SME Finance is the funding of small and medium sized enterprises and represents a major function of the general business finance market – in which capital for firms of types is supplied, acquired, and costed/priced. Capital is supplied through the business finance market in the form of bank loans and overdrafts; leasing and hire-purchase arrangements; equity/corporate bond issues; venture capital or private equity; and asset-based finance such as factoring and invoice discounting.
However, it should be noted that not all business finance is external/commercially supplied through the market. Much finance is internally generated by businesses out of their own earnings and/or supplied informally as trade credit (i.e., delays in paying for purchases of goods and services).
The economic and social importance of the small and medium enterprise (SME) sector is well recognized in academic and policy literature. It is also recognized that these actors in the economy may be underserved, especially in terms of finance. This has led to significant debate on the best methods to serve this sector.
There have been numerous schemes and programmes in markedly different economic environments.
However, there are a number of distinctive recurring approaches to SME finance
• Collateral based lending offered by traditional banks and finance companies is usually made up of a combination of asset-based finance, contribution based finance, and factoring based finance, using reliable debtors or contracts.
• Information based lending usually incorporates financial statement lending, credit scoring, and relationship lending.
• Viability based financing is especially associated with venture capital.
The effective management of lending to SMEs can contribute significantly to the overall growth and profitability of banks.
There has been considerable research and analysis into the methods by which banks assess and monitor business loans, manage business financing risks, and price their products – and how these methods might be further developed and improved.
There has been particularly intensive scrutiny of the kinds of business financial information that banks use in making lending decisions and how reliable that information actually is.
Banks have traditionally relied on a combination of documentary sources of information, interviews and visits, and the personal knowledge and expertise of managers in assessing and monitoring business loans. However, when assessing comparatively small and straightforward business credit applications banks may largely rely on standardized credit scoring techniques (quantifying such things as the characteristics, assets, and cash flows of businesses/owners). Using such techniques – and also centralizing or regionalizing business-banking operations generally – can significantly reduce processing costs. Standardized computer-based assessment may also be more accurate and fairer than reliance on the personal judgments of local bank managers. As a result, banks may now be able to offer more loans, faster and in larger amounts, and reduce previously high security requirements.
However, business lending as a whole is substantially more diverse and complex than (say) personal and residential mortgage lending. This coupled with the large size and inherently risky nature of many business loans tends to limit the scope and desirability of computerized credit scoring in assessment and monitoring.
