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Why the SME lending gap needs alt finance to embrace collateralized lending

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Despite making up 99 percent of European companies and the backbone of its economy, small- and medium-sized enterprises (SMEs) remain underfunded in the billions of euros. Recent research estimates the gap is about 400 billion euro in the E.U. alone. These businesses are overwhelmingly underbanked, and it’s keeping them from growing.

This situation is only made worse by a loan amount gap that’s plagued European SMEs for the last decade. It’s very difficult for these companies to attain loans between €50,000 and the low millions. These are amounts that facilitate real and sustained growth, not just incremental revenue boosts. They’re also the kind of loans that necessitate putting up collateral of some kind. There’s a reason collateralized lending dates back to antiquity. It’s the simplest and most straightforward method for lenders to protect themselves and ensure mutual investment between lender and client.

Alt finance has been somewhat slow to embrace collateralized lending. That’s not a criticism. In fact, it’s understandable considering the industry environment. The SMEs that alt finance has grown around have less collateral than established corporations. Alt finance lenders are by default smaller than major banking institutions, meaning they have less available pure capital to lend. 

Alt finance’s risk aversion on this front was once realistic, but now it’s overcautious. Instead of stifling innovation, the pandemic prompted something of a startup and entrepreneurial boom across Europe and the United States. The demand for the kind of loans needed to rapidly accelerate growth has only grown, and the lending gap with it. However it might first appear, this presents the right opportunity at the right time for alt finance at large. 

Embracing and innovating on collateralized lending together with our SME clients fosters mutual growth. This growth will reverberate well beyond individual lenders and businesses. You will not see real growth on either side of the lender-client relationship (or the larger economic growth it stimulates) if available loans max out at €50,000. The only realistic way forward is to lend bigger, and the best way to do that securely is through collateral. Addressing this funding gap head-on is a rare opportunity for alt finance. Matching old-school collateral lending with the meaningful innovation this sector is capable of is the obvious solution.

What does meaningful innovation look like? Using AI and machine learning the right way, for starters. These are indispensable tools in terms of evaluating lending applications and suggested collateral. The use of both is becoming increasingly widespread in financial services on the whole, but alt finance institutions are primed to adopt it faster and more efficiently than legacy institutions encumbered by the size and complexity of their operations. .

The advantage alt finance has on this front is two-fold.. The first is technical agility. Alt finance institutions can adopt and adapt AI and machine learning processes faster in reaction to their customers’ needs and the larger market. Large, legacy institutions move slowly by default – not so with alt finance. The second is its human element. In other words, base-level automation allows alt finance lenders to devote more time to high-value interactions and loans. Machine learning also looks deeper than a credit score, which is important when working with small businesses owners who may or may not have substantial credit.

While traditional financial institutions may have seemingly more data with which to train AI programs, sheer volume of data isn’t everything. Traditional institutions often lack the specific data relevant to SMEs and this range of lending. Problems have already arisen around major banks’ AI lending platforms mimicking racial and gender bias gleaned from their data. And pure data calculations often don’t account for a surprising left turn within an industry. Take aviation and travel, for example, which is booming in the ongoing “revenge travel” era. It takes human understanding of those factors to know that a travel-centric SME isn’t a bad investment because of data pointing to a semi-recent slump in the industry.

Alt finance has to embrace and innovate on collateralized lending products in order to grow and sidestep the challenges plaguing traditional finance institutions. This can bridge the larger SME funding gap within Europe. It can also close the loan amount gap holding back individual and collective growth. It’s the only way forward if alt finance wants to shore up its future, and the futures of businesses driving European economies forward.

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This content is provided by an external author without editing by Finextra. It expresses the views and opinions of the author.

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