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Revenue-based lending for SMEs

Author

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  • Hassan Mazengera

    (Department of Statistics, Rhodes University, Grahamstown, South Africa)

Abstract

Most small businesses face uncertain demand for their products and services. The revenue they earn is most likely to be of stochastic nature. They face difficulties in making a fixed loan repayment throughout the life of the loan as they earn stochastic revenues. If banks are to lend to this market using the fixed loan repayment schedule/regime, it is highly likely that these businesses will default on their repayments several times in period n. If default rate is high in a loan portfolio, it means that the bank has to set up a higher bad loan provision, thereby tying up its capital. This reduces the lending business, profitability and growth of the financial institution. This is one of the reasons why financial institutions perceive these small businesses as a high risk market. Only financial institutions with a very high risk appetite will tap into this market. We are proposing revenue-based lending as a solution to the problem. Stochastic repayments will reduce periodic defaults. This reduction in periodic defaults will reduce the bad loan provision thereby making more funds available for lending. We want to show that the bad loan provision for the bank will be higher for a fixed loan repayment compared to the stochastic loan repayment.

Suggested Citation

  • Hassan Mazengera, 2017. "Revenue-based lending for SMEs," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 4(02n03), pages 1-20, June.
    • Handle: RePEc:wsi:ijfexx:v:04:y:2017:i:02n03:n:s2424786317500359
    DOI: 10.1142/S2424786317500359
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    References listed on IDEAS

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    Cited by:

    1. Li-Fei Huang, 2018. "Using App Inventor to provide the amortization schedule and the sinking fund schedule," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 5(04), pages 1-9, December.

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