Access to finance is a critical component of any company’s operating model, and funding strategies should always be as simple and transparent as possible.
However, the latest data from the Bank of Lithuania show that business funding from traditional sources (i.e. banks or credit unions) is weakening. In April 2020, for example, the loan portfolio of MFIs to non-financial corporations was 2.7% smaller than in the same month of last year.
The flow of new loans is also declining rapidly. In the first four months of 2020, the total amount of new loans made to non-financial corporations was only half the size of the equivalent figure for 2019.
At present, SMEs are seeing the biggest drop-off in traditional sources of funding. This is mainly due to an increased reluctance to lend on the part of banks. A recent survey of non-financial corporations, undertaken by the Bank of Lithuania, revealed that 61% of small business applications for new credit (or changes to existing credit terms) were rejected. For large corporates, meanwhile, this figure was just 5%. In total, the share of rejected applications is the highest since the survey began in 2011.
These trends can be explained by a number of factors. The first of these relates to concentration in the Lithuanian banking market, which has increased significantly over the past decade. During this period, some operators went bankrupt, others merged and a few withdrew from the Baltic market (including Lithuania) altogether.
Most of their former customers switched to the biggest banks on the street. This migration allowed the top-tier lenders to become more selective, and only extend loans to established businesses with stronger credit profiles.
Secondly, lending to SMEs is inherently risky, since many smaller companies operate in volatile and cyclical sectors (e.g. construction, restaurants, hospitality). Defaults and non-performing loan ratios in these industries tend to be quite high. Accordingly, whenever banks tighten lending requirements, SMEs often get hit disproportionately hard.
A final contributing factor is that many smaller companies only have a very basic vision and business strategy. In the context of low levels of capital and transparency, and weak balance sheets, many lenders are put off by the lack of forward planning, and choose to steer clear of this market.
Interestingly, despite the overall drop-off in bank lending, companies are still taking on a lot more debt. In Q1 2020, the total liabilities of non-financial corporations increased by 4.9% year-on-year. This implies that firms must be borrowing from alternative financing sources. But in contrast to previous decades, where trade credits and other similar channels were most often used, Fintech companies now appear to be taking a growing share of the alternative financing market.
Indeed, lending to SMEs is becoming an increasingly important activity for the Fintech sector. There are several reasons for this. Notably, SMEs in Lithuania are not heavily indebted compared with other European countries. Their average debt ratio doesn’t exceed 60%, which is a pretty healthy level in the world of corporate finance. As a result, Fintech companies view this market as a source of untapped lending opportunity.
Moreover, the Fintech sector will have no choice but to take on additional credit risk if it is to steal market share from traditional lenders. This inevitably means orienting their operations towards SMEs.
Small businesses likewise have a natural interest in cooperating with Fintech companies, due to their flexibility and nimble decision-making processes. Hence, while traditional banks remain the dominant source of finance for SMEs, things are changing rapidly. It’s likely that Fintechs and other innovative lenders will continue to grab a bigger share of this market.
Cooperation between SMEs and Fintech companies also provides a positive feedback loop which will result in fiercer market competition and a broader array of financing solutions for smaller companies.