Finance
SMEs often find it more challenging to obtain bank loans compared to larger firms. Instead, they heavily rely on internal funds or financial support from friends and family to initiate and sustain their operations. This reliance on traditional banking institutions for financing has created a significant gap between the capital SMEs require and what is readily available. The lack of access to formal credit is a problem that plagues approximately half of formal SMEs. When considering micro and informal enterprises, this financing gap expands even further.
The financial crisis of 2008 exacerbated this issue, rendering traditional bank lending less accessible for SMEs. The increased strictness in credit requirements, driven by regulations like Basel III, further strained SME financing. In the Netherlands, for example, 99.8% of companies are SMEs, contributing significantly to the country’s GDP and employment. However, their funding difficulties have hindered their growth, pushing them to postpone investment plans until more favorable economic conditions emerge. The lack of diversity and limited capital buffers leave SMEs vulnerable to funding shortages. They rely heavily on bank loans, making rejected loan applications a common problem, particularly during the financial crisis.
The Future of SME Finance
In light of these challenges, experts and organizations like the World Bank and the Organisation for Economic Co-operation and Development (OECD) have been diligently working on solutions to bridge the SME financing gap and chart the future of SME finance. According to the World Bank, the future of SME finance lies in exploring innovative alternatives to traditional bank lending. Crowdfunding and microfinance have emerged as promising financing mechanisms. Crowdfunding, for instance, allows SMEs to access funding from a diverse group of investors, reducing their dependence on banks. Furthermore, Initial Coin Offerings (ICOs) have started gaining traction as a source of financing for SMEs. According to the OECD, these ICOs can address financing gaps, providing new avenues for SMEs to access the capital they need. However, they come with their own set of benefits and challenges, and it’s crucial to understand how they can best serve the SME sector.
Additionally, marketplace lending (MPL) is changing the landscape of SME financing, as highlighted by the OECD. MPL platforms, driven by the participation of institutional investors, provide funding and enable SMEs to access capital more efficiently. As these platforms evolve, they enhance credit assessment, underwriting, origination, and servicing through innovative technologies like big data and analytics. Policymakers are working in tandem with experts to design future-proof policies to stimulate SME finance in the post-crisis era.
The financial landscape for SMEs has indeed transformed dramatically. As the financing world evolves, enterprises must broaden their horizons, exploring new tools and channels to secure the capital necessary for growth and innovation. The future of SME finance is promising, offering a diverse range of options beyond traditional bank loans. Embracing these alternatives will not only help SMEs thrive but also foster economic growth and innovation on a global scale.
Overall, the challenges faced by SMEs in securing financing have prompted global institutions and experts to seek innovative solutions. The future of SME finance, as highlighted by the World Bank and OECD, holds great promise, with crowdfunding, ICOs, marketplace lending, and evolving policies playing a pivotal role in unlocking the potential of SMEs. As these initiatives continue to develop, the path forward for SMEs is becoming clearer, ensuring their vital contribution to job creation and economic development continues unabated.
If you’re eager to deepen your knowledge about the dynamic landscape of SME Finance, we invite you to participate in the upcoming Holland Fintech Meetup in November using this link.