Small and medium enterprises (SMEs) are vital for emerging economies. They are a major source of employment and drive national economic growth. According to the World Bank, SMEs contribute up to 40% of gross domestic product and seven out of ten jobs in emerging countries.
But SMEs face challenges which hold them back from reaching their potential, including lack of access to capital, often a result of absence of credit and cash flow history and insufficient collateral. This makes them a higher credit risk for traditional banks.
Lack of formal credit constrains the SMEs’ business operations and curbs their opportunities for growth and expansion. SMEs in developing economies face a financing gap of as much as US$5.2 trillion.
Many of the barriers that SMEs face in accessing financial capital can be overcome through blended finance and financial technology.
Blended finance is the combination of commercial lending and concessional funds -- loans with below market terms, such as lower interest rates, extended grace periods, or subordinated debt.
Concessional capital and donor funds are provided by public and philanthropic entities such as government agencies or foundations, and implemented through development partners, enabling crowding in of private investment offered by commercial banks, development finance institutions, or institutional investors.
Blended finance is used to support projects which are commercially viable and offer high developmental impact. For SME financing, the inclusion of concessional finance reduces enterprise risk by offering subordinated debt or risk sharing of losses on loans, galvanising commercial capital for development purposes.
One example is the Women Entrepreneurs Opportunity Facility (WEOF), a blended finance partnership between the International Finance Corp. (IFC), the private sector arm of the World Bank, and Goldman Sachs. Launched in 2014, it’s designed to support economic growth in developing countries by empowering female business owners through improved lending practices.
Through WEOF, concessional capital is blended with private capital from investors and lent to financial institutions in emerging markets for the purpose of increasing lending to women entrepreneurs. WEOF also supports female business owners by providing capacity building services such as business management education, mentoring and networking opportunities.
As of 2017, the programme has economically empowered more than 52,000 women business owners.
Fintech innovations also present an exciting opportunity to catapult financial inclusion of SMEs and other underserved groups. Digital financial tools leveraging artificial intelligence offer alternative methods for accessing credit risk through proxies, allowing faster loan approvals.
Advances in fintech also significantly reduce administrative costs of service delivery. Such innovations provide the means to quickly scale SME financing and reach larger numbers of enterprises in emerging economies.
Some fintech players focus their business on solving the funding gap for SMEs in Southeast Asia. For example, Funding Societies, the region’s largest digital financing platform, has extended more than $1.21 billion of loans to SMEs since its inception in 2015.
Meanwhile, fintech platforms like Grab Financial Group are expanding their product offerings to include SME loans.
Building on its growing ecosystem of fintech solutions, Grab in March 2019 launched a platform for small business loans for SMEs in Singapore. It provides loans of up to S$100,000 (US$73,000) under the GrabFinance brand to SMEs with fewer than 200 employees that have been in existence for over six months.
Advisory support and governance
In addition to capital for lending, fintech platforms focused on serving marginalised communities need expertise in market development to reach underserved communities, and commercial advisory support. Meanwhile, socially focused enterprises require expertise in market development, reaching underserved communities, and business expansion.
Partnering with both development financial institutions and commercial capital providers enhances advisory support by pooling knowledge from both sectors.
For example, the Global SME Finance Facility, a blended finance programme which combines commercial funds from IFC and the European Investment Bank, and donor funds from the UK and Dutch governments, provides support to financial institutions for development of business models and tailored product and services to improve lending practices to SMEs. Funding from both development and commercial partners reflects social impact fintechs’ dual goals, enabling pursuit of the double bottom line.
But like with all financing, there must be strong oversight to prevent misuse. Blending subsidised funds with commercial capital can affect the risk level or potential profitability of projects, which may create misalignment of interests between the providers of concessional and commercial finance.
Providers of concessional funds should ensure projects are commercially viable and consider the minimum amount of funding necessary to support the investment, and when the financing can be phased out. And funding partners should specify success metrics and implement strict reporting requirements to ensure accountability to development goals,
Blended finance channelled through fintechs has the potential to generate high development impact by increasing capital lending to SMEs quickly and at scale. These innovations solve different sets of challenges faced by SMEs.
While blended finance helps empower SMEs by making available credit on easier terms, fintech solves the problem of accessibility of credit by leveraging the scale and reach of digital technologies.
Together, these innovations can catalyse economic growth in emerging markets and create greater social impact. By using blended concessional finance, socially focused fintechs can reach particularly underserved market segments with smaller profit margins, including SMEs, allowing them to look past short-term profitability targets and concentrate on long-term shared value creation.
*Bethany May Brice is a double degree MBA/Master of Public Policy candidate at the National University of Singapore currently interning at Funding Societies.