Reaching the missing middle - technology is closing the SME credit gap

Constanze Lehmann, Business Development - Financial Inclusion, Mambu
Missing Middle – Technology is closing the SME credit gap

SMEs are considered the missing middle, struggling to securing funding as they are too big for MFIs and too small and risky for banks.  But technology is changing this.

In 2006, when Rishi Khosla and Joel Perlman were trying to get funding to grow their business, a financial research outsourcing business, they found that banks were unwilling to help because they had no property to act as a collateral. Over time, they came across many more entrepreneurs in the UK, who faced the same challenge. “Many smaller companies emerging in the digital age lack sufficient property portfolios to obtain a loan,” Khosla says.

To address the structure void, Khosla and Perlman created OakNorth Bank. It is a bank by entrepreneurs for entrepreneurs that lends to fast-growing SMEs via a fintech platform and fully cloud based operations. Of course, it’s not only UK SMEs that lack access to funding and are hampered from growing their business. In developing countries, the situation is more acute: despite being the backbone of most economies, about half of the estimated 400 million SME’s in these economies have unmet credit needs totaling about 2.6 trillion USD.

But why is that so? 

SMEs are widely referred to as the ‘missing middle’. With long-term financing needs of up to 2 million USD, they are too big for microfinance institutions and too small and risky for banks: MFIs find themselves often ill-adapted to serve larger clients that require more complex products and credit assessment. Banks, on the other hand, consider SMEs to be risky and costly clients to acquire, underwrite and serve. SMEs often do not have the necessary systems in place to provide transparent information to investors or lenders. And they also cannot supply the high collateral requirements that banks require for higher operational risk.

Rise of Digital SME Lending

However, this state of affairs is now changing with the digitisation in SME finance. On the supply side, lower costs and the rising use of smartphones are helping SMEs produce transactions and accounting information more efficiently. On the demand side, that new data plugs into better analytic and processing capabilities in financial institutions. This drives the spread of new data-driven intelligence and lowers transaction costs to acquire SMEs, and to serve them. The greater digital footprint of SMEs has led to a proliferation of technology-focused SME lenders, like OakNorth Bank, that focus on new data and analytics to decrease costs associated with loan origination and collection. At the same time, new partnerships between banks and fintechs are starting to emerge. They allow banks a fast and convenient way to innovate their product offerings and better serve their SME customers, and fintechs to gain access to the banks’ large customer base and existing infrastructure.

Massive Market Opportunity

Digitising SMEs’ finances holds massive potential, both for SMEs and SME lenders. It proves that SMEs are a profitable business opportunity. OakNorth Bank was able to break even after just 11 months and within two years of operations has grown its loan book to over 800 million GBP. Recently, they have reached the unicorn status, being valued at over 1 billion USD, faster than any other fintech in the European banking history.

04 SMEs are considered the missing middle, struggling to securing funding as they are too big for MFIs and too small and risky for banks. But technology is changing this.

About the Author

Constanze Lehmann is Mambu’s financial inclusion specialist. She develops relationships with strategic partners and raises awareness of industry trends in digital finance. Before joining Mambu, Constanze gained experience in various development institutions, including GIZ, CGAP and Frankfurt School.