Written by GIAN BOEDDUANA FIORELLA CARVAJALJENNIFER CHIENIVOR ISTUKLIGIA LOPESMARGARET MILLER on World Bank Website
Alternative lenders using fintech—such as crowdfunding platforms and marketplace lenders—have been an increasingly important source of financing for small and medium businesses. Differently from traditional lenders, these firms rely on technology that allows them to assess the creditworthiness of borrowers through alternative data. They also use electronic platforms to process requests, which makes their services more accessible and faster than those from traditional lenders.
Before the coronavirus (COVID-19) crisis, the alternative finance industry was growing rapidly. In 2018 alone, the sector expanded by nearly 50 percent excluding China, reaching just under $90 billion in finance. Yet the trend has been upended by the crisis. And this could bring long-term harm to financial sector competition, innovation, and access to finance for small businesses.
In the short term, distress for alternative lenders limits an important avenue for supporting businesses and jobs. Their advantages of speed, convenient service, flexibility, and focus on smaller customers can be leveraged to help distribute relief funds, provide small-business finance, and offer other digital business services, such as e-invoicing or cloud accounting. Taken together, these capabilities can be a lifeline for small businesses.
The good news is that, with targeted support, regulators and policy makers can preserve this important conduit for small-business finance while strengthening economic recovery.
- Their clients are weaker. Alternative lenders typically serve micro and small businesses, which have limited cash buffers. Any drop in their clients’ earnings quickly affects the repayment of loans, pressuring the quality of lenders’ portfolios. Reports show that a growing number of small businesses are now requesting payment holidays or restructurings. This is curbing new lending, increasing interest rates, and in some cases leading to cost-cutting, including furloughing of employees.
- Investors flee quickly. Heightened risk aversion has reduced investor appetite for lending to small businesses through alternative-lending platforms, leading to a reduction in lending volumes. Many investors are trying to sell their existing investments through bulletin boards offered by some platforms. However, sales are taking longer, and some platforms have even stopped such facilities in an effort to stabilize this run to the bottom.
- Access to new funding is limited. Unlike commercial banks, alternative lenders do not have access to retail deposits. As investors reduce their exposure to risk during the crisis, alternative lenders are facing constraints to obtain the necessary funds to continue lending to small businesses, or to offer restructuring of existing loans.
Support measures to be considered
- Grant access to existing liquidity facilities or other support programs. Governments could consider extending liquidity facilities to some alternative lenders; this can enable them to continue serving small businesses and facilitate debt restructuring. Clear eligibility criteria—based on prudential, market conduct and business model parameters, such as the funding structure and the type and size of clients—would ensure that the support aligns with policy objectives. They should also consider offering alternative lenders access to programs such as loan guarantee schemes, in terms and conditions that foster sound lending. We realize that these measures need to be carefully assessed given their monetary or fiscal impact.
- Allow alternative lenders to participate in relief programs and subsidized lending to help micro, small, and medium-sized enterprises weather the COVID-19 crisis. Governments could consider using regulated alternative lenders as partner institutions for distribution of relief funds to small businesses, leveraging their existing digital capacity and efficiency. Speed and efficiency of distribution, as well as increased competition with incumbent institutions that typically channel these funds, would bring direct benefits to small businesses while simultaneously increasing the transparency of government relief programs.
- Include alternative lenders in regulatory relief initiatives. Policy makers around the world are stepping up to provide banking systems with various types of regulatory relief, including flexibilizations in regulatory and supervisory requirements as they relate to small business lending. To the extent applicable, they should consider similar approaches for alternative lenders. It is important, however, that any of these measures avoid increasing financial risks.
A shrinking alternative lending sector could seriously undermine the ability of small enterprises to survive the crisis and recover. In addition, the loss of newer, innovative financial services providers could result in less competition, less dynamism, and less technology in the financial sector at a moment when more digital financial services are needed.
In the medium to long run, governments should provide alternative lenders with a clear, effective regulatory framework to support the design of innovative products via accelerators, innovation hubs, and regulatory sandboxes. This will foster access to finance for small businesses while ensuring that appropriate consumer protection rules are in place.
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