Most SMEs have significant cash tied up in assets, such as inventory, machinery, equipment, real estate, or financial assets. Using these assets in a simple and flexible way for loans could unlock huge amounts of cash and alternative sources of business finance. In this blog, we discuss new techniques to make the qualification of underlying assets more fluid and automated.
In the B2C market, consumer loans can already be initiated with a few clicks and entirely online. This is for example the case with credit cards, overdrafts, installment loans and more recently Buy Now Pay Later (BNPL). Additionally, many banks are further digitizing their mortgage origination processes, allowing clients to simulate and initiate a home loan without going to the bank branch.
In the B2B market however, we are still seeing a lot of manual effort. For larger businesses, this may be justified to some extent, given the generally high amounts of credit and the high degree of customization. However, for SMEs this is less acceptable from both the customer’s and the bank’s point of view.
The client representative is often the CEO (or CFO) who performs these operations themselves, which means they want it to be as quickly and efficiently as possible. Additionally, SMEs often lack the tools to optimize cash management, which means that issuing credit quickly can mean the difference between the life and death of the business. For banks, (lower) SME loan amounts often do not justify a high degree of human interaction, as this would reduce profit margins.
As a result, there is a need for further digitization (in the form of online self-service). Many SME loan products are already well automated, such as an overdraft facility or a tax credit, and more recently several Fintech offers have entered the market automating invoice factoring (i.e. using the accounts receivable or invoices as the underlying asset product for a credit). Nevertheless asset loans remain fairly manual, because the underlying asset (collateral) must be identified, described, analyzed (for example, verify the quality, ownership of the asset, the liquidity of the asset, etc.) and valued, which is much more difficult to automate.
However, new techniques can make this much more fluid and automated qualification of the underlying assets. Some examples are:
- In the event that the asset relates to a securities account or an insurance contract under management with the bank, a Lombard credit loan may be ideal. These assets being very standardized and under the total control of the bank, it is possible to generate these credits in a few clicks. Cfr. the Lombard² offer from Capilever.
- IoT devices (like sensors) can help with the ongoing monitoring of the underlying assets (i.e. monitor whether the asset still exists and if its quality has not declined). This allows for continuous monitoring of the underlying assets and can automate some labor intensive manual tasks performed today.
- a automated asset valuation can be done via estimation models, for example by adapting the value using indexes linked to the assets (cf. NLPT offer from Capilever) or by using specific service providers (eg Rockestate).
- A regular quality and ownership control can be supported by an automated alert when a control is necessary, supported by the uploading of certain supporting documents or a simple photo of the asset (cf. NLPT).
- Open accounting can help banks get an immediate real-time connection to the company’s latest accounting situation, allowing real-time information to be extracted on certain assets. Tools like Silverfin, Xero, Sage, Intuit QuickBooks, etc. can help you. Such a connection makes it possible to assess the creditworthiness of an SME by evaluating business performance in real time, rather than using outdated annual reports. More and more banks are also offering value-added services to SMEs for financial management (for example to forecast future liquidity). Offering these tools also allows banks to have a better idea of the reliability, liquidity and solvency of an SME client.
- A number of blockchain-related initiatives are under development, which will publicly store ownership of certain assets (like property, art, etc.).
- Contract management tools, which allow to automatically generate tailor-made warranty contracts, based on an extended set of rules, which determines how to compose the contract by concatenating a number of paragraphs and standard clauses.
For banks, the valuation of collateral should be a continuous and global effort, that is to say
- A guarantee should ideally be a mix of different types of assets. For example, a good maintains a relatively stable value and is less risky, but is not very liquid, whereas some stocks could be liquidated much more quickly but can also quickly lose value (for example when the expiry date of the product is outdated). For banks, it may therefore be interesting to use a collateral pool, with different characteristics in terms of value stability and liquidity. The better the quality of the asset pool, the lower the risk of the lender and the lower the interest rate.
- A continuous monitoring of the underlying assets is required, i.e. not just at the time of origination. This means regular monitoring of the quality and ownership of the asset, a reassessment of the liquidity of the asset and a revaluation of the asset. In this way, the lender ensures that sufficient collateral value remains in the event of credit repayment issues or even payment default. It also means that margin calls must be made when the value of the collateral no longer covers the outstanding credit.
Despite his huge potential as illustrated above, asset-backed loans are always underestimated. Most SMEs have significant cash tied up in assets, such as inventory, machinery / equipment, real estate or financial assets. Use these assets in a simple and flexible way for loans could unlock huge amounts of cash.
For banks and SMEs alike, this can be reliable access to capital with limited risk. It also makes SMEs less dependent on credit scores, which allows for better
prospective credit risk assessment. This means that you can qualify even as a young or new business, as long as you can provide the necessary assets as collateral.