South-East Asian SMEs are missing out on the digital revolution. Here's how to get them on board

Major economies in South-East Asia have been hit hard by the pandemic and are still navigating the path to recovery amid renewed outbreaks, new virus variants and an uneven vaccine roll-out. Yet as devastating as lockdown restrictions have been, they are also proving a positive driving force for millions of consumers to adapt to new ways of spending and embracing digital commerce, permanently changing consumer behaviour.

According to research conducted by Bain & Company and Facebook, eight in 10 consumers in South-East Asia are now digital. To put that number into perspective, the number of new digital consumers added in just one year in the Philippines, Singapore, Malaysia, Indonesia, Thailand and Vietnam is equivalent to the population of the entire UK.

Digital financial services, in particular, have kept the South-East Asian economy afloat. The rise of digital payments and greater access to the internet have fuelled the rapid rise in digital consumers amid the pandemic. Online payments in the region are poised to exceed $1 trillion by 2025, driven by the ongoing trend away from cash payments and increased usage of e-commerce, as well as further development of new payment methods, particularly for e-wallets and prepaid cards.

However, in a shift that can be regarded as much a challenge as an opportunity, the benefits of going digital are not being experienced equally by all sectors of the economy. In particular, millions of South-East Asia’s small and medium enterprises (SMEs) face significant barriers related to access and use of digital technologies that prevent them from reaping the full rewards of participating in the new economy and reaching their full potential.

In the Philippines, SMEs play a vital role in the economy as they comprise 99.5% of all businesses and employ 63% of the workforce. But they underperform – only accounting for 36% of value added to the economy. This gap is expected to worsen if SMEs are not able to shift to digital, lagging as economies and societies across the globe shift to new ways of doing business.

Many barriers prevent Philippine SMEs from reaching their full potential in the digital economy – the most obvious ones being poor internet infrastructure, as well as digital skills, funding and policy gaps, among others. This problem becomes even more acute for the 80% of SMEs located in rural areas outside Metro Manila where business owners, typically in their 40s, have limited digital and financial literacy and have little to no access to reliable mobile or broadband internet.

But perhaps the most interesting barrier, and arguably the lowest hanging fruit, is the one related to a lack of innovation in digital financial products addressing the specific needs of SMEs. After all, financial inclusion for the backbone of the economy employing the majority of the population is the first step toward broader inclusive growth and economic development.

Most fintech players introducing innovation in financial services have been primarily focused on individual consumers; understandably so, as it is the most obvious opportunity to tackle considering more than 70% of adults remains either “underbanked” or “unbanked” (see below).

Leading the charge is South-East Asia’s leading fintech platform, Grab Financial Group, which offers payments and financial services across lending, insurance and retail wealth management in the region. This rise of consumer fintech is expected to accelerate even further as it takes the biggest slice of the pie in venture capital transactions in South-East Asia; it already hit a record $10 billion in the first half of last year, surpassing 2020’s level of $8.2 billion.

However, we have yet to see the same level of activity in innovation in the SME fintech space, an untapped trillion-dollar market opportunity that will unlock potential for a largely underbanked segment in the region.

Why is there a lack of innovation in financial services for SMEs? Historically, traditional banks did not invest enough in digital innovation and business capabilities to serve SMEs simply because it was unprofitable. For example, while it’s clear that SMEs in South-East Asia face large funding gaps (see below), extending credit to this customer segment is often not “worth it” for banks once risk profiles, or lack thereof, are taken into consideration.

Despite this challenge, it is possible to address this critical barrier through innovation in the collection and use of new data sources on SMEs. Fintech lender First Circle has been successful in profitably lending millions of dollars to underbanked SMEs in the Philippines every year. This is enabled by its robust risk engine built on top of proprietary data collected from mapping thousands of business-to-business (B2B) supply chain transactions across various industries since 2016. This level of granularity in data also allows for further segmenting of the SME market into smaller homogeneous groups with similar working capital needs and risk profiles. Subsequently, it is easier to provide tailor-made financial products, from credit lines to B2B supplier payments, deposit and payroll accounts, and more.

While banks and fintech companies play a critical role in innovation and inclusive economic growth, the private sector cannot and should not do it alone. It takes longstanding public-private partnerships to make a significant impact, especially in the area of SME development. In the Philippines, its central bank, the Bangko Sentral ng Pilipinas (BSP), is at the forefront. The BSP’s Deputy Governor of the Financial Supervision Sector, Chuchi Fonacier, said: “The BSP is working closely with both the government and the private sector in pushing for various programmes recognizing that a whole-of-nation approach is needed to further the financial inclusion of SMEs.”

This work spans multisectoral projects, like the credit risk database of anonymized financial, non-financial and default-related data of SMEs, which addresses two critical barriers: the issue of cumbersome requirements faced by SMEs when applying for credit; and financial institutions’ lack of access to high-quality SME data.

Finally, the BSP is spearheading progressive legislation such as the Philippine Identification System Act, the Philippine Innovation Act and the Personal Property Security Act, which that will be game-changing in bringing millions of SMEs into the formal financial system so they can actively participate in the digital economy.

The digital economy in South-East Asia is at an inflection point. The pandemic has brought unprecedented challenges, but also spurred innovation and rapid change. Individual consumers have flocked online, with consumer fintech and e-commerce innovation on the rise, while the SME sector remains stuck with traditional ways of banking and doing business.

The private and public sectors must work together to address the digital and financial skills gap for SMEs; they should also facilitate new fintech innovation, especially in the area of credit and payments, to unlock the sector’s potential and speed the pandemic recovery. Ultimately, bringing SME development to the forefront will be the bridge to achieving broader inclusive growth and economic development in the region.