The increasingly important role of technology in the financial sector, together with a new regulatory framework, has forced large institutions around the world to ‘clean house’ and identify new strategies in terms of functionality and client base. But they have also created an environment wherein small and medium sized companies fall through the gaps.
One legacy of the financial crisis is the blockage in liquidity for SMEs, together with obstructive and inefficient processes that prevent access to the working capital they need to thrive. Although this situation imposes a risk for true economic recovery, there is hope in an alternative: fintech companies are now stepping in to enable small start-ups to achieve extraordinary things.
No risk, no gain
“Regulations like Basel III have had an unintended consequence of making it harder for banks to lend to these SMEs, as they look to rebuild capital bases and de-risk lending portfolios”, said Mark Thomas, Director of Client Operations at C2FO, the world’s largest working capital marketplace. “As a result, lending to SMEs is still far lower than pre-financial crash levels in Europe.”
Large companies have also implemented a substantial increase in their cash reserves since 2008, but they are still struggling to generate returns on them in an environment of low or negative interest rates.
“Ultimately, more of this liquidity needs to flow to SMEs to kick-start the economy again”, said Thomas. “Online lending, and in particular P2P lending, often dominates discussions about the changes and disruption associated with fintech. There have certainly been important developments in this area, which have benefited both lenders and investors, but, in reality, the amount of liquidity provided to consumers or businesses via P2P to date is still small and remains dwarfed by traditional lending models.”
There is around $40trn in outstanding invoices at any point in time globally
Invoice discounting is another area that is undergoing a renovation. This form of alternative finance enables suppliers to offer buyers a discount in exchange for early payment of their outstanding invoices. As such, it provides a chance for suppliers to access liquidity that can support their growth and expansion.
“To put this in context, there is [around] $40trn in outstanding invoices at any point in time globally”, said Thomas. “Even if a small amount of this can be made liquid through invoice early payment models, then the benefits to the whole supply chain can be measured in hundreds of billions, or even trillions, of additional global GDP.”
New model
Traditionally, the practice of invoice discounting was carried out manually by large businesses: procurement teams negotiated with suppliers individually, and then sold their invoices to a third party in a process known as factoring. Technology, however, has transformed factoring through digital platforms that enable suppliers and buyers to negotiate early payments en masse.
“The most effective [and] dynamic discounting model uses a real-time marketplace to discover the unique price for early payment that is profitable for both buyers and their suppliers”, said Thomas. “This gives SMEs control over their cash flow and corporates have an opportunity to create a healthier supply chain, while also improving their bottom line.”
Accelerating payments is vital for facilitating the flow of liquidity to suppliers, which can use cheaper rates to invest in their development. “As the invoices are already approved for payment, this is risk-free to the large corporates, and the return they receive on their cash from the discounts is far higher than other options”, Thomas told World Finance. “Technology platforms like C2FO make these early payments straightforward for all parties by automating the process and connecting buyers to their whole supply base, which might be tens of thousands of suppliers, in a single marketplace.”
The financial sector still has a long way to go to iron out all the creases that resulted from the financial crisis, with more likely to appear in the coming years as the true picture continues to emerge. During this interim period in banking, small fintech companies are becoming increasingly competitive, using the edge they have in terms of technology to provide much-needed and workable solutions (such as alternative financing models) to help corporate clients.
With more flexibility and possibilities, companies have a far greater chance of expanding their operations. The outcome in broader terms is a flourish of economic activity that can provide a real impetus to the economies of individual states, as well as the entire global system. Meanwhile, larger traditional financial institutions are now faced with new competition from a rapidly evolving market, meaning they will have no choice but to adopt the mechanisms offered by fintech firms, or else risk being left outdated, outmoded and unwanted.
