The world’s financing structures have been unable to match SMEs’ demand for credit. With their credit needs unmet, alternative finance channels have entered the spotlight.
Trade financing is one of most significant obstacles to growth in emerging markets, particularly in Asia. The global trade financing gap was estimated to be US$1.6 trillion in 2016, according to one report. Another suggests that the trade financing gap in Asia stands at $700 billion.
Traditional bank lending is struggling to meet this demand. This has created space in the market for newer solutions in the form of alternative finance.
“It doesn’t mean that the banks are not good, it’s just complicated. And there needs to be that alternative where we can do something that is different [from banks], and sometimes complementary,” says Morgan Terigi, CEO of alternative trade financing platform Incomlend.
Why is it so difficult for SMEs to access traditional trade financing?
A force behind SMEs’ growing inclination toward alternative finance is that traditional lenders – banks – are unable to accommodate their credit needs. Entrepreneurship and technology have only helped to increase access to financial products.
“There’s more regulatory requirements on the bank side, meaning that it’s getting more complicated for them to finance small companies, and it’s becoming very costly. An SME is too much work and too expensive in terms of man hours to onboard them,” Terigi explains.
SMEs are at increased risk during times of volatility. This is due to weaker financial structures, low to no credit rating, a heavy dependence on credit, and fewer financing options. The repercussions of economic crises also tend to fall on the shoulders of SMEs. Studies suggest that market failures often result in increased credit rationing, screening costs, and interest rates from banks, all of which tend to disproportionately affect smaller businesses.
This results in complications at the bank financing level. For one, the due diligence process for lending to SMEs can be complicated due to the additional risk. This year in particular, the banking sector’s shrinking risk appetite has also been exacerbated by the economic slowdown.
Fintech can help bridge the gap through alternative finance
Asia’s $700 billion trade financing gap is a $700 billion opportunity for fintech startups. Fintech adoption in Asia-Pacific markets have doubled. In some cases, they’ve grown 3X. Fintech adoption in China and India, Asia’s biggest markets, is 80%. Hong Kong, Singapore, and South Korea come close, with 67% adoption.
With agile business models and growing tech prowess, the region is bustling with innovation in the fintech space. Startups are at the helm of this growth. They can respond to market needs quicker than organizations with traditional, solidified structures such as large corporates or banks.
Terigi says that digitization and automation can be challenging for larger companies and banks. Smaller, younger companies, such as Incomlend will find it easier to integrate technology into their business models.
“We’ve been working for four years. Compared with banks, four years is no history at all. So we can still make changes very quickly, whereas a bank has to go through multiple departments,” he notes.
He adds that the effects of instability in financial markets this year will carry on into the next year. Riskier bets such as SMEs – whose balance sheets have already taken a hit this year – may not have much luck with traditional trade financing. The financial crisis of 2008 had already nudged SMEs towards alternative finance, and developments this year are on track to reinforcing their decision to switch.
“With the banks withdrawing this year, there will be less financing available, lower credit limits, and another wave potentially of companies that will be in difficulties (next year), unfortunately,” Terigi explains. “This is where alternative finance will be important as an alternative whenever the banks are not willing to provide assistance, and when we can provide assistance.”
How SMEs can tap into alternative finance
Founded in 2016, Incomlend’s model is based on cross-border invoice trading. Traders can sell their invoices to investors on the platform at a discounted value to get paid early. Investors, mainly institutional, either buy into a portfolio of invoices or invest directly into individual invoices or groups of invoices on the platform.
This is an example of a platform-based alternative finance solution for cross-border trade. It is one of several trade financing alternatives available for SMEs.
Alternative finance fintechs have diverse solutions for both domestic and cross-border trade, Terigi notes. They can be categorized into platforms, such as invoice trading or balance sheet lending or brokers, which directly connect investors and traders. When opting for one, Terigi recommends that SMEs must “shop around.”
“The reason why I say shop around is because we all have different approaches. It can tend to be a little messy when you look at it from the outside, because a bank is a bank from a customer’s perspective,” he says. He also points out that banks have standardized products whereas fintechs offer a variety in solutions.
Terigi also suggests that SMEs look to secure non-recourse funding. Non-recourse funding does not hold the proprietor liable in case of a default. In this case, lenders realize what they can from any loan collateral, if promised, towards repayment. Apart from this, the proprietor’s personal and business assets cannot be seized.
“In the current situation you want to avoid, by all means, any type of recourse, meaning, any type of financial burden on your balance sheet where you would take on a loan in a situation that is extremely unstable and will remain unstable for the near future,” Terigi says.
This is useful for traders with a longer invoice repayment schedule, such as those who trade by sea. In 2019, over 11 billion tons in trade volume was seaborne trade. About 40% of this came from Asia-Pacific alone.
“It’s very difficult to see what’s going to happen even six months from now, so taking a loan over three or four years is extremely dangerous. At present, focusing their attention on anything that is non-recourse is definitely the way to go,” Terigi notes.
He adds that SMEs will need to put in some legwork in understanding which fintech solution to go for. Doing so keeping diversification in mind will be critical, he says.
SMEs are the lifeblood of economies the world over. They create jobs, create economic value, and attract opportunities and capital. Around 90% of businesses around the world are SMEs, creating 50% of the world’s employment. In emerging regions, which include big emerging markets in Asia, organized SMEs can contribute nearly half of GDP.
With global supply chains and financial markets taking a staggering blow this year, SMEs have found themselves in deep trouble. In such a situation, alternative finance has thrown these small businesses a lifeline. And in doing so, it has also opened a countercurrent of opportunities.
Header image courtesy of Incomlend