By Tim Davies, Head of Financial Design at Blackstar Capital
The process of large banks de-marketing non-core clients began in the recent financial crisis as a survival mechanism against losses, regulatory capital inefficiencies, and below hurdle relationships. As a result, in 2018 there was a $5-trillion gap between the working capital requirements of SMEs and the funding options available to them.
Just as banks began adjusting to a new business paradigm, the pandemic wiped out any recent gains in addressing this gap as banks go risk-off in response to feared economic fallout.
Governments, export agencies, and central banks have made valiant, albeit expensive and temporary attempts to open working capital to SMEs through emergency loan schemes, reducing administrative barriers to access, and furlough payments. It is clear however, that the extent of this aid is neither sufficient nor sustainable through to a full economic recovery. Does the solution lie outside the traditional banking system, then? As effective and welcome as non-bank working capital lenders are, on the surface they would not appear to carry enough collective balance sheet capacity to patch up much of the gap.
What about the capital markets? As a staple asset class, trade receivables have historically occupied a healthy share of the asset-backed securitisation market. It remains a viable funding tool for large portfolios, but price prohibitive for smaller SME-sized portfolios. Recent high-profile problems with the funding tools (but notably not with the assets) used by Greensill Capital risks a repeat of the near-miss ‘baby-out-with-the-bathwater’ situation facing securitisers a decade ago.
So, if the banks are risk-off for the foreseeable future, governments and agencies cannot sustain, non-banks cannot fill, and capital markets are once bitten; what else, if anything can fill the sizeable working capital finance gap?
As with many other areas today, technological innovation creatively applied to the working capital finance market is at the same time complementing, disrupting, creating, and widening working capital channels in unexpected and seismic ways. How exactly are FinTechs enabling wider participation and liquidity for the benefit of SMEs in such a challenging environment?
Complementing
Nimble FinTechs are partnering with large banks, non-banks, and government agencies to speed delivery of product to their clients by sidestepping massive tech spend to repurpose inflexible legacy systems. The best example of this are FinTech-managed white labelled Supply Chain Finance (“SCF”) platforms that are increasingly used by banks. Non-banks are using FinTechs to remove bottlenecks in their processes; for example, in payments, credit, and KYC/AML/Sanctions checking. New classes of investors are discovering that FinTechs can offer a conduit to the previously inaccessible receivables asset class, and its attractive risk adjusted returns. The net beneficiary of these developments are SME borrowers particularly as suppliers to large buyers in SCF.
Disrupting
The arrival of FinTechs into a financial product market is a harbinger of change. There are many reasons for this, but three are obvious. First, an exploitable niche, structural inefficiency or imbalance in an existing market has been identified by a FinTech, and remains unaddressed by current participants. With swift customisation, new technology is brought to bear on the anomaly. Second, FinTechs challenge market practice and status quo causing current participants to take stock of their own position and react accordingly. Thirdly, these new business models create competitive pressures (for example offering micro-services, or building products using an interchangeable FinTech ecosystem) as FinTechs look to apply their technology to incumbent-held market share. FinTech is providing access to a wider variety of lenders, allowing them to access the tools to manage large scale, high velocity data processing, digitisation and risk management, driving working capital products deeper into the SME world.
Creating
Disruption creates new products and starts new markets. The new wave of FinTechs are not only attacking adjacent competitors in their chosen market, they are also incorporating elements up and down the transaction value chain. For example, FinTechs can find themselves originators and arrangers themselves, rather than just a data exchange or a receivables marketplace. Importantly, FinTech has brought the cost of using efficient financing structures like securitisation within the reach of SMEs.
Widening
New investors with value and risk metrics that align with receivables finance are using FinTech channels to deploy capital. Large institutional investors tend to proceed with caution, but as comfort grows, so does the investment. As a result, SMEs are increasingly being given multiple options as to where they would like to take finance in the working capital cycle. These options are popping up in unexpected places, for example, ERP and accounting software screens to e-invoicing and inventory systems, to name a few. The new offerings have some commonalities, mainly: they are from lenders the SME does not have a relationship with; they are designed to be non-intrusive to the seller’s business; and, most importantly they can deliver working capital to the SME at exactly the right place in the cycle – at an attractive price and with a minimum friction.
It was always going to be the case that the working capital finance gap would be filled by all the above channels, in varying proportions. Encouragingly, the current wave of FinTechs are aiming at the gap, rather than to stake claim to parts of the territory on each side of it. While FinTechs can be disruptive, complementary, creative, and widening, in their own way; the net effect will continue to be a drive to reverse the outflow of capital from the SME lending sector, and deliver it back in efficient, targeted ways, for the benefit of SMEs and investors alike.
