This is the final article in the blog series on Digital Transformation and Business Strategy for Financial Institutions, written by the Q-Lana Team. We have conducted our observations and analyses of prevalent trends, integrated with our experience, to shape the series’ structure and content. Our approach is grounded in common sense and a steadfast belief in evolutionary development. We kick off the series with insights into effectively navigating the realm of Digital Transformation. From there, we delve into compelling ideas for crafting a dynamic Business Strategy, tailored specifically for financial institutions. While our work so far focused on financial markets in lower and middle-income countries, it’s worth noting that the overarching concepts we present are universally applicable across all financial markets.
In this final chapter of the blog series on digital transformation and business strategy, we would like to introduce to you the concept of the SME Lending Fund, which we have developed over the past years. We are planning to launch this together with our own Asset Management subsidiary Q-Lana Investment Advisors this concept over the course of the next 12 months.
An essential part of the Business Strategy is the ability to share risks with investors. To approach these sources of risk capital, the financial institutions shall work with one or more funding providers or find an asset manager for the concept of risk sharing. A fund manager can launch a targeted open-ended or closed-ended investment fund to reduce the risk from the loan exposure for the financial institution. Such a funding provider will also provide advice on the proper structuring and the pricing of assets that are earmarked for selling.
Providing financial services for SMEs and corporates is among the most interesting and challenging business areas for traditional financial institutions. Financial services for SME clients require a specific understanding of the way those companies conduct their business, entrepreneurs’ personalities, strengths, and weaknesses. Providing financial services for SME clients is for the largest part relationship banking. It can take several years to build an understanding of the client and the business potential. A good SME relationship manager in a financial institution has gained the trust of the entrepreneur and of the management of the company. The relationship manager fully understands the business of the client and the personality of the people involved. Successful financial institutions in the SME space build up this understanding and knowledge through a strong focus on the interaction of the client. Entrepreneurs on the other hand value both solid and modern financial services as well as a trustful relationship with their financial institution. They prefer to rely on a financial institution as long-term partners based on trust and understanding. The local presence and the proximity to the SME put local financial institutions in an advantageous position when it comes to monitoring and collecting loans. The entire business strategy that we have presented in this blog series is based on the concept of customer centricity and proprietary knowledge in the assessment and management of risks.
According to several studies, there is still a significant funding gap for these SMEs. If you follow the studies for example the one published by the IFC this funding gap is in excess of four trillion dollars for developing markets alone.
Let’s revisit the challenges. SME lending presents difficulties on multiple fronts. SMEs require competent financial partners who can provide funding and financial advice. Local banks possess expertise in SME business and relationship management. However, they often lack sufficient risk capital and a stable source of funding, relying heavily on short-term deposits. This scarcity of risk capital constrains their ability to offer larger and long-term loans. Moreover, international investors are typically absent from these markets due to unfamiliarity with local conditions. While some international investors extend balance sheet lending to local banks, the risk still resides with the local bank. Direct lending initiatives through funds have proven to be inefficient, frequently encountering problems during monitoring and collections, especially with SMEs. Larger funds and transactions follow more standardized international practices.
Addressing the SME funding gap requires bridging international knowledge and investors with local banks through the Q-Lana platform, an intelligent Asset Management platform. The SME Lending Fund offers an attractive, cost-effective solution. It resolves the SME lending challenge by harnessing the strengths of local banks and investors. In this model, financial institutions serve as capable financing partners for SMEs, providing both funding and financial advice. This leverages the deep SME knowledge held by local banks. The risk capital shortfall of local financial institutions is mitigated through a risk-sharing mechanism, wherein the SME Lending Fund and ultimately investors assume the actual default risk in the underlying loans. This reduces regulatory capital requirements for local banks and addresses the funding gap. By aggregating funds from international and domestic investors and investing in loan participations originated by local financial institutions, investors gain direct exposure to trade risk while entrusting origination monitoring to the local institution. Through risk-sharing mechanisms, such as silent participations, the interest in monitoring loans and collecting outstanding amounts aligns between financial institutions and investors.
The diagram provides a general structure of the SME Lending Fund, with various participants. Please note that this is a sample structure illustrating the key parties involved. On the left, we have Investment Partners, typically financial institutions responsible for originating assets, including lending to local SMEs. Local Partners or guarantors, such as lending platforms, may also play a role in asset generation. At the bottom are the investors, which can include commercial investors seeking market yields or structured funds combining impact-oriented equity investors with market-oriented senior investors. A fund manager oversees fund management, and other partners focus on measuring ESG and impact to ensure asset transparency. The SME Lending Fund holds the assets, which are loans denominated in local or hard currencies as defined in the fund’s basis. The fund finances itself through investments from investors, which may take various forms, including single-charge funds or blended structures for impact-focused investments. At the bottom, the Q-Lana platform provides the foundation for the fund by managing and monitoring assets and collaborating with originating institutions, rating agencies, and asset monitors.
This structure represents a powerful solution to unlocking the SME funding gap, and at Q-Lana, we are diligently working to launch this fund within the next 12 months.
This brings us to the end of our blog series about digital transformation and business strategy. We have started with a couple of trainings on the topic of digital transformation and then explain to you the ways how for example a business strategy could evolve around customer centricity and risk management. We have provided you with various details and explained to you how we at Q-Lana are eager to work with your financial institution to make these business strategies and digital transformation a reality.
Please find the video version of this blog below:
https://youtu.be/xIx9Sb7C3rY
