The race to crack the SME credit scoring dilemma

Meaghan Johnson

The SME sector has undergone a significant level of (much needed) digital transformation.

Prior to this revolution, SMEs were tied to inadequate solutions from incumbent banks which, let’s face it, were not truly tailored to business needs. Business solutions were incredibly broad, with customer segmentation based on large company threshold amounts, rather than type of business formation, sector, or company stage. Furthermore, onboarding was tedious, time consuming and was limited in digital capabilities, and the integrations of non-core banking platforms and softwares were in their infancy.

The digital revolution in the SME space has been a godsend for SMEs. New players such as Tide, Coconut, Penta and Kontist developed innovative current account solutions based on the type of business (e.g. Freelancer, UG, Limited Company), helping SMEs with the day-to-day business activities such as cash flow, tax management and incorporation, based on who the business was as its core, rather than the amount of turnover.

Outside of core SME services we have seen the likes of Pleo, Divvy, Fluidly and others supporting SMEs with cash flow management, employee card management etc, giving them a better grasp of their finances and spend. However, one area that continues to remain a challenge is SME lending. Lending is known by all as essential, given the importance of SMEs to the economy. At the crux of the lending problem are two issues:

  1. Ascertaining SMEs' creditworthiness, particularly for new firms or early stage companies: Traditionally banks have used data sourced from credit bureaus and company accounts.
  2. Speed in dispersing funds: This is largely driven to the lack of automation from traditional banks.

In this article we will look at the newcomers around the world who are revolutionising the SME lending space by addressing the first issue. These firms are essentially getting creative in how they utilise alternative data to assess the creditworthiness of SMEs, while simultaneously using the latest technology. We explore three providers that will inspire any player in the SME lending space.

Using qualitative data points to assess creditworthiness: Capital Float

Capital Float is an Indian-based company, originally targeting merchants in the eCommerce industry. Its three main areas are Term Finance, Loan Against Swipe and School Lending. Although businesses need to be in operation for at least three years to quality for Term Finance (one year for Loan Against Swipe), they are taking an interesting approach to their credit scoring. The platform accesses applicants' suitability based on 2,000 data points.

The data behind this comes from an array of sources including: online data such as customer feedback and transaction history from online marketplaces. Capital Float partners with the largest wallet players in India, including Paytm and Payworld to track the payment history for micro-companies through to larger merchants.

Capital Float only operates in India, truly focusing on the immense opportunity and uniqueness of the Indian market. However, their approach could certainly be exported to other markets.

The second core factor, and what makes Capital Float a winner is their psychometric assessment, which asks applicants questions which gauge to what extent founders have the ability to scale a business, attitude towards credit and how they compare to competitors. Using qualitative, soft data points is a unique, yet powerful way to understand creditworthiness. Capital Float only operates in India, truly focusing on the immense opportunity and uniqueness of the Indian market. However, their approach could certainly be exported to other markets.

Deep Machine Learning and a pioneer in Open Banking: iwoca

iwoca, perhaps the most well known of the lending fintechs in the UK, offers business loans between £1,000 - £200,000 for cash flow, stock or investments. As of November 2019, the firm had lent over £1billion. iwoca maintains two core factors which set it apart.

The first, its use of deep machine learning models to automatically assess businesses based on data taken directly from online marketplaces, accounting platforms, bank accounts and other online and offline platforms. Specifically for online e-commerce merchants, iwoca explores the quality of customer feedback, and how successful they are at attracting business through social media.

The second, which will prove pivotal in keeping the momentum of innovation in SME lending, is utilising Open Banking. In 2018, iwoca became the first UK lender to provide finance using Open Banking. It did this by allowing potential customers to securely link their Lloyds Bank account in order to submit up to five years of transaction history in a few clicks. As a result, applicants could submit a loan application in less than 60 seconds. For loans less than GBP £15,000, a decision can be made in seconds, with larger loans typically decided within 24 hours.

As a result of iwoca's innovative use of Open Banking, applicants can submit a loan application in less than 60 seconds, with a decision made in seconds.

The forward thinker: OakNorth

OakNorth, the first UK challenger bank to reach unicorn status in its market valuation, is at the pinnacle of innovation in SME lending. In addition to directly servicing SMEs, they offer a white label platform to banks to enhance their lending process. It enables banks to cater to the lower mid-market segment, by supplementing the traditional method of relying on backward-looking historical data sources from the borrower, and scenario analysis with technology, and large data sets to model a forward-looking view that’s informed by industry benchmarks, macroeconomic drivers, and scenario analysis specific to each business unit.

Speed and breath of data points are at the heart of a revolution in the world of SME lending.

OakNorth takes a highly personalised approach to its own SME lending solutions. It does not offer off-the-shelf solutions, taking its time to fully understand an SME’s business, instead of fixing it on collateral.

While this is in theory the opposite approach to the majority of new players such as iwoca and Capital Float, it differs from the traditional banks in the high level of personalisation. At the heart of its lending agreements sit credit committees which are attended by both OakNorth and the business.

The future will be ruled by integrations and capitalising on the growing amount of digital data created every day.

Speed and breath of data points are at the heart of a revolution in the world of SME lending. Successful new players use creative means, and unique alternative data points to fill the gap in lending. By using new types of data in scoring such as customer reviews, industry benchmarks, marketplace data, and psychometric data, these firms can bet on the future when making a lending decision, rather than hinder SMEs based on their past.

But how are these data points extracted? If there are no means to quickly and accurately submit the quantitative data, then the developments in credit scoring are irrelevant to an SME. This is where integrations, and the capabilities provided from open banking will really enhance the lending experience for SMEs.

Furthermore, as we as individuals and businesses generate an exponential amount of data each day, the sources and types of data to judge the creditworthiness of a business will grow, perhaps soon making the traditional scoring mechanism used by banks in the past a thing of the past.

Meaghan has spent almost 7 years looking at everything and anything related to CX in digital FS. She uncovers and demonstrates best practice experiences for banks, fintechs and company builders, supports in-product and digital experience development and provides strategic research in the data and blockchain spaces. Based in Berlin, she has worked with dozens of brands in FS across the globe.

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