Small and Medium Enterprises (SMEs) facilitate economic growth with their flexible and innovative methods. However, they face the challenge of getting adequate funds for operations and growth initiatives.
One of the major obstacles that SMEs come across is the shortage of credit data, which prevents them from accessing traditional credit facilities through banks and other lenders.
This current state of data inequality is gradually being negated by identifying new ways to evaluate SMEs’ creditworthiness, which includes using alternative data in credit worthiness assessment.
Credit Gaps and Opportunities in the SME Market
SMEs provide a vast number of customers to various financial services and play a crucial role in developing the financial markets.
The total number of SMEs is around 400 million in the global developing markets. Nearly 93 percent of them are formal or informal micro, small, and medium enterprises. In addition, informal firms outnumber formal firms by 3.4 to 1 ratio.
As per SME Finance Forum ; SME Credit Demand Opportunity Value in the Global Markets is as presented below:
Despite all the positive aspects, the SME credit gap has been a structural feature across developed and developing markets. The credit gap exists even in the nations that have rolled out various policies to back SMEs and increase their financial inclusion.
The credit gap stems from the issues related to both demand and supply.
Many SMEs are unable to access credit due to:
- Lack of financial documentation and collaterals required to get a loan; Manual, paper-intensive processes
- Steep costs and interest rates;
- Long timeframes for decision-making.
Alternative Data & Types of SME Loans Relevant to it
As per the International Committee on Credit Reporting (ICCR), alternative data is about collecting and analyzing data to determine creditworthiness based on available digital information.
Alternative data replaces the conventional methods like documented credit history for obtaining SME lending. The broad categories of alternative data are below:
- Structured data, such as mobile phones, utilities, taxes, and rental information.
- Unstructured data, such as internet usage, emails, social media, text/messaging files, digital pictures, and audio files.
Utilizing alternative data; banks can provide Digital unsecured loans to SMEs by digitizing the entire loan lifecycle of the customer. Various use cases of SME lending arise such as:
- Working capital through cash credit
- Credit Line
- Supply chain financing
- Overdrafts through bills of purchase;
- POS financings loans
The new-age lenders are also empowering the SMEs by offering POS terminal loans, where businesses can obtain loans against their EDC or POS machines.
In general, the duration of these loans is shorter (for example, ranging from one month to 1 year) and they have higher rates than those of P2P SME lenders. They generally mine transactional data as a key source of information in their credit scoring model. In addition to providing loan origination and risk-based loan pricing, they are also able to reduce the costs and risks associated with repayments by automating loan payment deductions from business accounts or directly from regular sales transactions on a regular basis, most often daily.
Transaction data also supports ongoing risk management, and provides continuous feedback on the situation of a borrower using data analytics.
How Alternative Data is Revolutionizing SME Lending
SMEs are considered as high-risk clients by banks as information available about SMEs is scarce. This makes it difficult for lenders to measure their creditworthiness. Due to these inherent characteristics, alternative data, along with traditional data sources, will help develop a more comprehensive view of the SME’s business. Adopting credit scoring based on alternate data sources will aid the lenders in the decision-making process; improve risk assessment while boosting revenue growth, tapping into a vast market of new applicants who have traditionally been unscorable.
For instance; in the small-business lending sector, Kabbage uses alternative data — including business volume, time in business, transaction volume, social media activity and the business’ credit score — to determine the line of credit a business should receive.
The new era of digital SME lending using alternative data is transforming the future of micro-financing. A fast-growing group of SME lenders are incorporating alternative digital data, customer requirements, and advanced analytics as their core business models, which has triggered a significant shift in the market.
Lenders are more keen to adopt technology for automating the end-to-end loan origination process. The current situation, when social distancing is the need of the hour, makes digital even more relevant for providing SMEs easier, faster, and customized financing solutions.