Small and medium enterprises (SMEs) are often flattered by being called the backbone of world economies, however, this seemingly important sector is usually undermined by a lack of access to appropriate financial services.
That creates a financing gap which acts as a hurdle for building SME resilience and potential growth.
There are many already well-established reasons for this financing gap – some related to financiers and some related to the very nature of SMEs.
Financing SMEs comes with a higher cost and service relative to potential revenue.
This drives financiers’ focus away from SMEs towards corporate and retail clients, resulting in a lack of SME finance skills and specialised financial products.
Although the diversity among SMEs means their financing needs and issues would not be homogeneous, some of their common characteristics contribute to the financing gap too.
They are small, relatively young, risky, and lacking in financial education with financial reporting of questionable quality and and a lack of assets to be used as collateral.
Addressing these issues requires well-coordinated multifaceted policy actions targeting different types of conflict underlying this problem.
Current rapid technological advancements in the financial services industry beg the question of what role digital financial services (DFS) can play in bridging the financing gap.
How are DFS developments being leveraged by all relevant stakeholders to improve access to finance for SMEs, and what are the implications of these developments for designing future policies?
A recent World Bank report, called ‘Fintech and SME Finance: Expanding Responsible Access’ discusses these and other related questions, including the current level of the adoption of fintech solutions for SMEs, the impact on the incumbents and the implications for market structure, and the challenges and risks these fintech solutions pose.
It also provides policy recommendations to address the challenges and risks.
The report argues that digital financial services can help close the financing gap for SMEs by providing access to alternative sources of funding and improving access to traditional players by enabling new digital products and process automation.
Digitisation and automation make the financing process more efficient, thereby lowering costs.
The use of alternative data sources and big data analytics provide additional information sources to the credit risk-assessment process, allowing SMEs that were once unable to obtain finances to gain access to this.
New business models, such as the sharing economy and e-commerce, the digitisation of the SME business processes, and open banking provide rich data on SME activities and cash flows, enabling DFS.
This could help SMEs obtain access to financial products.
Fintech solutions with promise for SME financing include digital loans, supply chain finance platforms, secured revolving lines of credit, merchant receivables finance, P2P/marketplace lending, as well as investment-based crowdfunding.
In addition, the digitisation of internal business processes and business-to-business processes, such as electronic invoicing (e-invoicing), and tokenised assets using blockchain/distributed ledger technology, could also help address the major barriers to SME finance.
Competition for finance is also being developed by the introduction of innovative solutions by fintech and big tech firms and neo-banks or challenger banks disrupting traditional financial institutions.
At the same time there are obstacles and challenges that make it difficult for SMEs to fully adopt digital financial products.
The main areas where challenges have been identified are digital financial literacy and awareness of DFS, digital infrastructure, financial supervision and regulation, identity, and data privacy and data protection.
Some issues are more prevalent in emerging markets, which have less-developed digital infrastructure, systems, and processes.
To overcome these challenges and enable the realisation of a fintech promise for SMEs, policymakers should focus on foundational elements such as creating an enabling environment, empowering potential users, and balancing risks and benefits of innovative financial products.
The report presents and discusses specific policy and regulatory actions to be considered for this intent.
These include policy and regulatory recommendations specific to digital financial products for SME financing, digital financial education programmes for SMEs highlighting DFS awareness, affordable digital infrastructure that fosters widespread internet access and use, along with robust cybersecurity frameworks.
- Ivor Istuk is a senior financial sector specialist.
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