Small and medium-sized enterprises (SMEs) play a vital role in driving job creation and innovation, making them a critical component of a thriving economy. Nevertheless, these entities frequently encounter challenges in obtaining funding from traditional lenders due to demanding requirements such as collateral, extensive documentation, and lengthy approval processes. Consequently, a funding gap for SMEs has emerged, posing a significant obstacle to their growth and development. The Bank of England (2019) has reported that approximately 25% of small businesses seeking loans from banks are denied, resulting in a significant financing gap of £22 billion for UK SMEs.
The global emergence of FinTech companies has brought about a notable positive transformation in the finance industry in the past decade. These companies use cutting-edge technology to offer tailored financial products and services that meet clients’ diverse needs. They have embodied a new range of products made specifically for the needs of SMEs. For instance, P2P (peer-to-peer) lending, invoice financing, online supply chain financing, online trade financing, and e-commerce financing.
These alternative funding sources are particularly beneficial for Startups and businesses with limited credit history or collateral, who may not meet the eligibility criteria for traditional bank loans. Additionally, banks, as traditional lending institutions, are susceptible to different macroeconomic events, as evidenced by the recent collapse of Silicon Valley Bank (SVB), which marked the largest bank failure since the Global Financial Crisis. With assets exceeding $200 billion, SVB was a leading institution in the venture capital industry, primarily focused on Tech Startups. Its collapse has had adverse implications for SMEs that had secured funding through SVB, exposing them to external shocks and potentially jeopardizing their operations.
According to a paper published by ECB (2022), SMEs are more likely to turn to FinTech lending when they have relationships with banks that possess less stable funding sources, lower asset liquidity, and lower capital ratios. This suggests that one of the reasons for the shift towards FinTech is to mitigate exposure to banks that may not have the capacity to absorb shocks and are more prone to reducing lending activities during liquidity crises. These findings highlight the importance of the quality and resilience of banks in the decision to utilize FinTech lending platforms.
By obtaining loans from FinTech companies, SMEs can diversify their lending relationships and reduce their dependence on a single bank, thereby enhancing their financial stability. The findings indicate that the SMEs seeking access to FinTech platforms are motivated to decrease their vulnerability to potential shocks to the banking system. Such shocks can restrict their access to financing, consequently impeding their growth prospects. Notably, the lending sector has experienced significant changes due to FinTech innovations, particularly for SMEs (Feyen et al., 2021).
Five main influences of FinTech lending on SMEs
Increased Access to Financing
According to a report by the World Bank, approximately 70% of SMEs in developing economies lack access to credit. FinTech lending has helped bridge this financing gap by providing SMEs with access to credit that was previously unavailable to them. These credit lending platforms use alternative data sources and advanced analytics to evaluate creditworthiness. This way, they make it easier for SMEs to access the funds they need in a way that traditional lenders would have deemed too risky. Based on a study made by Nesta (2013), 33% of SME borrowers using marketplace lending platforms believed they would not have been able to obtain funding from other sources.
Decreased Borrowing Expenses
FinTech lenders have disrupted the lending market by offering reduced interest rates and fees in comparison to traditional lending institutions. They do so by applying Data Analytics and Artificial Intelligence to evaluate credit risks and determine loan eligibility, which can reduce borrowing costs for SMEs in several ways. Firstly, data-driven decisions can help lenders make more accurate credit assessments of SMEs, considering data points such as cash flows, payment history, and credit scores. This is made to ensure that only creditworthy SMEs receive loans, thus reducing the risk of default. Secondly, lenders can provide more personalized lending solutions by analyzing data on SMEs’ specific needs and characteristics. This assists SMEs in achieving their objectives without getting excessive debt, reducing again the likelihood of default. Through the usage of Data Analytics, lenders can develop early warning systems to detect potential signs of financial distress among SMEs, allowing them to take proactive measures to help SMEs avoid default. Also, by using Data Analytics and Artificial Intelligence, the lending process is more automated, from credit assessment to loan disbursal. This reduces the time and resources required to process loans, resulting in lower borrowing expenses for SMEs.
Efficiency and Effectiveness
Traditional lending processes can be time-consuming, with borrowers having to wait for weeks or even months to receive a loan. FinTech lenders have streamlined the lending process, making it faster and more efficient. According to a study by Harvard Business Review (2020), FinTech lenders can process loan applications in as little as 24 hours. This speed is particularly beneficial for SMEs that require financing urgently to take advantage of business opportunities or address cash flow challenges.
The rise of FinTech lending has not only made it easier for SMEs to obtain the financing they need to grow and expand their businesses, but it has also increased competition among lenders. Traditional lenders have been forced to adapt to these changing conditions and innovate their own lending products to remain competitive in the market, thus offering a wider range of opportunities and better conditions for SMEs seeking financing.
Improved Customer Experience
Another benefit SMEs have from FinTech lending is the improved customer experience. Most FinTech lending allows SME borrowers to apply for a loan online. With a user-friendly interface offered by those digital lending platforms, SME borrowers can track their applications more easily, and the entire process is relatively transparent. It is safe to say that digital lending helps SMEs save time and energy to focus on their businesses.
According to a report published by Allied Market Research (2021), the worldwide market for FinTech lending had a value of $449.89 billion in 2020 and is projected to increase by 27.4% (CAGR) from 2021 to 2030 to reach $4,957.16 billion. In the past year, 22% of European startups in the financial and technology sectors increased a sum of $22.2 billion, making FinTech the most well-funded industry in 2022 (Pun, 2023). As the FinTech lending industry continues to grow and evolve, SMEs can expect to benefit from even more innovative products and services that help them achieve their business goals.
A survey conducted by EY in 2022 showed that a significant percentage of SMEs are interested in accessing financing quicker. Specifically, 66% of SMEs expressed interest in faster access to funding, with 55% wanting to secure financing within one week and 31% seeking to do so within three days. While banks remain the preferred source of funding for the majority of SMEs (63%), the popularity of FinTech lending institutions has grown considerably (56%) since the onset of the COVID-19 pandemic. In light of these developments, SMEs are increasingly seeking digitally driven, simplified, and faster funding solutions. Consequently, if banks are unable to provide these services, more and more SMEs will turn to FinTech lending companies.
In the future, it is likely that FinTech lending will continue to play an increasingly important role in providing financing solutions for SMEs, as FinTech lenders continue to refine their offerings and cater to the needs of this growing market. This could consist of solutions such as revenue-based financing, which enables SMEs to repay loans based on a percentage of their expected future revenues, or invoice factoring, which allows companies to receive an advance on their upcoming invoices.
Finally, as the global economy becomes increasingly digital, FinTech lending may end up becoming the main source of funding for SMEs across many nations. By utilizing the most recent technological developments, digital lenders can reach a broader range of customers than traditional lenders, especially those in emerging markets with limited credit histories. This could help drive economic growth and create new opportunities for entrepreneurs and businesspeople worldwide.