SME access to Finance A 300In Australia the Small Business Minister Bruce Billson wants to push ahead with legislation to limit the ability of banks to use non-financial conditions such as loan to value ratios to foreclose on small businesses borrowing up to $250,000.

The problem is that the current model for bank lending to small businesses satisfies neither bank customers nor shareholders. Fortunately there is a solution at hand and it is the fintech model.  Fintechs and banks possess attributes the other doesn’t but together everyone, especially the SMEs, could be a winner.

A small business owner won’t go to a fintech if a bank will provide the required funding within an acceptable time frame and with acceptable security. Fintechs appeal to small businesses when the bank has said “no”, or if the owner feels it would take the bank too long to make a decision, or if they don’t have or aren’t prepared to offer the security the bank required. Fintechs don’t take security so they have to be extra sure that the borrower can afford to service and repay a loan from cash flow so their credit analysis, while quick, is comprehensive. Statistics from the US reveal only 38 per cent of small business loan applications to fintechs are approved.

Apart from being able to make quicker decisions on unsecured business loans, fintechs currently struggle to compete with the banks. They have a limited product offering, mostly principal and interest loans for terms usually from a fortnight to six months. And they are expensive with annualised interest rates ranging from 20 to 100 per cent. The main reason fintechs are expensive is that they have to pay up to five times more than banks to access funding. The other reason is their default rate is higher ( 7 per cent in the case of US provider OnDeck).

The banks on the other hand face a problem that is not going away. Their legacy structures make it nigh on impossible to profitably service the thousands of people who run successful small businesses and who want to borrow less than $250,000 but can’t offer property security. SME customer satisfaction rates are at record lows and they are skeptical of bank advertising slogans. In the US, 70 per cent of all business loans are for sums less than $250,000. Banks have to find a better way of providing unsecured debt funding to small business.

Fintechs which offer a smart, quick, low cost and scalable way of evaluating and providing unsecured small loans to businesses? While they are user friendly and don’t yet have any reputational baggage they do have issues to work on like funding, liquidity, product development and regulation but a bank would be invaluable in helping fast track such challenges.

Leveraging the strengths of each other could produce a better outcome for all. This could this be done in a number of ways including formal joint ventures, loose referral arrangements, white labelling by fintechs for bank customers or passive investments in fintechs by banks.

Fintechs, other than the likes of PayPal and eBay, as yet don’t have a customer base whilst banks operate accounts for over two million small business – although many of these don’t borrow from banks. So perhaps the biggest opportunity with any tie up would be to develop and maintain long term relationships with small businesses by becoming their primary supplier of debt finance and other banking products and services. Any SME that wants to borrow less than $250,000 without security would be directed to the fintech until such time they transfer, by mutual agreement, to the bank’s business banking platform.

In the UK, Santander Bank has an arrangement in place with peer-to-peer lender Funding Circle in which Santander refers rejected business loan applicants to Funding Circle, where it believes they are better placed to help. In turn Funding Circle directs SMEs to Santander when they require day-to-day relationship banking or other services such as international banking and cash management.

Not every bank will want to join forces with a fintech and vice versa, and of course there is nothing to prevent a bank from establishing its own fintech. Incumbents can also be disruptors, NAB’s creation of UBank is an example. Equally there will be fintechs that may want to maintain their independence. Remaining totally independent of a big bank would a real point of differentiation that would appeal to those SMEs which don’t like big banks.

The first bank that adopts a fintech approach to unsecured business lending for sums less than $250,000 could become the dominant lender in this sector. SMEs should be encouraged and optimistic with this prospect. It will undoubtedly happen and probably sooner rather than later.  Which bank will lead the way? Only time will tell.