Can data innovation help SMEs meet their financial needs?

Small and midsize enterprises (SMEs) are the backbone of most economies, with the World Bank reporting that they make up 90% of all businesses and more than half of the global workforce. Unfortunately, they don't get the same opportunities as their bigger competitors, as they rely heavily on external funding sources for operations and investments and are less likely to obtain loans.

The International Finance Corporation estimates that 65 million SMEs in developing countries face an unmet financial requirement of $5.2 trillion annually. East Asia & Pacific have the worst finance gap (46%), followed by Latin America and the Caribbean (23%) and Europe and Central Asia (15%).

The challenges SMEs faced during the pandemic worsened with a more pessimistic global economic situation. In the UK, the Federation of Small Businesses December report, "Credit Where Credit's Due," warned that financial markets might soon restrict lending to small businesses, similar to the period after the 2008 crash.

It doesn't stop there, as SME priorities, concerns, and resources have changed over the last decade and a half. Amid the pandemic-induced upheaval and political turmoil, SMEs seized the opportunity to reinvent themselves and reach new customers, resulting in a shift in their needs from their banks.

"SMEs have entered a digitalisation stage in the aftermath of the pandemic," declares Augusto Paz-Lopez, head of the SME segment of BBVA in Peru. He then explains how BBVA is positioning itself to provide products and services to businesses that optimise delivery in both physical and digital channels while keeping costs down.

A UK Perspective

The UK has secured itself an unenviable position of being the worst-performing economy in the G7. A succession of political gaffs and turmoil has seen the economy suffer as a consequence. As far back as 2016, the then prime minister Theresa May made a bold announcement outlining the first steps in a modern, ambitious Industrial Strategy to build on the UK's strengths. Despite multiple changes at the top, those first steps eventually culminated in what today is called Business Connect.

UK Business Connect & Levelling-up

In January 2020, the UK government announced their plans to introduce several Freeports intended to boost international and domestic trade, investment, and job creation, all while promoting the government's 'levelling-up' agenda.

Freeports provide businesses with customs and tax reliefs, simplified export and import procedures, and enhanced trade opportunities, making them attractive to international and domestic investors. Furthermore, to enable investment in skills and infrastructure, local firms in these areas enjoy full retention of their business rates. Combined with seed capital from the government, Freeports offer a variety of advantages to businesses and trade.

Yet, despite these efforts, and bold promises, levelling up doesn't seem to be helping everyone. The Yorkshire Post published an article claiming, "The number of companies filing for administration across Yorkshire and the North East jumped by third in the third quarter of 2022, as economic headwinds continued to buffet businesses across Britain." More recently, another article was published indicating that the problem is worsening, with another attention-grabbing headline "Number of businesses filing for administration across Yorkshire and North East rises by 41%."

What's the Financial Sector View?

Dennis Khoo, author of `The allDigitalFuture Playbook` and co-creator of TMRW, the first digital bank in the ASEAN region, shared that "SME credit bureaus are not that strong on risk-ranking companies that banks should and should not lend to. But fixing this problem isn't easy, as the data required is fragmented, disparate and difficult to obtain and verify for authenticity and integrity."

Herein lies an opportunity for both SMEs and financial innovators. With the UK's expertise in the financial sector, we could witness the emergence of new technologies, similar to when mobile phones and computers gave rise to the smartphone.

As economic pressures continue to rise and COVID-19 lending slows down, the heat is on banks to get credit decisions right, especially since many SMEs have lost market share over the last three years. By bringing accounting and banking together, this could become much easier.

Data from accounting systems could revolutionise finance for SMEs. Combining account and banking systems could reduce or eliminate reconciliation processes and double entries in separate accounting and payment systems.

Khoo even envisions SMEs carrying out all their banking on an accounting system rather than a business banking app. But without a breakthrough in the use of data for alternative credit assessment and underwriting, the potential for improved transactional banking for SMEs is limited.

The question is, are the improved customer experience and operational gains for SMEs and banks enough to turn this potential into reality? How close would this be to open banking? SMEs might hesitate to put all their eggs in one digital basket, so communication and transparency towards customers will be paramount to making open banking a tangible benefit.

The UK is taking steps towards open banking, but the FSB argues that the framework needed to make it appeal to SMEs is not yet there. Often small businesses are early adopters of new technology, and changes in technology are changing the way small firms interact with banks, finance providers, and new entrants to the market all the time. Only time will tell if open banking and digital transformation will evolve and benefit businesses of all sizes in all locations.