Small Is Beautiful

Just as it has brought changes in other walks of life, the Covid-19 pandemic has sparked and accelerated trends that are dramatically changing the way small and midsize enterprises (SMEs) in Europe and North America finance their operations. “What was thought impossible for 20 years happened in 10 days,” says Nanda Kumar, CEO of SunTec, a global pricing and billing company.

While they provide the foundation of most national economies, SMEs have long relied on traditional loans obtained through antiquated application procedures. Most small businesses still look to banks and credit unions for financing; but their applications are regularly rejected, often on account of poor credit ratings. Proprietors often lack business checking accounts and instead must run operations out of their personal accounts. Bankers, meanwhile, have lacked reliable tools to predict winners and losers among smaller companies.

Many SMEs have had their activities severely curtailed during the crisis, especially by lockdowns. The most affected sectors, according to an OECD report last July, include “transport manufacturing, construction, wholesale and retail trade, air transport, accommodation and food services, real estate, professional services, and other personal services (e.g., hairdressing).”

Thanks in part to the pandemic response, these handicaps either are being addressed or no longer appear so daunting. Due to new government stimulus programs and a clutch of new technologies, banks are “doubling down on SMEs” and looking to “build out a value proposition,” says Matt Cox, corporate, commercial and SME banking leader in the US for consultant EY. “This has big implications for the longer term.”

Quick Action in Our Crisis

When the pandemic-generated economic crisis hit, most governments acted quickly. The fiscal response in G20 countries impacted 11.2% of GDP as of the end of June, according to estimates cited in the OECD report. Several countries boosted loan guarantees. Germany, for example, doubled the volume of publicly backed credit to €2.5 billion ($3 billion).

Many countries earmarked funding specifically for SMEs. The $2 trillion US stimulus package included a $367 billion fund for SMEs with fewer than 500 employees. In January, the US rolled out a second Paycheck Protection Program (PPP) designed primarily to help businesses, large and small, keep employees on their payrolls.

“Government support, especially in Germany, was really good for SMEs,” says Thomas Michael Hogg, consultant and the author of the recently released book Profitable Growth Strategy. “Angela Merkel understands that SMEs are the backbone of the economy.”

Governments are relying on banks to implement these initiatives. Often overwhelmed by the sheer volume of funds and requests, banks have established platforms to streamline and improve the approval process: sometimes alone, sometimes working with fintechs. Amid shuttered storefronts and restrictions on physical movement, everything is taking place online.

Some banks have also taken unilateral action, offering moratoriums on loan payments and other facilities with or without public guarantees, says Miriam Koreen, senior counselor on SMEs at the OECD’s Centre for Entrepreneurship, SMEs, Regions and Cities. In Ireland, banks offered payment holidays and emergency capital; the Italian Banking Association adopted a lenient debt repayment scheme; and leading banks in Canada offered six-month deferrals on loan payments.

Implementation has gone more smoothly in some countries than in others. In Germany, two prominent local commercial banks, Volksbank and Sparkasse, led the way, says Hogg. But in the US, there were several cases of SME loans going to bigger, higher-profile businesses than anticipated, including the Los Angeles Lakers professional basketball team. (The Lakers returned the money in the wake of bad press.)

“The first window [of loans] went fast, but it wasn’t clear that small businesses were getting their fair share,” says Mike Salfity, global head of Product Strategy and general manager for North American Community Markets at Finastra, a London-based fintech.

To address the problem, the second PPP gave a brief head start to 5,000 lenders that focus on minority-owned businesses. Big players, such as Bank of America, JPMorgan Chase, Cross River Bank and Wells Fargo, were leaders during the first round and are again involved in the second.

“Banks are there to give money to their customers, but what`s standing in the way? Credit risk,” says Kumar. “Archaic” lending systems based on “traditional information” cannot do the job, he argues, especially during a crisis. Instead, banks need to get in tune with up-to-date enterprise resource planning and risk mitigation. “Banks need more-reliable cashflow forecasting,” says EY’s Cox; and to their credit, “the banks have mobilized.” Accelerating pre-pandemic initiatives, they have “changed to deliver play-safe procedures, digital documents and e-signatures.”

A Bigger Role for Fintechs?

Some banks have developed new in-house capacities such as these, while others have partnered with fintechs. Finastra, which says it was already working with 4,500 financial institutions, has developed software to help smaller players deliver loans to SMEs during the crisis, says Salfity, including e-notary, e-signature and other online tools. “The challenge, especially for smaller institutions, was that they didn`t have the right software and workflow tools to handle the volumes they were seeing,” Cox notes. Thanks to these advances, “banks have been able to earmark money to SMEs,” he says, including working capital loans. To dig up more business with SMEs, banks are exploring the idea of offering additional services, such as accounting and treasury management.

One key trend that appears to have slowed during the Covid-19 crisis, however, is the diversification of financing options for SMEs, a November OECD report found. In recent years, SMEs had been gradually gaining access to new forms of funding including venture capital, online alternative finance, leasing and hire purchases and factoring. The 2020 numbers show a downturn in these areas despite the potential to reduce the debt burden of small firms.

“Governments should pay attention to this,” says Koreen. If government policy aims to avoid overindebtedness by SMEs, she argues, it should promote the use of other instruments.

Despite all the support measures, Koreen predicts a shakeout—“reallocation”—among SMEs. But most analysts believe they will continue to drive national economies.

“SMEs are and will remain the strength of the economy,” says Cox. “No doubt many will feel the pain, and many will close temporarily or forever. But I am impressed by the ability of companies to shift.” For some, this could mean a move to different geographic markets or to online sales. It could also include adaptations in their supply chains.

While it might seem counterintuitive, online travel companies might help fuel the recovery, says James Allum, James Allum is Vice President and Head of Europe of Payoneer, a global payments firm. Despite a decline in use after the pandemic hit, Airbnb and Booking.com, with their sundry SME partners, may be primed for a comeback. “They had a tough year,” Allum says, “but in the longer term, people may be more inclined to take private holidays and not get on a cruise ship.” Some SMEs, regardless of their sector, might want to expand beyond their borders, where they might make “three years’ progress in three months.”

Lenders will also have a role to play as SMEs implement these after-the-pandemic strategies. Their part could include a shift from liquidity to structural support, more digitalization, help with insolvency and boosting consumer demand by providing additional services, the OECD suggests—all the while remembering that one size does not fit all. “Keep in mind that diversification is important for SMEs,” says Koreen. “Not all are well-suited to bank lending or equity.”