The need for alternative finance
Previously, small business owners had only one option when applying for a business loan – their local bank. However, there are now hundreds of alternative finance providers that facilitate fast, flexible and affordable business loans to SMEs - at better terms.
But why the need to switch from traditional lenders to alternative providers?
It's because SMEs have always faced unique business challenges - they typically run with little working capital and cashflow is a persistent problem. With growing market instability in the wake of inflation, SMEs are increasingly looking for easily accessible financing. The British Business Bank reported that 59% of SMEs applied for external funding support in 2020 compared to 13% in 2019. The problem is that traditional lenders are often ill-equipped to properly serve SMEs’ specific needs. They don’t differentiate between companies with 2 employees and those with 200, struggle to tailor down offers at scale, and use risk assessment models that would unfairly reject many modern small businesses. That’s why fintech lenders currently provide most of the flow of new SME lending in the UK.
Why traditional lending is failing SMEs
We know SMEs are in need of credit, but without more lenders using alternative finance solutions, they’re struggling to access it. This is in part because traditional credit models neglect various invisible populations. Younger people with limited credit records, those who don’t rely on credit products, the unbanked, and recent immigrants without an established credit footprint are all hard to serve for traditional lenders. Experian estimates there are 5.8 million adults in the UK with a ‘thin’ or non-existent credit file, and the same problem applies to many SMEs.
A lot of this comes down to data, or a lack of it. Because SMEs tend to be younger than other businesses and rarely have an established credit record, traditional lenders not using alternative finance are unable to assess them for risk, and the process is often complex and slow. In fact, 57% of all SME credit applications are abandoned because they’re too difficult to complete, or are ultimately rejected. The overreliance on traditional credit models punishes the most successful SMEs, because high growth makes their earlier credit history less relevant.
The feedback loop caused by traditional credit models, where SMEs fail because they’re unable to access the credit that would see them succeed, has even calcified into regulation. Under Basel III, the global regulatory regime for banks, lenders are obliged to hold twice as much capital against an SME loan as for other kinds of financing. That means less profit, and less willingness to lend.
The consequences are far reaching. For SMEs unable to access the credit they need to operate, it can be life or death. For the traditional banks failing to help them, it’s a missed opportunity to serve a fast-growing market. And for the economy as a whole, it’s a huge waste of potential. SMEs employ 16.3 million people in the UK, have a combined annual turnover of £2 trillion, and account for 52% of all private sector turnover. A recent study found that targeted support for SMEs could unlock £140bn of additional Gross Value Added (GVA) growth by 2030, equivalent to creating ~3.2m new jobs across the UK. Luckily, embedded finance solutions enable banks and other platforms to use a data-driven approach to lending, and give SMEs the support they need.
What is alternative finance? A data-driven approach to embedded finance solutions
Alternative finance is the best way for traditional lenders to better serve SMEs, because it sidesteps many of the obstacles that have historically held them back. Here’s how:
More Accurate Risk Assessment: YouLend has compelling evidence that partner-sourced transaction-level information coupled with cash flow variables that aren’t conventionally used in risk scorecards (such as cash flow from operating, investment, and financing), are the strongest predictors of credit risk across different target segments. Alternative finance makes it possible to gather and use that data.
More Regulatory Leeway: Because revenue-based embedded finance solutions aren’t subject to the same regulations as traditional debt financing, YouLend can open up a wide range of credit markers. For example, a bank or lending platform using alternative finance could assess risk using digital markers appropriate to a modern SME, like TripAdvisor reviews, or social media engagement, and lenders can use these non-traditional checks with confidence.
More Flexible: YouLend carries out all necessary KYC and AML checks automatically in the background, ensuring every approval of funding is compliant with the regulations relevant to the business owner. Because YouLend’s revenue-based funding sets repayments as a percentage of revenue rather than a fixed rate, both lender and borrower can feel confident that once funding has been approved—which it is more than 90% of the time—it can be repaid despite seasonal or economic externalities.
SMEs are a vital part of the economy, and for all the reasons we’ve seen traditional lenders are often ill-equipped to serve them, but alternative finance solutions like YouLend’s can make supporting SMEs quick, simple, and rewarding.
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