We look at some of the challenges and opportunities ahead.
Following years of expansion, Latin America’s GDP growth in 2014 fell to less than 1.5 percent amid the Chinese slowdown and falling commodity prices. The task falls to its SMEs, which make up more than 95 percent of its businesses and employ 67 percent of its workforce, to get the economy moving again. Unfortunately, a lack of access to adequate finance means that these vibrant engines of employment creation are struggling to reach their potential. With risk-averse banks shying away from the unknown quantity of micro-enterprises, an innovative approach is needed to reach the as-yet unreached businesses and meet their financing needs.
The Inter-American Development Bank (IDB) estimates that the financing gap for SMEs in Latin America stands at as much as $250 billion. To put that into perspective, that figure is roughly equivalent to the GDP of Chile. Barriers to access range from informality, such as the lack of audited financial statements or credit history, to the inability to access guarantees. Hurdles also vary across different economic sectors. The agricultural sector, in particular, is underserved thanks to the effect of volatile commodity prices on financial risk.
That’s not to say that banks don’t see potential in this market sector. A recent IDB survey showed that fully 90 percent of Latin American banks 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 percent during 2015. Indeed, there’s been a flurry of activity as financiers try to serve as many SMEs as they can: Banco Santander has a strategic Latin American SME planthat aims to grow its lending to the sector to $20 billion by 2016, up from $10 billion in 2013, while BBVA has launched “Camino al exito,” part of its new responsible business plan, which aims to double the volume of SME business by 2018. But even with the best will in the world, there are many SMEs that banks simply cannot reach. Indeed, less than 15 percent of lending in the region goes to smaller firms, according to the OECD’s Latin American Economic Outlook – something that needs to be addressed urgently.
“Within the last few years, we have identified that there is a need to help both small businesses and the financial institutions that we work with to innovate in order to close the SME financing gap in Latin America,” says Greg Da Re, chief of the Strategy and Innovation Division at the Inter-American Investment Corporation (IIC), which in September held the first Latin American and Caribbean Forum for Innovation in SME Finance (FINPYME), bringing together over 400 representatives from financial institutions, government, civil society, industry and academia in Medellin, Colombia to exchange ideas. He adds that while banks for the most part acknowledge that SMEs are a crucial part of their business, about 44 percent recognize that they don’t have the right financial products that can adequately serve them.
“SMEs are looking for alternatives,” says Vicente Fenoll, founder of Kubo Financiero. His Mexican start-up, set up two years ago, allows small businesses in the country to access private funding of up to $17,000 through an online platform. The platform puts firms in direct contact with funding sources that are prepared to invest in them, and by June 2015 it had already authorized over 2,000 transactions – demonstrating the level of pent-up demand that exists in the sector. As well as being a digital offering that enables even the most far-flung SMEs to access finance as long as they have an internet connection, it targets the lower end of the market, which has so far been relatively untouched by banks.
While cutting out banks entirely and creating new finance platforms is one solution, building partnerships that combine their hefty balance sheets with the agility of new technological players is also proving highly successful. “We are certainly seeing more interest in addressing the needs of this market from financial institutions,” says Eugene Danilikis, co-founder and chief executive at Mambu, a banking and microfinance technology provider set up in Germany in 2011. It recently created an entity for micro-enterprises and small businesses within Argentina’s Banco Macro, using its cloud banking platform. Named “Alumbra,” the initiative will be operated via the bank’s charitable arm, Fundacion Macro, and will offer loans ranging from $250 to $6,000 initially in Salta, one of Argentina’s poorest northern regions. It aims to reach more than 6,000 clients and disburse $3.5 million in loans by 2017.
“Financial inclusion is about the right mix of products delivered at an affordable cost and in a simple manner,” points out Danilikis. He adds that if fintechs can provide the technology to enable new entrants to come up with innovative ways to meet market needs, and to allow existing institutions to redesign their products and services, then SMEs will gain greater access to a broader range of financial products. “SMEs are the backbones of many economies and if they can grow through financing, expand their services, and hire more staff then SME financing can have a big impact on financial inclusion,” he adds.
Going forward, bringing together fintechs with traditional financiers will be key to bridging the SME finance gap. Be it geographic access issues, product offering problems or simply a matter of profitability versus scale, there’s probably an app for that. One example is the Entrepreneurial Finance Lab (EFL). This initiative, which sprang out of Harvard University’s Center for International Development, promotes the use of psychometric scoring as an alternative to traditional credit scoring where credit underwriting challenges exist. Already adopted by some Latin American banks, this has enabled high-growth SMEs with everything but a traditional credit file to access the finance they need to develop further.
Although up until now, “the LAC region has trailed the rest of the world when it comes to financial innovation,” according to Da Re, banks and fintechs alike are waking up to the vast opportunities – and challenges – Latin America’s SME financing segment presents. The overriding impression is one of complementarity, where fintechs can help banks reach the last mile of customers, and those customers in turn can then reach their potential.
In the photo: A worker pours cooking oil into a bottle for a waiting customer in a bodega in Old Havana, Cuba. (AP Photo/Ramon Espinosa)
Published in partnership with News Deeply