For financial institution (FIs), SME lending forms the core of their business. Despite this, the SME lending sector suffers owing to the untimely and complex credit-seeking process. For banks too, credit underwriting and identifying SMEs with reliable credit history is a time-consuming process, which in turn has led to a situation where the relationship between banks and SMEs have started dwindling. This huge gap in the market has given birth to a new breed of fintech firms who specialise in SME lending by providing a structure to their credit flows, enabling them to seek credit faster. Most popular of them are the digital-only banks or Neobanks.
Word ‘Neo’ is a fictional character from the Hollywood movie Matrix, released in 1999, and has made its entry into the otherwise mundane banking world globally, to revolutionise how consumers and SMEs bank! Let us evaluate why Neobanks could be phenomenal for the SME lending industry.
How Neobanks Are Helping Small Businesses?
Neobanking is a relatively newer concept in India as compared to the West, and is still on a take-off mode. However, market experts observe the gradual and steady adoption of Neobanks and credit their fast growth to its lender and SME-friendly characteristics.
Being a digital-only platform, Neobanks are fast, efficient, straightforward, adaptable and highly cost-effective. In India, Neobanks are evolving to suit the needs of the local economic environment. They are characterised by millions of SMEs with the low capability to efficiently manage their cash flows, credit, necessary compliances and business documentation – all of which are required for them to access capital and maintain financial health to aid in their growth.
Different Neobanks have a different focus – some help with managing online bank accounts, and with budgeting and saving tools. Some specialise in accounting to help automate finance; some are assisting with the credit-underwriting process (which is the biggest choke point between banks and SMEs seeking credit); while a few provide all under one roof. In the lending process, they do precisely what they are meant to do, which is to connect customers to its most suitable lenders.
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Neobanks address multiple related needs of customers like centralising their cash flow, enable various banking activities and offer tailor-made products at a single instance, which also helps SMEs in creating a digitised credit history. These are some of the key differentiators, which give Neobanks an edge to service SMEs in a much efficient manner over traditional banks.
Why does SMEs Feel Banks Fail To Understand Their Requirements?
Macro-economic developments are leading to large-scale consolidations among banks. While SME lending has been on the priority list of banks, ground-level challenges including the chaos due to the sheer number of SMEs, the volume of transactions and lack of data and documentation have prevented banks from growing their SME lending business significantly.
Many banks feel that small businesses seeking credit, lack creditworthiness as most of them have secured loans from informal sources, lack collaterals for a mortgage, do not possess proper accounting and documentation – that support credit-seeking process. SMEs, on the other hand, find banks’ credit processes as lengthy, cumbersome, often a “black box”, unrealistic due to demand for collaterals.
This interplay creates a classic demand & supply side mismatch leading to low bank credit off-take, reliance on informal loans and very often trigger a vicious cycle. and this is the gap that digital banks are trying to plug through technology.
Why Should Traditional And Neobanks Become Allies?
Riding on technology, Neobanks are changing the game altogether by their ability to process significantly larger volumes at a higher speed, while addressing the challenges of weak data and underwriting through technology and data science.
India, especially, is a cost-sensitive market where Neobanks fit very well with their least-cost models and ability to serve a much larger customer base efficiently. Also, technology is increasingly playing a significant role to understand the requirements of borrowers and lenders, and pushing the right product to make sure square legs fit square holes.
Banks, who are primarily driven by traditional processes and are at the cusp of transformation are partnering with Neobanks to serve their customers better. Neobanks specializing in SME lending, centre their whole business around creating the perfect match and harmony between borrowers and lenders through their technology firepower.
Will Neobanks Take Over Traditional Banks?
Neobanks and traditional banks bring different capabilities on the table and the two complement each other. Banks have large balance sheets and access to public deposits, which act as an efficient lending currency. Neobanks bring technology and data science – which create a viable and highly scalable model to serve a large customer base, which otherwise is not possible.
So, at this point, we see the two complementing each other. However, it may be possible that few Neobanks will turn into full-fledged banks or limited banks after they achieve scale. Whichever direction the industry pivots – it is inevitable that Neobanks are here to stay and scale – as they are solving some real and substantial problems.
[This post is co-authored by Lucas Bianchi and Gaurav Anand, co-founders of Namaste Credit, an online credit assessment platform for MSMEs.]