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COVID-19: The Rise of Alternative Lending
The two keywords that we have heard repeatedly over the past few months when we speak to fellow business owners are - Covid-19 and cash flow.
Majority of businesses in Singapore have been badly affected by Covid-19, especially during the Circuit Breaker period when many businesses are not allowed to operate. Even though we are now at Phase 2 of reopening the economy, most Singaporeans are still wary and prefer not to go out unless necessary.
No one knows when the Covid-19 pandemic will end and how the Singapore economy is going to recover. With cash flow being one of the top concerns for many SMEs, with or without the pandemic, it is no doubt that the current situation has further aggravated and highlighted the importance of having adequate cash flow to last for the next 12 to 18 months, at least.
While profits and turnover are important to Small and medium-sized enterprises (SMEs), it is the cash flow that will make or break a company - Cash flow is the lifeblood of any company.
SMEs Seeking Business Loans To Solve Cash Flow Issue
Banks are definitely the most popular source of funding that SMEs will go to first because they are able to provide the cheapest form of financing in terms of lowest interest rate to eligible SME borrowers.
Over the past few months, we have assisted many SMEs in their business loan applications to banks and financial institutions for Government-assisted financing schemes such as the Temporary Bridging Loan Programme, where government risk-sharing has increased to 90% for loans application until 31st March 2021 and is open to all sectors, capped at a loan amount of S$5 million.
Unfortunately, while banks are the most popular option favoured by SMEs, it might not necessarily be the easiest means for financing.
We have also encountered many SMEs who are not able to apply for a business loan with the banks and financial institutions due to their lack of eligibility to meet the stringent lending criteria of banks and financial institutions.
Why SMEs’ Business Loan Applications Are Rejected By Banks
Banks and financial institutions tend to be more strict when it comes to approving business loans. Lending criteria also differs across banks and financial institutions, nonetheless there are a few key factors that these lenders look out for:
- Annual turnover of business
One of the key criteria that banks use to qualify an SME for a business loan is by looking at the annual turnover of the business. Needless to say, companies have to be earning money before banks will consider approving their business loans.
Banks generally prefer companies that have an annual turnover of S$300,000 and above. Hence, for companies that have annual turnover of less than S$300,000, their loan approval will be subject to case by case basis, or they can seek alternative funding options.
- Credit Bureau Score
As all banks require a Personal Guarantee for unsecured loans in Singapore, the company’s director(s)’ personal credit bureau score plays a vital role in getting the business loan approved.
Banks also look at the director(s)’ credit report to determine the loan quantum that the company can qualify for, as well as personal credit history to determine the capability of repaying the loan.
- Duration of company operations
Another key criteria that banks look at is the duration that the business has been operating for. The longer the company has been in operation, the more stable it is deemed to be.
Most banks usually use a two year benchmark to gauge the stability of a company’s business operations.
As such, new startups with less than two years of operations are often not within the risk appetite of banks, and more often than not, they have to seek financing from higher-risk appetite non-bank financial institutions and be prepared to pay higher interests.
Even for SMEs that are more than two years old, they still have to maintain good financial standing before banks will even consider their loan approval. Otherwise, they will have to seek alternative financing options to solve their cash flow issue too.
Alternative Lending: Peer-To-Peer Lending, Or Crowdfunding Platforms
Although banks and financial institutions still make up the bulk of SME business loans, the funding options available now have changed drastically over the years.
The rise of financial technology (FinTech) has accelerated the growth of Peer-to-Peer (P2P) lending, also known as Crowdfunding platforms, that involves borrowing money from the general public through an online platform. P2P lending platform pools together funds from investors, and connects lenders to borrowers.
P2P lending has been gaining popularity and traction among the SME community as they provide new methods for getting funds in a shorter processing time compared to banks and financial institutions. P2P lending platform also provides an interesting channel for individuals to invest, thus resulting in a win-win situation for lenders to earn relatively high interest rates for short-term loans, while SME borrowers are able to access financing easier at a quicker turnaround time instead of going through traditional channels.
However, do note that interest rates for P2P fundings are usually much higher than that of a traditional bank loan, which can start from 1% up to 5% or even higher per month.
The fast approval and funding process from P2P lending are the highlight of their business model, whereby funds are usually disbursed within days. SMEs can also utilise P2P funds to capitalise on short-term business opportunities, albeit at the mercy of investors pricing their loans at higher interest rates.
The Future Of Alternative Lending
SME financing remains a key issue, as cash flow for companies has been and always will be a challenge. While banks may still be the first go-to option for cheaper financing for many SMEs, there has been an increasing trend of SMEs seeking alternative fundings from P2P lenders, especially when they are looking for a shorter term loan or want a faster approval.
In times of uncertainties and in need of financing to ease cash flow, SMEs just want to know whether they qualify for a business loan instead of having to go through multiple layers of assessment without clear guidelines. The lack of transparency and cumbersome application process are usually the cause of frustration for many SME owners.
P2P lending platforms focus on speed, technology, and are even able to customize based on what SMEs need. Their lending criteria are less strict and they are also able to provide more flexible financing options and loan conditions for SMEs. Some of these P2P platforms also provide invoice financing avenues that SMEs can turn to.
Instead of seeing alternative lenders as competitors, banks like DBS and UOB have tied up with crowdfunding platforms to offer a wider range of financing options, where P2P funding and bank loans come together as complementary financial products.
Nevertheless, P2P lending platforms are not without their own issues. As mentioned, interest rates charged by P2P lenders are usually higher compared to banks, and this may not be a sustainable arrangement for SMEs in the long term. In addition, seeking financing options from P2P platforms may also give a negative signal as it indicates that the SME is unable to obtain cheaper forms of financing from banks due to the lack of certain criteria.
The need for financing for SMEs will always be present. SMEs need funds not just to ease cash flow, but also for various reasons such as a business expansion, to capitalise on investment opportunities, or to buy new machinery or equipment. Before seeking any business financing, SMEs have to do proper business planning and ensure that the money spent on is worth paying the interests for.
Stay tuned to understand more about how different P2P lenders in Singapore work as we feature them in our weekly P2P Lenders’ Profiles.