Shaping the future of MSME finance to help small businesses thrive

MICRO, small and medium enterprises (MSMEs) are a vital contributor to a country's gross domestic product (GDP). This is particularly true for South-east Asian countries where these entrepreneurs contribute up to 40 per cent of the region's GDP and employ nearly 70 per cent of the workforce.

In Singapore, MSMEs are an integral part of the enterprise scene making up 99 per cent of companies and employing 72 per cent of the workforce in the city-state. The smallest of SMEs, MSMEs (or micro-enterprises) typically refer to firms with fewer than 10 employees and very limited capital.

Despite the importance of MSMEs, there remains a significant financing gap for smaller businesses. Research conducted by consulting firm McKinsey & Co showed that 51 per cent of MSMEs in South-east Asia face a financing gap of some US$175 billion. This is driven by the belief that MSMEs are riskier due to limited or no credit history and have less financial experience and backing. Stuck between micro and corporate loan plans from financial institutions, these companies are often driven to seek funding from alternative lenders.

This is one of the factors that has contributed to the rise in fintech credit options ranging from balance sheet business lending and invoice financing to crowdsourcing and P2P (peer-to-peer) lenders. In line with the tenacious and driven nature of these entrepreneurs, 68 per cent of MSME owners are receptive to loans from lenders outside of the traditional financial services industry.

But MSMEs face significant limitations to securing these types of loans, especially when using them to achieve sustainable business growth.

MORE CHOICE, GREATER RISK

Many non-traditional lenders promise greater flexibility and less stringent qualification requirements for loan applications. These benefits come with some risks, such as harsh penalties for borrowers who fail to pay on time or in full. Following a number of scams uncovered in mid- 2017, the Chinese government enacted stricter laws to combat the fraud.

The high interest rates at which loans are sometimes granted can eat into a company's cash flow, an issue that is already pressing for MSMEs. In some cases, these lending platforms do not allow reprieve from the scheduled payment plan or take into account the complexities of running a small business, such as delayed customer payments. Products like these can promote irresponsible financial behaviour and create a vicious cycle that traps MSME owners in debt.

CURRENT STATE OF CUSTOMER PROTECTION REGULATION

Given the value MSMEs contribute to national GDP, it is imperative that local governments and businesses combat negative lending practices and find ways to address the financing gap.

Many countries in South-east Asia are taking steps to regulate the space. In Singapore, the Ministry of Law passed new regulations in November 2018, adding further restrictions to money lending. In Indonesia, Otoritas Jasa Keuangan also extended its regulation by controlling licences for digital lenders.

But these legislative efforts do not address the formidable funding gap for MSMEs. To help improve access to finance and positively impact small businesses, it is necessary to look further than regulation. Increasingly, we are seeing that the potential to bridge this gap lies in the intelligent and collaborative application of technology.

Machine learning (ML) has made significant strides in recent years and has an important role to play in advancing access and financial inclusion. In the financial sector, ML is accurately predicting payment behaviour and informing safeguards to protect the end user. And this only represents a start - if properly implemented, technology can help support the development of positive financial behaviours and fundamentally improve the lives of customers.

New technologies can also help build healthy financial behaviours and support responsible lending practices. The ultimate goal should be to help these entrepreneurs leverage their digital financial footprint and build up their creditworthiness. This can mark the beginning of the journey out of the poverty cycle and away from being trapped by alternative lenders.

PARTNERSHIPS - THE FUTURE OF FINANCE

A collaboration between fintech and traditional financial services providers can create opportunities to bridge the financing gap for entrepreneurs. Partnering fintech allows banks to mitigate the risks of individuals having no previous credit history. When run through ML algorithms, large-scale alternative data from different ecosystems such as mobile money transactions and cell phone signals can be used to create a bespoke financial identity for a customer.

Partnerships of this nature can provide banks with high visibility over historically unmapped markets on platforms that are scalable, fast and secure. This will also enable banks to take a more active role in MSME empowerment and protection.

With the increasing sophistication of fintech providers, more financing options are available to business owners all across South-east Asia. Most importantly, these alternatives will be offered by a highly regulated and consumer-centric industry, supplying MSMEs with a regulatory safety net so that they can concentrate on what matters most - growing their business.