Why Europe Must End Its 30-Year Digital Winter to Ensure Its Long-Run Future

Alternative Data Revolutionized Small Business Lending in 2023

small businesses, capital, loans, digital banks

A lot can change in a year, particularly for the small- to medium-sized business (SMB) segment.

And while change can be a constant, constant change is not always a good thing — particularly when liquidity is tight, customer spending is low, and SMBs looking for credit or working capital solutions struggle to find access to financing products that can ease their cash flow shortage.

Business bankruptcy rates jumped 30% between September 2022 and September 2023, as macro factors like record high interest rates and the end of pandemic relief increasingly battered small businesses’ prospects.

The year 2023 wasn’t easy for the Main Street businesses that make up the heart and soul of today’s modern economy, nor was it an easy one for the banking sector that supports them.

However, the way financial institutions and providers underwrite and approve their loan products and other financing vehicles also changed this year.

Loan products, and their approval rates, look very different today than they did a few years back — and that difference boils down to the use of insights gleaned from alternative data generated by the broader digitization of the SMB operating landscape.

It was a big year for expanding access to alternative financing solutions, and 2024 is poised to be an exciting one as businesses increasingly tap those sources to grow.

Read also: Young SMBs Can’t Find Enough Business Financing

Why Data-Driven Decisioning Is Good News for SMBs

The need for capital continues to be strong for SMB. October saw the release of new data showing that almost 1,500 small businesses filed for bankruptcy under Subchapter V in the first nine months of 2023, nearly as many filings during the entirety of last year.

In light of ongoing macro challenges and operational squeezes, many SMBs are increasingly looking to tap emergent financing solutions that help them better operate in today’s fast-evolving digital landscape.

“It’s not simple for small businesses to get a loan, even if it’s a small loan,” Galileo Financial Technologies Chief Product Officer David Feuer told PYMNTS in an interview posted in October. “Banks are becoming increasingly sophisticated in their use of data and their use of [artificial intelligence] to make intelligent decisions about who to make their offers to.”

Still, PYMNTS Intelligence found that 53% of SMBs have “no current access to credit.” The percentage is even more starkly seen among the smallest companies surveyed, with $150,000 or less in annual revenue.

When PYMNTS CEO Karen Webster spoke with Matt Baker, head of small business at Visa, earlier this year about the need for small business lenders to look past their standard considerations for loans, Baker explained that the traditional processes by which small businesses apply for credit, and the metrics by which FIs gauge risk and make decisions are both time-consuming and less than efficient.

“What small business owners want is a fast ‘yes’ or a fast ‘no,’” he said. “What they hate is a slow ‘maybe’ and then a ‘no.’”

A lack of financing sources, or clarity around future access to capital, limits companies’ ability to undertake expansion plans and sometimes makes it difficult to carry out their daily activities.

It is a worrisome double-edged sword: The worse the economic situation, the more the SMBs need help easing their cash flow shortages, but the less likely risk-averse banks and lenders are to help them. Compounding matters, many SMBs have shied away from using innovative digital lending options due to a lack of education about their availability and benefits.

As advanced AI and data analytics become the norm, drawing upon this new source of contextual information will enable platforms to offer increasingly personalized financial products, services and recommendations to their business customers.

See also: Leveraging Data to Close the Small Businesses Targeting Gap

The Positive Feedback Loop of Leveraging Data

“Where lenders differentiate is how they underwrite the loans…,” Michelle Boros, product lead at Plaid, told PYMNTS in an interview posted in December. “And that flows not just into whether or not a borrower gets a loan, but also what type of offer they get, what pricing they receive, and what the term of the loan is.”

Using the right data can improve the underwriting process, and having broader, better data about SMBs beyond the traditional underwriting frameworks can help improve those businesses’ access to financing solutions.

“In the payments industry, we’ve had a very data-rich environment, but we’ve operated in an insight-poor environment,” Enigma Technologies CEO Hicham Oudghiri told PYMNTS in an interview posted in November.

Granular insight into a business’s financial profile, including through their credit and debit card revenues and other card processor-led information, can help lenders tailor products to individual business needs, rather than forcing SMBs to queue up for one-size-fits-all credit approval processes.

These insights from operational and payments data go both ways, particularly for SMBs looking to provide their own customers with embedded financing solutions, like buy now, pay later options.

“If you think about an eCommerce marketplace interested in providing credit or loans to their customers, they already have visibility of all the payment flows, which is essential to embedding a robust risk management framework to make that product viable,” Luke Latham, general manager of Australia and New Zealand at Airwallex, told PYMNTS in an interview published this month.

When it comes to the health of the Main Street economy, the collection of additional data points from a variety of data sources beyond the information that’s been traditionally gathered by financial institutions couldn’t be more crucial to success.