Alternative sources of finance should support SMEs

Small and medium-sized enterprises, SMEs, make up 99% of all European companies and are the backbone of the EU economy, as they account for the vast majority of growth in the labor market. Despite that, SMEs are still seriously underfunded, in fact by as much as around €400 billion in the EU alone according to a recent study.

The reason is that SMEs generally have difficulty getting loans, which prevents them and thus the European and global economy from growing.

The situation is further aggravated by the fact that there is a limit to how much an SME can borrow. It is often difficult for a smaller company to get a loan of more than half a million i.e. an amount that enables real and sustainable growth and makes a significant, long-term difference.

But the risk aversion of alternative finance has gone from being realistic to being overly cautious. Instead of stifling innovation, the pandemic fueled a startup and entrepreneurial boom in both Europe and the US. Demand for the type of loans needed to rapidly accelerate growth has only increased – and with it the gap between loans. This shows that there is a great need for alternative financing and that the time has come for smaller lenders to step in and fill the lending gap that the big banks have created.

AI and machine learning

But expecting to see real growth on both sides of the relationship between lender and customer – or the broad economic growth it stimulates – from too-small loans is unrealistic. In order to achieve real growth, the institutions have to offer larger loans.

Addressing this funding gap directly is a rare opportunity for alternative funding. Matching traditional lending with the innovation that the fintech sector is able to offer is the obvious solution.

But what kind of innovation is this sector spearheading? It could be things like using AI and machine learning in the right way. These are indispensable tools when it comes to evaluating loan applications and payment guarantees. The use of these technologies is becoming more and more common in the financial sector as a whole, but alternative financial institutions are poised to adopt them faster and more efficiently than traditional institutions, which are often hampered by both the size and complexity of their operations.

The advantage that alternative financing offers is twofold: the first factor is technological agility. Alternative finance institutions can adopt and adapt AI and machine learning processes more quickly in response to both their clients' and the wider market's needs. Large, traditional institutions often move significantly slower than those in alternative finance.

Human contact

The second factor is the human element. In other words, basic automation allows alternative lenders to spend more time on human interactions and high-value loans, so AI's main function will be to contribute to better and deeper personal relationships between lenders and borrowers.

Machine learning also looks deeper than a credit score, which is critical when working with small businesses that may have little or no payment history.

Although traditional financial institutions likely have more data to base their AI programs on, the amount of data is far from sufficient. Traditional institutions often lack the specific data relevant to SMEs. Problems have already arisen with large banks' AI lending platforms due to factors such as gender discrimination.

Pure data calculation also does not take into account unexpected changes in an industry. For example, the travel industry is currently booming, and it takes human understanding of these factors to know that travel-focused SMEs are not a bad investment if the data points to a temporary, minor downturn in the industry. In a world increasingly characterized by technology and digitalisation, human contact and personal, genuine relationships are more important than ever - not least between borrowers and lenders.

Alternative finance must embrace small businesses as valuable customers and act innovatively to grow, while avoiding the challenges that plague traditional financial institutions. This not only bridges the financing gap for SMEs, but also reduces the gap in loan amounts that hinders individual and collective growth. In short, it is the only way forward if alternative finance wants to secure its future as well as the future of the companies that drive the economy forward.