Alternative data transforming SME financing
The World Bank Group has analysed 800+ innovative digital SME lenders in 60 countries (58) to find out how alternative data can be used to solve the SME financing gap.
A rapidly growing group of technology-focused SME lenders are putting the use of SME digital data, customer needs, and advanced analytics at the centre of their business models, thereby setting forth new blueprints for disrupting the lending status quo for SMEs. They can also offer more transparent, faster, easier, and better-tailored financing solutions that today’s increasingly tech-savvy SMEs seek. SMEs are often willing to share their data in exchange for value, that is, access to credit and other value-added tools that help them grow and become more productive. No longer are SME lenders limited to just underwriting a borrower based on dated, often incomplete financial statements, missing or limited credit bureau information, or collateral that substitutes for a deeper understanding. Instead, they are now able to develop a more comprehensive view of the borrower’s business — one that illuminates previously invisible SME strengths and weaknesses.
The basis for this amplified view is a real-time flow of the SMEs digital footprint from the borrower to the lender that creates and continuously updates a rich model of the business. Digitally native lenders leverage the advances in computing power to match smart algorithms to these massive data streams, including banking transaction information and money flows— and at increasingly lower costs. Data is gathered in a variety of ways, including through partnerships between Fintech providers and banks; Fintechs with direct access to transactional data via bank Automated Programming Interfaces (APIs); or the use of screen scraping technology. The more diverse the data and the faster the data can be analysed, the more predictive its value will be.
Key findings include:
- Banks have valuable data, but are often not using it: Banks have a highly valuable repository of SME data, including SME owners’ customers’ daily transaction data that provides reliable real-time visibility into SME cash flows and credit capacity. However, most banks cannot create innovative SME lending models from it. The data often resides in a patchwork of legacy systems and data silos that make it difficult and costly to access. This gap has created an opening for digital SME lenders to capture this market segment.
- Digital SME lenders are developing new relationships with SME customers and their data: In some cases, nonbank digital SME lenders insert themselves between banks and their SME customers and forge fundamental changes in SME customer expectations. SMEs are embracing the digital world more and more every day. Increasingly, many SMEs are more tech-savvy, more sensitive to slower service and paper-intensive loan applications, and more willing to shop around for unmet and unserved financing needs.
- New SME digital data streams are becoming more readily available and accessible: Digital SME lenders leverage vast and expanding stores of data, including from electronically verifiable, real-time sales, bank account money flows and balances, payments, social media, trading, logistics, business accounting, and credit reporting service providers, as well as a wide range of other private and public data sources used in the SME credit assessment process.
- There are wide-ranging digital SME originator lending business models: The new digital SME lending originator business models that take advantage of the expanding universe of SME digital data vary widely. It includes marketplace lenders, tech, e-commerce, and payment giants which are extending SME lending into their non-banking digital ecosystems where they are already dominant. It also includes supply chain financing firms, mobile micro- lenders graduating to SME lending, and innovative banks.
- Digital SME lending is becoming more of a global trend: That these innovators are sometimes simultaneously launching nearly identical products in developed and developing markets alike demonstrates just how profoundly alternative data and technology are levelling the playing field. As such, they are enabling new digital SME lenders in • many parts in the world to leapfrog traditional bank SME financing barriers.
- Digital SME lender-bank collaboration is also a growing part of the future of SME finance: Banks
may have been blind to digital SME lenders at first, and digital SME lenders may have said they would replace banks. However, both parties now have come to the simple conclusion that there are limits to what each player can do on their own. There is strength in collaborating. Apart from partnerships with banks, some nonbank digital SME lenders are instead partnering with each other, tech giants, • cloud-based SME service providers, or alternative lenders in other sectors. In other cases, they are securing their own banking licenses, suggesting some new nonbank digital SME lenders still plan to forge an alternate path, thereby bypassing traditional legacy banks altogether. A vital characteristic of these collaborations is a sharing of each partner’s SME digital data. This information facilitates the development of new and innovative SME credit decision models and expanded access to credit.
- Access to data is no longer the problem in SME lending: Digital SME lenders have dispelled the long-held notion that SME lending is not achievable in a scalable, efficient, and profitable manner. In an increasingly digital economy, these lenders are beginning to demonstrate that access to data is unlocking many of the earlier challenges to expanding SME lending. The digital economy has also given rise to an ever-evolving set of value- added cloud-based services to help SMEs with their finances, business planning, productivity, legal issues, data backup and security, file sharing, web conferencing, website builds, online marketing, business training, e-commerce, payments, loyalty programs, business intelligence, and more. To increase customer engagement and help their SME customers be successful, banks and other SME lenders have started partnering with these platforms to offer SMEs these applications individually, together, or wrapped up with other core products and services.
- However, access to data for SME lending brings new challenges: With the abundance of alternative data, there are new issues of what to use, how to use it, and how to do this responsibly — while also respecting privacy and other important rights of SMEs.
There are a wide range of digital SME originator lending business models.
The most common lending business models are:
- SME marketplace lenders broadly describe nonbank digital lenders originating loans to SMEs through intermediary platforms, which connect SME borrowers to investors, directly to their balance sheets, or from a combination of the two. These lenders digitally access and substitute alternative SME data for missing conventional credit data, or enhance conventional credit data with alternative data. As such, they can expand the pool of credit- eligible SMEs and greatly simplify, speed up, and lower the cost of SME credit applications, underwriting, and portfolio management.
- Tech, e-commerce, and payment giants are leading global and/or country companies that have their origins in online marketplaces, search engine providers, payments, e-commerce, social networking, or computer technology. They are leveraging their diverse, massive alternative data streams generated from their platforms or via their many partnerships. In this way, they are now offering loans and other financial services to their millions of captive SME customers.
- Supply chain platforms support SME financing during financial transactions — purchase orders, invoices, receivables, other claims, as well as related pre-shipment and post-shipment processes — between buyers and sellers trading and collaborating along the supply chain. Triggers from the physical supply chain underpin each financial transaction. Emerging cloud-based digital supply chain platforms (including the use of blockchain24) to gain visibility and insights into the different parts of the complex trade flows between buyers and sellers (for example, invoices, accounts payable, procurement data, historical business cash flows, shipping history, bills of lading, economic indicators, and taxes paid). This process is done by digitising documents and transactions and applying big data science and analytics to make credit decisions. They also leverage the financial stability and strength of bond-rated, large corporates who buy SME products or services. As such, they can offer SME financing faster and often at a lower cost. Innovative supply chain financing platforms vary widely (for example, there is invoice or receivables discounting, payables finance, dynamic discounting, working capital auctions, factoring, inventory finance, or pre-shipment finance), as do the funding sources for financing (for example, banks, retail and capital market investors, corporate buyers, and lenders that compete for the financing). For all concerned, however, digitisation provides for more efficient SME lending models.It helps suppliers, accelerates approvals, increases SME credit access, reduces the chance of supplier or procurement fraud, and often, but not always, lowers the cost of financing for SMEs.
- Mobile-data based lending models offer small mobile loans based on credit scores derived from mobile calling patterns, mobile transactions, mobile e-money usage, and mobile e-money linked savings history, as well as prior credit history data.
- Digital Bank models are among a few traditional banks, as well as a host of new banks, that are directly developing their own in-house alternative lending systems. In this regard, they are opening up their APIs to third-party service providers, or acquiring or partnering with alternative lenders.