While finance institutions have traditionally been the first port of call for Latin American SMEs, fintechs are springing up to fill in the financing gaps. Should banks in the region be concerned? Eleanor Wragg reports.
After the region’s GDP growth rate slowed to less than 1.5% in 2014, Latin America’s SMEs, vibrant engines of potential growth and employment creation, became the focus of economic policy. But the performance of these companies, which account for over 95% of businesses and employ 67% of the region’s workforce, is drastically limited by their ability to find adequate finance.
According to a survey by the Inter-American Development Bank (IADB), 90% of banks in Latin America consider SMEs as “strategic to their business” (up from just two thirds in 2008), and half said their SME portfolios would grow by between 1% and 20% during 2015. However, the IADB estimates that the financing gap for SMEs in the region still stands at between US$210bn and US$250bn – a figure equivalent to the GDP of Chile. Factors standing in the way range from informality – such as the lack of audited financial statements or credit history – to the inability to access guarantees. Access is also uneven across different economic sectors. The agricultural sector, in particular, is underserved due to the effect of volatile commodity prices on financial risk. “Overall, micro and small companies across the board in the region are suffering because of the de-risking policy, wherein banks are being very selective on providing credit,” says Antonio Alves, principal and regional head for the Americas at the IFC. “This is due to capital allocation, risk management, Basel III and anti-money-laundering regulations. At the same time, that still provides an opportunity for non-financial institutions to use non-traditional financial solutions
to help these small and medium companies.”
“SMEs are looking for alternatives,” explains Vicente Fenoll, founder of Kubo Financiero, a Mexican start-up which allows small businesses in the country to access private funding of up to US$17,000 through an online platform which puts firms in direct contact with funding sources that are prepared to invest in them. Set up two years ago, it had already authorised over 2,000 transactions by June 2015 – demonstrating the level of pent-up demand that exists in the sector. As well as being a digital offering – enabling even the most far-flung SMEs to access finance – it targets the lower end of the market, which banks have generally shied away from for the simple reason of profitability. “It’s very common that SMEs here use diverse providers, from banks to microfinance organisations, but in the majority of cases, the paperwork is complex and slow,” adds Fenoll. “The new digital alternatives are becoming an option that is being used more and more.”
The growing opportunity presented by these digital alternatives was the focus of the first Latin American and Caribbean Forum for Innovation in SME Finance (FINPYME), held by the Inter-American Investment Corporation (IIC) in September. “We recognise that there is this real gap in financing,” says Greg Da Re, chief of the IIC Strategy and Innovation Division and organiser of the event. “The Latin America and Caribbean (LAC) region trails the rest of the world when it comes to financial innovation, and the goal of the FINPYME Forum was to bring global expertise from around the world to Latin America and show to financial institutions and technology companies that are operating in LAC what is going on and get some of them to take advantage of some of the incredible things we are seeing.” Over 400 representatives from financial institutions, government, civil society, industry and academia gathered in Medellin, Colombia to exchange ideas and set up alliances during the forum.
Among the innovations is DineroMail, an online payment service which acts as an intermediary between buyers and sellers, and which landed a US$5mn equity investment from the IFC earlier this year. Even Cemex, the Mexican cement giant, is getting in on the action. Its initiative, Construrama, provides small construction stores with capital for new storefronts, inventory-tracking software and computers, and shares best business practices to help them build stronger, more competitive and sustainable businesses.
For Adriana Peon, regional head of SMEs for PayPal in Latin America, this is an “unprecedented time in history”. She anticipates that the big data movement and the rise in new technology will see SME finance surge in the region. “We are seeing a lot of very innovative working capital loan companies and peer-to-peer lending structures, and access to financing is now easier.” PayPal already offers SME working capital solutions to the North American and European markets, and there is speculation that the online payments gateway will soon roll out something similar in Latin America. Right now, however, the focus is on building skills. “For me, the biggest gap is in education,” adds Peon, highlighting the fact that PayPal has developed a series of free tools to help SMEs get started with cross-border trade.
