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How Can We Address the SME Funding Gap?

What if we lived in a world of abundance where all our basic needs were catered for? Set against the threats of climate change and geo-political tensions, this may seem fanciful but it has to be the ultimate aim of every nation. And prosperity through SME job creation is an absolutely essential part of this. Therefore, access to finance and the growth of confidence within the sector are the critical components required to achieve that.

The World Bank estimates “600 million jobs will be needed by 2030 to absorb the growing global workforce”. Despite this, an enormous funding gap exists globally. In the US, this was estimated to be $5 trillion in 2019, £56 billion in the UK, and €730 billion in Europe. UK banks funded just 8% of small business loans at that point.

The global recession of 2007-08 resulted in government action to ensure SMEs would be able to access a wide range of competitive financial products, which led to the emergence of the fintech industry. While the Covid-19 pandemic has stymied progress, growth in lending was stalling before it, according to the OECD report ‘Financing SMEs and Entrepreneurs 2020: An OECD Scoreboard’. Will we see further government action to support the SME community and address this major issue?

State of play in the UK

Although this is a global issue, it seems appropriate – as a UK-based business – to evaluate the current lending situation at home first.

While the cost of credit is very low, the cheapest credit lines are not universally available in the UK where incumbents benefit from exclusive access. As a result, SMEs often suffer from a lack of choice and competition among lenders and the beginning of the pandemic was empirical evidence of this. The big banks were often unable to adapt quickly to an ever-changing situation, while smaller, more agile alternative lenders were largely excluded from government schemes despite their ability to pivot quickly to changing market conditions.

Business and consumer confidence has been severely dented and trade tensions have deepened. These factors – in addition to Covid-19 – have contributed to SMEs swaddling what cash they have and adopting a strategy of retrenchment out of necessity. In particular, many regional businesses are struggling to address these issues and look towards growth. The government’s Levelling Up plan, while welcome, doesn’t promise immediate salvation and, in that environment, the confidence to invest in growth is proving hard to build.

Now, a rapidly developing cost of living crisis has added to those concerns as we come out of the pandemic. Interest rate hikes, skyrocketing energy bills, supply chain issues, and inflation hitting its highest level in close to 30 years have left many business owners in a heightened state of anxiety (or perma-crisis as some are calling it).

We may be starting to see the fallout of this already, as a recent BVA BDRC SME Finance Monitor report found that one in five SMEs were now borrowing more than before the pandemic. The growing SME funding gap should then perhaps be characterised as an issue for which capital is there, but accessing the right finance options often proves harder for these businesses.

Innovation to meet demand

Small and mid-sized businesses represent 90% of the private sector and more than 50% of employment worldwide. Whether businesses are in survival mode or looking to grow, it is vital to make access to finance faster and easier so SMEs can get critical cash in the bank without manual intervention.

In January of this year, Funding Options observed a 58% year-on-year increase in lending. As the legacy players simply can’t meet this demand, only innovation within the fintech industry will provide businesses with finance at speed. Auto-decisioning, made possible by Open Banking and AI and supported by third party verification such as AML (Anti-money Laundering) and KYC (Know Your Customer), is required globally to ensure the ready flow of capital from proactive lenders into deserving businesses. This proprietary technology has the potential to solve the SME funding gap the world over.

Data-driven decision making and the removal of manual intervention and human bias will lead to fair and fast delivery of vital funding to SMEs. However, to get there, further building blocks are still required – both in the UK and beyond.

Creating an environment for growth globally 

First and foremost, it’s crucial that there is a thriving alternative finance lending community which is supported at governmental level to ensure a wide variety of market-based lending products suitable for all SME needs can be offered.

Beyond this, while we have seen greater adoption of embedded finance among fintechs, standardisation of its use within the alternative finance industry will ensure lenders and introducers (e.g. accountants and advisors) move as one towards a model where they all compete for customers fairly. To do this will require a mindset shift among lenders, both in terms of their digital transformation journey and willingness to adopt data-driven processes and protocols industry-wide in the first place.

More broadly, there needs to be further collaboration and consolidation within the industry to ensure business customers can access the most advanced products and services with a frictionless experience. At present, the alternative finance market is highly fragmented, with many small lenders competing for share of voice, which leads to a lack of awareness of what’s available and which product to select. The industry is now at a stage of maturity to lead from the front, working together to enable SME growth around the world.

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