The share of non-banking financing options among small and medium sized-enterprises (SMEs) in the Netherlands has increased significantly over the past years. With this increase, the importance of up-to-date and efficient customer’s risk assessments is also rising. Such risk assessments can be performed in multiple ways. As of January 2018, financing providers may also consult the Payment Services Directive 2 (PSD2), a revision of the European guidelines adopted in 2007 by the European Commission. Under PSD2, customers can grant access to their transaction data for banking as well as non-banking institutions. The data remains the property of the customer, which means it may be shared with other parties at the same time. This should, among others, improve competition, enhance innovations and create a level playing field in the European payment market. In this blog, we will zoom in on the trends in non-traditional financing possibilities and how PSD2 can help non-banking financing providers to properly assess their risk position in relation to their profitability.
How does PSD2 work?
With the introduction of PSD2, customers can give (one-time) access for a maximum of 90 days into their personal or company-specific transaction history to banks as well as third parties with a DNB permit. When the 90 day term has expired, the third party access is automatically revised unless the customer specifically agrees to extend. If and only if such access is granted by the customer to an external company, the company is able to provide its services to the customer. Typical services that may be offered by a third party are cashless payment services, aggregations and visualizations of historical transactions to indicate expense or income patterns for financial planning and building quantitative or qualitative models to indicate customer risk levels. At the moment access is granted, the external company can get full insight in the historical transactions and extract typical information like account balances, potential contacts with debt collectors, outstanding active debt levels, etc. The available historical transaction period varies per bank but is limited to the most recent two years.
Market trends in SME financing
Over recent years a significant shift is observed from banking (i.e. traditional) to non-banking (i.e. alternative) financing in the SME segment. This shift is mainly observed for financing up to one million euros and is largely impacted by the possibilities provided under PSD2, where alternative financing providers can easily enter the financing market. Stichting MKB Financiering (SMF) projects that this trend continues over the upcoming years. According to their projection as shown in Figure 1, it is expected that alternative financing will become the dominant option for SMEs with financing needs up to one million euros as of 2023.
Figure 1: Projections of traditional versus alternative financing over time for financing needs up to one million euros. Source: stichtingmkbfinanciering.nl*
Traditional banking financing options have a long history and are a well-known financing form for the SME segment, whereas the alternative financing options are somewhat newer. Among the realm of alternative financing options one could consider crowdfunding, credit unions, direct lending, SME exchanges, real estate financing, lease and factoring. When visualizing the developments of alternative financing over recent years, one may conclude (from Figure 2) that a steep positive trend is observed over time for all of these alternative financing forms.
Figure 2: Alternative non-banking financing options presented in outstanding financing over time. Source: stichtingmkbfinanciering.nl*
Advantages of PSD2
As there is clear evidence of an increased market for alternative financing demands in the near future, there is also the need to efficiently facilitate the financing process. The latter requires a thorough and quick assessment of the applicant’s risk level. Currently, it is observed in the market that financing companies are not using all available information to its fullest by only assessing for example the Bureau Krediet Registratie (BKR), outdated balance sheets, buying external data or even manual checks of transactions. These are ways of working that are no longer sustainable and profitable as the market for alternative financing keeps on growing. Using PSD2 in this context has a large variety of advantages:
- Up-to-date insights: it enables the financing company to get accurate and up-to-date insights in the current financial state of the financing applicant. In the current setting with Corona for example, it would show whether the applicant used one of the support measures offered by the government, which the financing company would have never spotted when solely looking at the balance sheets.
- Standardized data: the data provided is very standardized and transparent and hence decreases the possibilities of fraudulent applicant behavior (as long as you know how to indicate such behavior).
- Efficient process: when PSD2 access is provided by the applicant and further semi-automated processes are already in place, the process is very efficient and clear insights could be obtained on the spot.
In addition to alternative financing providers, the usage of PSD2 might also be of interest to other parties like banks for their mortgage/loan acceptance as well as monitoring processes and insurance companies to assess their client’s behavior to identify moral hazard issues and to provide customer-specific insurance premiums. Finally PSD2 can be used to look for fraudulent activities on a large scale by means of highly-technical machine learning models.
The new way of working with PSD2 provides the market with endless opportunities to get insights into the transaction history of customers. In a way it ensures that all ingredients for a proper risk assessment become available to everyone who gets explicit access from the customer. However, to properly use the ingredients, additional treatments are required that are not always straightforward. Two large workflows that may add value to the ingredients are 1) processing, aggregation, categorization and enrichments of the transactions and 2) creating visualization and monitoring products as well as quantitative or qualitative risk assessment models (e.g. debt capacity analysis).
Added value RiskQuest
RiskQuest focusses on adding value in the latter workflow. We can provide an interactive Dashboard that has the sole purpose of getting quick and clear insights in a customer’s transaction history, obtained through practical experience, to better organize the application acceptance process. This Dashboard provides insightful and meaningful metrics as well as the opportunity to quickly see any indications of, for example, missed tax payments and debt collector or regular debt commitments. In addition to this interactive Dashboard, RiskQuest is a market leader in building tailormade quantitative risk models based on available datasets. This enables us to create models together with our clients that could help in further automation of the decision making process.
*The numbers shown throughout the blog are for illustrational purposes to show the general market trend. No reliance can be placed on these numbers.
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