Business Loans

What is information asymmetry and how does it affect SMEs?

Belinda Wan
July 1, 2021

Information gap: Information asymmetry in the financial sector can potentially cause SME owners a lot of confusion and result in wasted time. Photo credit: Unsplash


The relentless pace of technology is unceasing, and the pandemic has sped this up even further – with companies forced to digitalize to attract customers online, or run their operations remotely.

Similarly, much has changed in the banking and financial sector as consumers increasingly go online to pay their bills, check their bank balances, open their business bank accounts or apply for a business loan, as compared to say, five years ago.

But what does this mean for you – an average SME owner who is struggling to keep your business afloat in an economy that is showing sure but uneven signs of recovery?

In an uncertain and volatile business climate, it is reasonable to expect more instances of bad credit from buyers. Or perhaps they are requesting for more time to make payment.

Under such circumstances, the best recourse for SME owners is probably to seek a business loan.

However, the financial ecosystem can be an intimidating one to navigate because of the asymmetric information in the sector – especially from the business owner’s point of view.


Definition of information asymmetry

Simply put, asymmetric information, or “information failure”, is used to describe an instance when one party has more information over the other.

This is not always a bad thing, as it is a natural outcome of a skilled workforce where workers are specialized in their chosen fields.

As such, as it is with many things, the impact of asymmetric information depends largely on the context. For instance, the identities of the respective parties, the nature of the transaction, and the intentions of the parties involved.

In the case of the SME owner trying to get a loan, asymmetric information is likely to pose a disadvantage to him as most personnel working in banks and financial institutions hold their cards very close to themselves and may not divulge as much as they should.

Here are some instances when you may encounter asymmetric information during the loan process.


Unclear loan eligibility criteria

Many start-up and SME owners like yourself are unaware of what will help them qualify for a loan, especially if they have never applied for one before or are applying for one without any assistance.

The eligibility criteria varies, but most financial institutions (FIs) would prefer to grant loans to locally incorporated SMEs that have been operating for at least two years –with at least 30% of its shareholders made up of either Singaporeans or permanent residents.

Of course, your chances of getting a loan will be much higher if your company has the relevant records to prove its profitability.

You can try this free tool to get a rough gauge of your loan eligibility.


The unstated importance of the credit rating

When all is said and done, most FIs do take the credit ratings of company directors into consideration. However, first-time loan applicants may not know this.

While your credit report shows your credit and repayment history, your credit rating indicates how creditworthy you are.

This rating, which is generated by Credit Bureau Singapore (CBS), denotes the level of credit risk you pose based on your credit records so far. This rating can be anything from the worst score of 1,000, to the best score of 2,000.

So the higher this score is, the more creditworthy you will seem to the FI. The rating may also take the form of a credit grade – HH being the worst, and AA, the best.

FIs also have their own scoring systems, separate from that of CBS’.


No specific reason given for a rejected loan application

It’s an unspoken rule that most FIs (including banks) do not reveal the real reason why your loan application was rejected. Or even if they did, it may come across as inexplicable jargon.

The reason could be due to security and competitive reasons – or perhaps for fear that applicants will start making up false numbers and data once they know the exact reasons behind their rejected applications. In the long run, this could give the FIs a big headache.

As a result, you will probably be left scratching your head as to why your company fell short – unless you hire a business loan broker to shed some light on the situation.


High barriers to entry

This brings us to our next point: The high barriers to entry. Not only is it quite difficult for new businesses to get loans, the loan eligibility criteria, and the lengthy application loan process that involves the thorough checking of your credit history need to be factored in when you apply for a loan, especially if you need one urgently. The process is a long one that requires a lot of waiting and patience.

You could, however, pay for some advice by hiring a broker, provided you have the budget to do so.


Lack of knowledge

It may not seem like it, but there are other loan options out there. Apart from the standard term loans such as secured and unsecured loans, there are other options you can consider, depending on the main reason why you need a loan.

An overdraft or credit line could be a good way to solve payroll issues. Invoice financing or factoring can help you accept more orders without you having to wait for payment to come in before accepting another order.

If you have had enough volume in terms of credit card payments paid out to your business every month, perhaps a Merchant Cash Advance would work.


Limited pool of lenders to choose from

The first instinct of most SME owners like yourself is to apply for a loan with the bank they are already banking with.

If that bank politely but firmly closes the door in your face, you are likely to apply with another bank – and in doing so, repeat the same arduous process of applying, getting rejected and reapplying… and getting rejected again.

Some SME owners may not be aware of other types of FIs such as private lenders, peer-to-peer lenders, or more rarely, family offices; and even if they were, they wouldn’t know who to trust.


Unequal playing field

When you think of it, it can be said that the bank knows almost everything about you and your company – whether or not it approves your application.

They have information or data such as your company profile, how well it’s doing, the credit ratings or scores of your company directors, the last two years of your company’s financial statements; the last six months of bank statements; and the last two years of your company directors’ tax bills.

But in contrast, you know little about their approval process or even why you were rejected. This imbalanced relationship and information asymmetry can deter a lot of SME owners from applying for a loan.

That said, the same information asymmetry works against the lenders as well. Much of what they know about an SME was made available to them either in the public domain or through materials provided by the SME owner.

Lenders will always wonder whether the SME owner is withholding any adverse information. One way to mitigate this in part is to maintain records, ideally from independent parties, for example, sales records from POS or e-commerce platforms, invoice information from buyers' procurement platforms and bank records, that can both tell the SME's story as well as validate the information.

This would give the lender a clearer picture of the SME’s finances, and make a stronger case for the SME owner who is requesting for a loan.

If you wish to learn more about how best to communicate your entrepreneurship story to the lenders, reach out to us at ask@lendingpot.sg, or register with us so we can assist you in making a financing application.


Leading digital loan marketplace Lendingpot connects SMEs to its network of 45 lenders comprising relationship managers from banks, financial institutions, and private and peer-to-peer lenders in Singapore. It aims to help SMEs overcome the information asymmetry problem and lack of transparency prevalent in the SME financing sector by offering SMEs financing options such as business term loans, property loans, revenue-based financing, credit lines, working capital loans, bridging loans, invoice financing, and more.

About the author

Belinda loves thinking about random stuff, and collecting useless bits of facts and trivia. She often roots for the underdog, and believes the world needs more happy endings.

information asymmetry
SMEs
business
finances
financial ecosystem