SMEs should leave the big banks behind to get ahead

The last few years saw unprecedented levels of capital flow into Australia’s economy. While measures such as JobKeeper and the RBA’s Term Funding Facility (TFF) boosted cash flow and provided a safety net, it didn’t mean that every business needed to borrow at the time. With product supply issues, interest rates rising and the likelihood of a recession growing, SMEs need to proactively secure finance facilities. And they can’t rely on the big banks to help them.

The nature of the big banks is epitomised by extremely long turnaround times, rigid credit assessment frameworks and extensive security requirements. The traditional reliance on property security can no longer provide them comfort and for many SMEs, their specific funding needs aren’t addressed. Non-bank FinTech lenders have the same agility and flexibility that their customers possess while addressing the main barriers to SME funding, making them better placed to meet the current and future funding needs of SMEs.

Pre-COVID demand has helped SMEs, but the trade finance gap remains

The RBA’s recent bulletin, The Current Climate for Small Business Finance, found that, despite being amongst the most heavily affected by COVID-19 restrictions and lockdowns, SMEs across Australia are experiencing pre-COVID-19 demand, with their recovery starting from mid-2021. Not only did the economic recovery help SMEs, but strategic changes to business models and product lines have made businesses more resilient to the threat of swift changes in how businesses can trade — something that plagued SMEs throughout 2020. However, despite strong demand, the growing trade finance gap remains a problem, especially for SMEs.

A 2021 Asia Development Bank study found that the global trade finance gap widened to USD 1.7 trillion in 2020 — an increase of 15 per cent on the previous two years. Further, a recent World Bank report, Small and Medium Enterprises (SMEs) Finance, estimated that the unmet finance needs of SMEs globally amount to USD 5.2 trillion per year. In Australia, SMEs continue to bear the brunt of this gap. Despite the AUD 188 billion that flowed to the big banks since the start of the pandemic, SMEs still struggle to access the funding capacity and flexibility they need. Of course, it wouldn’t be prudent to provide finance to companies that don’t have a strong financial track record. However, perpetuating a business funding environment that mostly favours mature-stage companies and the institutions that lend to them jeopardises the potential for real economic growth — something that Australia greatly needs as it continues to rely on growth drivers (natural resources and residential property) that are sensitive to economic risk.

SMEs need finance without sacrificing equity or risking the family home

The key challenge that SMEs face in accessing funding is the need to provide personal collateral for facilities with the big banks. For instance, for most Australians, the most valuable asset they own is the family home. According to research by the RBA, SMEs with residentially secured loans typically have just over $300,000 in debt funding, while those with unsecured loans have around $50,000. These amounts may help businesses meet working capital requirements or bridge cash flow gaps, but for a growing business, this could still be inadequate.

It’s also important to note that measures such as the Australian Government’s SME loan guarantee schemes had a modest uptake due to misconceptions about how the loans were structured. While the government may have backed 50 per cent of the loan value, it didn’t address the high cost of capital that SMEs face. Further, issuing guarantees on bank credit arguably shifts the power to create money from the central bank to the government without the need for the usual mechanisms like issuing government debt or raising taxes. When power shifts like this occur, there is a risk that the trade capital gap could widen as it doesn’t address business funding challenges or fuel real economic growth. In short, it’s not just the amount of money that SMEs need access to that is the problem. It’s about what the capital will cost, the structure of the funding, and whether there is flexibility in the facility for it to change as the business evolves.

Tech-driven funding provides much-needed flexibility to SMEs

Non-bank FinTech lenders level the playing field for the businesses that have been underserved for too long. Using data and technology to quickly assess the creditworthiness of borrowers, means there is less red tape involved in getting the funding required to cover cash flow gaps and grow, while the agility of these solutions suits the often fast-changing needs of SMEs. For example, invoice financing provides suppliers with upfront payment for their customer invoices. Similarly, supplier and buyer finance connects both parties with a tech-enabled lending platform to provide flexible trade terms, benefiting both buyer and seller. A supplier’s potential market is given the ability to grow by being able to provide more payment and financing options. And for buyers, added flexibility in how and when to pay means that SMEs can take advantage of features such as early payment discounts and on-demand lending.

The key factor that differentiates non-bank FinTech lenders from the big banks is the ability of these platforms to use data from a connected business ecosystem to assume more of the financial risk. It takes the guesswork out of managing cash flow while providing the working capital that may be required to replace or upgrade assets, invest in new equipment and machinery, take advantage of growth opportunities, and grow the business’s financial safety net — all without sacrificing equity or putting the family home on the line.

Supporting alternative lenders would drive real economic growth

Supporting innovation in FinTech-driven lending is critical to not only helping Australian SMEs weather challenging economic times but helping them grow too. Modest uptake of schemes, such as the Australian Government’s SME loan guarantee, particularly the structure of Phase 1 and 2, which largely favoured the big banks due to its lowered cost of funding from the Reserve Bank of Australia’s term funding facility (TFF) didn’t address the core challenges that SMEs face in securing finance — unsuitable and inflexible funding structures and a high cost of capital.

Perhaps the biggest commitment that policymakers could make in supporting alternative lenders would be to provide access to liquidity facilities that would allow these lenders to serve more businesses and facilitate restructuring where required. Mechanisms that help lower the cost of capital and boost cash flow for SMEs are also critical steps to levelling the playing field for both alternative lenders and their customers. The industry also needs a regulatory environment that supports FinTech lending innovation in the same way policymakers, industry, and the RBA collaborated to build and launch the New Payments Platform in 2018. Accelerators, innovation hubs, and regulatory sandboxes would provide an environment to test new ideas and support innovation in the sector while maintaining a prudent approach to lending.

Modern businesses need flexible cash flow solutions

The perfect storm of inflation, rising interest rates and the growing likelihood of a recession presents an opportunity for policymakers, businesses, and their funders to innovate throughout what may be a challenging year for SMEs. Non-bank lenders are a key part of this puzzle, providing SMEs with the funding flexibility and solutions they need to exercise better control over their cash flow, better manage their expenses, take the guesswork out of waiting for customer payments, and plan for investments in growth. Without suitable finance solutions, the businesses that employ over 7.4 million people, real economic growth, and the country’s ability to compete globally are in jeopardy.