Small and medium-sized enterprises (SMEs) continue to seek out non-bank financing alternatives at an increasing rate. Bank credit is either difficult to access, it is just not available to them, or it does not suit their needs, requiring them to put up personal assets as collateral.
The jury is out on whether banks have reduced the number of SME loans they are approving in the wake of the 2008 financial crisis. The traditional banks claim they are approving up to 95% of the loan applications they receive from SMEs. However, the latest Reserve Bank of Australia Financial Stability Review published in October this year suggests otherwise. It finds that smaller businesses are continuing to face “relatively tight credit conditions.”
Figures collected by the central bank show lending to small businesses has effectively moved sideways compared with a 5% increase in lending to large companies. The RBA notes that tighter credit conditions have made it harder for small businesses to both fund their operations or refinance debt.
It will prove tough to turnaround the declining trend in lending to SMEs in slowing economic conditions, alongside growing risk aversion in Australia and globally. Also, the competition presented by alternative finance operators is becoming increasingly intense. Companies that are offering online alternative finance options are innovative and agile and thus better placed than banks to solicit and meet the financing needs of SMEs.
The Australian Banking Association has taken strides to improve SME ease of access to traditional bank finance. It has drawn up a new Banking Code that is intended to make banking easier for small businesses. Measures to improve access include simplifying loan contracts for loans under $3m, providing more extended notice periods ahead of changes in loan conditions, and improved communication and transparency requirements for valuers and insolvency practitioners.
Simplifying loan contracts does address one of the critical issues SMEs have with bank finance, and that is not nearly as much of a problem with alternative finance options. The application process required by traditional banks tends to be onerous, complicated, and time-consuming, with loan approval taking far longer, often a couple of weeks at least, than the digitally-driven alternative finance options.
An SME applying for a P2P loan or negotiating invoice financing will experience a much simpler and quicker application process. Most offer access to online service, with credit assessment driven by Artificial Intelligence. Thus it is much faster to ascertain whether a company has the credit credentials that meet the loan requirements. The applicant for the loan can expect a preliminary answer anything from minutes to 24 hours after fulfilling the application requirements and uploading the documentation needed.
Thus the measures introduced in the new Banking Code of Conduct are unlikely to be sufficient to stem the tide of SMEs opting for alternative finance instead. Alternative financing encompasses peer-to-peer (P2P) lending, crowdfunding, and invoice financing. Peer-to-peer funding brings together the SME borrow, lender, and partner bank on an online platform to raise the financing of the SME. Crowdfunding allows a company to gather small amounts of money from a broad group of people online in return for a potential profit or reward.
Invoice finance is a contract drawn up between an alternative invoice finance company and the SME in which the finance company provides discounted funding of approved customer invoices. It enables SMEs to manage their cash flows and improves working capital.
The most recent version of the Asia Pacific Region Alternative Finance Industry Report published in November 2018 gave some insight into the trends in demand for alternative, rather than traditional, finance.
It found that alternative funding raised in Australia had topped US$1.1bn in 2017, a growth rate of 88% year on year, and the most substantial volumes raised in the Asia Pacific region. Invoice trading was the third largest alternative financing segment, with US$142.7m raised during the year. Invoice trading followed balance sheet business lending, the largest segment raising US$574m, and P2P lending raising US$256m.
The study confirmed that Australian online alternative finance platforms have been able to adapt operational models and underwriting systems from overseas operators, as well as from local banks, “and therefore attract much higher levels of institutional participation and funding.” In terms of institutional participation rate, Australia was the highest country within the Asia Pacific region at 65%. There is no doubt that the tide has turned for banks, and they will need to work hard to compete with the non-bank financing alternatives available. SMEs benefit from access to a diverse range of funding alternatives that cater to their specific needs, particularly in the early stages of setting up the business, when they haven’t yet built up a sufficiently long credit history.