Ecosystem Design in SME Lending
The term SME refers to small and medium size enterprises. In India, the term MSME is used alternatively, including Micro size enterprises as well. The following table explains this classification in detail:
SMEs represent a very important part of the banking industry’s revenues. They form close to 20% ($850 Bn globally) of the banking revenue. A large part of this revenue comes from SME, who need the money to fund their growth. But lending is not the only way that SMEs can fund themselves. Before dwelling deeper into the SME opportunity for banks, let us explore in further depth what these various ways of financing are for SMEs.
Financing options for SMEs
The primary financing method for SMEs is usually Asset Based Financing. This refers to taking debt against the assets of the company — like Plant and Machinery, Account Receivables, etc. These assets are often taken as an indication of the valuation of the company, and hence it makes the task of the lender easier ascertaining the value of loan and risk they are willing to take in the company. This has been the most prevalent form of SME financing for many years now.
However, major changes in the capital markets have paved the way for more varied and flexible forms of financing, which can be of value to both the firm and the investor. Some major alternative forms of financing for SMEs are as follows:
1) Crowdfunding: Developing into one of the most prevalent forms of fund raising, crowdfunding has developed as a potent financing route for specific projects. A key benefit of crowd funding is that it helps prove the proof of concept for the SMEs. If the mass public find the project attractive to invest in, and of some utility to them, only then they will pay an upfront fee to obtain the same. Platforms like Kickstarter have really helped make this way of funding accessible to the general masses.
2) Hybrid Instruments: Hybrid Instruments help the investor and the SME gain an advantage of both debt and equity financing. This was of financing can especially be beneficial for SMEs that are reaching an upturn in their life cycle, where they want to a large amount of funds, but to neither pay a large interest amount, nor want to give up a lot of their equity. It also helps the investor have a skin in the game for their returns and helps them generate profits alongside the firm.
3) Venture Capital: Private Equity and Venture Capital, is quickly becoming the most prevalent way for young startups to raise capital. The key advantage it has is that they get a partner alongside the funding as well, who bring with them a wealth of experience in managing budding companies. For the investors, it represents taking up a larger degree of risk compared to asset-based financing, but also gaining a large reward in case the startup explodes, or is acquired at a later stage in their life cycle.
Ecosystems in SME Lending
The idea of an ecosystem is to offer a wide range of services to SMEs, which go beyond only Banking. For example, if the bank can look at a firm’s finances and accounts, they could advise them on how to be more financially frugal, and proactively recommend financial solutions for any current or potentially upcoming problems the bank might face. Banks are therefore at a certain level of advantage when it comes to building ecosystems that could benefit the SMEs, due to the large amount of data they have on each of their customers.
So how exactly can banks contribute, and be a part of the growth of the SMEs?
1) Banks can provide support in the form of its data, or financing, to players who are developing an ecosystem to support the SMEs. A good example of this is Goldman Sachs partnering up with Amazon USA to provide a Line of Credit to the sellers on its platform.
2) Banks can act as orchestrators, or matchmakers, and support SMEs by identifying their problems and connecting them to relevant solution providers.
3) Lastly, banks can build new businesses that support SMEs, and create its own ecosystem and portfolio of services. For example, ICICI Bank in India has launched a new platform — CorpConnect — which enables corporates to integrate their ERP systems using APIs or host-to-host protocols.
To understand the ecosystem design in greater detail, we can look at the case study of the Chinese personal financial services firm — Ping An — which offers an open platform and marketplace of services to more than 300 million customers online. Ping An developed this ecosystem through a three-stage approach. First, it acquired online customers by developing platforms that can be used to accomplish day-to-day tasks. Next, it converted these users into customers of the bank by providing them easy to use bridge products, such as a digital wallet, and providing a financial services supermarket which provides recommendations to the customers. Finally, the bank optimized its online offerings to generate demand for the product, through a distinctive Ux and seamless multichannel integration.
This new approach is quickly generating results for the bank, with the new platforms generating nearly 20% of the bank’s revenues in 2016, up from less than 1% in 2010. The following diagrams provides an overview of this ecosystem designed by Ping An.
References
- https://www.mckinsey.com/~/media/mckinsey/industries/financial%20services/our%20insights/how%20banks%20can%20use%20ecosystems%20to%20win%20in%20the%20sme%20market/how-banks-can-use-ecosystems-to-win-in-the-sme-market-vf.ashx
- Gartner Hype Cycle for Digital Banking Transformation, 2021
- https://www.oecd.org/cfe/smes/New-Approaches-SME-full-report.pdf
