Why open finance is key to ensuring all businesses have access to fair and affordable financial products.
Any small business owner will tell you that trying to grow a company from the ground up is no mean feat. And with every hurdle an SMB has to overcome – securing stock or services, growing their customer base, and mastering the art of marketing – one of the biggest challenges they have to face is managing their finances, with up to 80% of new businesses failing within the first year.
When setting up a business, a large proportion of managing finances is having the capital available to get started and fund growth. However, according to a recent study, over half of SMB lending demand remains unmet. As a result, six in ten of those who would like to borrow resort to using personal funds.
In the UK, credit score giant Experian refers to SMBs that are unable to access financial services as ‘invisibles’. In 2020, they estimated the invisible population to be around 3.5 million, but believe this could be reduced to just 1.6 million by utilising new data sources.
What is financial inclusion?
Financial inclusion is the idea that everyone should have access to fair and affordable financial products and services, regardless of their income or status. We are all familiar with the principle of improving financial inclusion for consumers but this is rarely extended to SMBs.
President Biden’s recent executive order which is aimed at increasing competition in financial services by encouraging the use of open banking will help to improve financial inclusion for consumers and is a promising step in the right direction. But, looking to the future, we should consider how these same principles can be better applied to SMBs. After all, in most OECD countries, small and medium sized businesses contribute more than 50% of GDP. So it’s not hard to imagine what a huge impact making financial products more readily available could be.
Open data is key
In a recent discussion paper, McKinsey identified open data as a key driver of increased access to financial services: “Data sharing enables customers to buy and use financial services to which they might not otherwise have access. For example, where limited data from traditional documentary sources may disqualify consumers from accessing loans, open financial data can help assess the creditworthiness of borrowers by sourcing rent, phone, and utility bills. Individuals and MSMEs with thin files or no formal records can gain access to formal credit, often for the first time.” By putting small businesses in control of their own data, they will be able to save, grow, safeguard against uncertainty, and ensure their futures.
Financial inclusion helps lenders too
The operational costs involved in manually reviewing data and processing applications often makes smaller loans simply unviable for large banks, something that the Biden administration ostensibly seeks to address as part of the recently announced $3.5 trillion spending package, which includes proposals to expand the SBA’s (Small Business Administration) remit into direct lending. However, it seems that by properly equipping existing credit providers with the tools they require to better meet the needs of small businesses, SBA involvement could be avoided altogether.
Streamlining the underwriting and decisioning process using data and technology makes smaller loans much more attractive to lenders by lowering costs, enabling them to remain profitable. Take for instance a four month old business set up to sell home improvement supplies online. While their business may be thriving, it’s unlikely that they would be able to secure funding via traditional methods due to their limited time trading. However, by accessing their accounting, banking, and commerce data, banks would be more confident in their ability to fund the business while sensibly managing risk and minimising costs.
Various studies have also found evidence that an increased share of lending to small and medium sized businesses, informed by real-time access to data, aids financial stability, mainly by reducing non-performing loans (NPLs) and the probability of default. This suggests that policy measures to increase financial inclusion for SMBs would have the added benefit of contributing to overall financial stability as well, and the benefits to lenders don’t stop there. With better access to high quality data, lenders can speed up decisioning processes, increase their addressable market, and loan volume, all while decreasing risk.
How Codat can help
Codat’s single API powers robust accounting, banking, and commerce integrations that allow seamless connections to leading financial platforms used by so many business owners. By utilising the wide range of real-time data sources Codat has to offer, financial service providers can address a real pain point for SMBs by ensuring greater financial inclusion without taking on additional risk.
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