A common thread runs through the current wave of innovations in SME finance in Latin America, and that is that there needs to be a personal approach. What works for one SME client may not work for another, and in order not to limit the market they can reach, new providers are ensuring they cover all bases. “At Kubo, we focus on clients from various angles,” explains Fenoll. “We have created a somewhat more appropriate credit process, where we concern ourselves greatly with the language that is used, making sure that it generates confidence. It’s a model that is operational 24/7, which enables the entrepreneur to seek finance whenever they are available.” The model also provides a certain amount of flexibility to the client to design their own product: they decide the payment term, the frequency of payment and the amount.
As with the mobile money revolution of recent years, new digital entrants into the SME financing space often find themselves at an advantage to established bank players, simply because what they are offering is so new it hasn’t been legislated for yet. “Given that those alternative financiers are not under the same regulatory framework as the banks are, they definitely have a competitive advantage because they can provide faster and more efficient finance to the borrowers as they can be more agile and less strict,” says the IFC’s Alves.
Threat to the banking system
But banks aren’t simply sitting back and allowing the SME finance opportunity to pass them by. Indeed, more than 20 traditional financial institutions attended the FINPYME Forum, proving that there is interest in reaching the sector. “Banks should be worried,” adds Alves. “There are a lot of non-bank players that are studying this particular niche and some of them are already financing companies. I think in the very short-term future, they will be an alternative finance channel to banks. This is a potential threat to them in the
SME financing sector.” Initiatives are already underway to try and boost banks’ share of business: Banco Santander has a strategic Latin American SME plan which aims to double its lending to the sector to US$20bn by 2016, up from US$10bn in 2013. Meanwhile, BBVA has launched Camino al éxito (Path to success), part of its new responsible business plan, which again aims to double the volume of SME business by 2018. But these programmes fail to reach a significant proportion of Latin American SMEs, with less than 15% of lending in the region going to smaller firms, according to the OECD’s Latin American Economic Outlook.
Bringing together fintechs with traditional financiers is key to bridging this gap. Be it geographic access issues, product offering problems or simply a matter of profitability versus scale, there’s probably an app for that. Going back to the prevailing tone of cautiousness among banks when it comes to providing finance, the IIC’s Da Re points out that “one of the biggest reasons banks are saying that they are not lending to SMEs is because it’s difficult to get information about the risks”. Enter the Entrepreneurial Finance Lab (EFL). This initiative, which sprang out of Harvard University’s Centre for International Development, promotes the use of psychometric scoring as an alternative to traditional credit scoring where credit underwriting challenges exist. It announced a pact with financial services behemoth MasterCard at industry conference Sibos in 2013 and since then this strategic partnership has signed up banks, such as Banco BHD of the Dominican Republic, to use the EFL model to credit score MasterCard small and medium-sized businesses’ credit cards, in addition to its usual small business term loan business. This has enabled high-growth SMEs with everything but a traditional credit file to access the finance they need to develop further.
The idea of banks and technology firms working together is one that PayPal firmly espouses. “We need to think of ourselves as part of an ecosystem, and we need to build partnerships with the other players in the ecosystem,” says Peon. “People are starting to think of fintech as being against banks, so it’s an either/or proposition, but for us, it’s not either/or; it’s ‘and’. No one knows their client better than a bank who has been in a country for years, so we work with them to get a better understanding of the local market, and then we create the partnerships to operate in the best way possible for the SMEs in that country.”
There’s still work to be done in terms of getting Latin America’s SMEs comfortable with technology; the IIC’s Da Re points out that tech adoption has lagged as compared to other markets, and PayPal’s Peon bemoans the lack of mobile-optimised websites in the region. But as banks and fintechs alike wake up to the vast opportunities – and challenges – Latin America’s SME financing segment presents, the overriding impression is one of complementarity, where fintechs can work with banks to reach the
last mile of customers.