Fintech and artificial intelligence can be employed to address the funding gap left by banks in providing capital to SMEs. We speak with Fasanara about how this can be done at a scale that is attractive to institutional investors.
With the ‘Magnificent Seven’ dominating stock markets in recent times, it is easy to forget it is actually small and medium-sized enterprises (SMEs) that form the backbone of any economy.
Not only will much of future economic growth come from SMEs, but they also represent about 90 per cent of all businesses today and provide employment to more than 50 per cent of the working population.
This is not just true for developed economies; formal SMEs also contribute up to 40 per cent of gross domestic product (GDP) in emerging economies, with this number likely to be much higher when informal SMEs are included, according to the World Bank.
Yet, access to finance is a serious constraint on SME growth. SMEs are less likely to get bank loans than large companies and often have to rely on internal funds or cash from family to run their businesses.
Access to finance is the second most cited obstacle facing SMEs in growing their businesses in emerging markets, the World Bank says, but it isn’t just developing countries that face this problem.
In many developed nations, banks are gradually stepping away from the SME market and they are leaving behind a funding gap into the trillions of dollars. Just in Europe, there is a US$1.5 trillion funding gap.
Stringent regulations around capital requirements have made it unattractive for banks to lend to small businesses as these loans are considered risky and, therefore, require a relatively high level of capital to be held against the loan.
But banks are also hamstrung in their ability to lend efficiently to SMEs because of their technology platforms, which have been cobbled together over the years as banks have expanded and acquired rivals. This patchwork of technology systems and lack of standardisation prevents them from further automating and digitising lending processes.
Yet, these platforms are hard to replace with more modern ones, Francesco Filia, Founder and Chief Executive Officer of Fasanara, says.
For banks, it’s incredibly difficult to perform IT upgrades because they are living in very entrenched legacy infrastructure. It is almost impossible
“For banks, it’s incredibly difficult to perform IT upgrades because they are living in very entrenched legacy infrastructure. It is almost impossible,” Filia posits in an interview with [i3] Insights.
“There are very glamorous examples of big banks, I don’t want to name names, where they spent US$300 million plus on the IT upgrade and failed.
“Besides, banks have been so profitable in recent years that they don’t feel the need to radically change their infrastructure and potentially jeopardise their profitability.”
This leaves a gap to be filled by non-banks for the provision of capital to SMEs. Improving SMEs’ access to finance in emerging markets is a key area of work for the World Bank, but innovative financial technologies can form part of the solution too, especially in more developed markets.
Fasanara is a key player in fintech lending and has invested heavily to build a decentralised global funding platform that now originates across 60 countries and has been able to generate millions of loans to tens of thousands of SMEs.
Through a fund structure, it then gives institutional investors access to a stable, diversified income stream. Insurance companies, in particular, are attracted by the robust nature of this income, Filia says.
“We’ve been trading for 10 years and so they can see that it is a very stable income stream with very transparent infrastructure,” he says.
“Loans typically have a duration of 30 to 90 days, so if there are problems, they arise fast and can be addressed, which has resulted in uncorrelated income generation, no matter where interest rates are, no matter where default rates are and no matter if there is a recession.
“It is also uncorrelated to traditional asset classes. This is especially important at a time in which traditional asset classes, such as bonds and equities, have a strong beta correlation to one another.”
Invoice Factoring Through E-commerce Platforms
Providing capital to SMEs can take many forms, but a key activity for Fasanara is invoice factoring.
E-commerce platforms often take 60 to 90 days before they transfer money to a seller after a transaction, which causes cash-flow issues for businesses with limited working capital. Fasanara offers a solution by paying out the SME much quicker, often within 48 hours, in exchange for a percentage of the amount e-commerce platforms owe them.
Considering e-commerce platforms is the counterparties in this transaction, the risk of default remains relatively low.
“These [SME] companies cannot go to the bank because they don’t have the requisite financial records for a loan, especially if they are only just starting and they’re not big enough. However, within the e-commerce channels, they can grow to become unicorns over time if they do a good job. So it’s a massive market,” Filia says.
“They come to us through our platforms – for example, one of our platforms in Florida, US, is called SellersFi – and they effectively sell us their invoices after they’ve sold goods on e-commerce platforms.
“We buy it at a little discount, but the little discount equates to a nice deal for our investors, and at the same time we provide working capital financing to those SMEs so that they can produce new goods that they can then sell on e-commerce platforms.
These [SME] companies cannot go to the bank because they don't have the requisite financial records for a loan, especially if they are only just starting and they're not big enough. However, within the e-commerce channels, they can grow to become unicorns over time if they do a good job. So it's a massive market
“From a credit perspective, it’s a great trade for the investors because they take a limited credit risk at a good yield. On the other hand, for the SMEs, it’s a huge deal because they can finance their stock and keep on growing.”
SellersFi is just one example of such a platform. Fasanara has agreements with over 140 originators globally and not just for invoice factoring, but also for the provision of payment solutions and business insurance.
“There are many use cases, including in sectors such as manufacturing, technology, e-commerce, transportation and real estate, but it’s all about the new economy. If you take all of these activities together, it’s really a new [form of] global bank,” Filia says.
Artificial Intelligence and Fraud
Fasanara has been running these fintech platforms for more than 10 years and has cumulatively traded over US$70 billion in loans across tens of thousands of businesses.
All of these transactions have generated a wealth of data that the company can learn from, including how best to design a loan structure, but also where transactions can go wrong. In the past, the company has relied on analysts to sift through this data, but more recently it has incorporated large language models (LLMs) to help with the task at hand.
“LLMs of all sorts can be utilised. For example, we use fraud detection techniques, where you can learn the patterns of behaviours in the data and where you can suspect that there is a certain pattern that doesn’t add up,” Filia says.
“It is an early warning signal, an indicator of potential fraud, although not a certainty.”
But you can also use these models to get a better sense of the probability of default. LLMs provide the ability to look through the universe of loans and see patterns of which loans are the most likely to perform compared to the most likely loans to default.
LLMs of all sorts can be utilised. For example, we use fraud detection techniques, where you can learn the patterns of behaviours in the data and where you can suspect that there is a certain pattern that doesn't add up
This also has implications for the yield on the loans, Filia says.
“For the same probability of default, perhaps you can get a better yield,” he says.
Fasanara’s activities are currently captured in a single fund structure, which is predominantly accessed by institutional investors.
But the company is planning a new strategy, which pertains to women’s empowerment, participation in the workforce and financial inclusion.
“In an effort to have an impact, we are going to launch a strategy in the next quarter that is going to be focused on receivables to companies led by women. It’s going to be the first tech-enabled SME lending strategy globally dedicated to women,” Filia says.
This article is sponsored by Union Bancaire Privée (UBP). As such, the sponsor may suggest topics for consideration, but the Investment Innovation Institute [i3] will have final control over the content.
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.