SME Banking: Why banks forget and neglect an untapped market

What is the state of SME banking today?

From a digital transformation standpoint, SME banking is an untapped market. In the UK, SME banking has not been properly digitized and compared to retail customers, SMEs have not benefitted from the same innovation.

SMEs want easy access to finance, yet they are often overlooked and underserved. SMEs play a major role is most economies, particularly in developing countries and account for the majority of businesses worldwide. According to the World Bank, SMEs are essential contributors to job creation and global economic development, representing 90% of businesses and more than 50% of employment. Yet SME lending is often seen as a low priority topic for banks. Why? Because for the banks the operational cost for SME customers is high but the cost of serving them is relatively disproportionate to the potential gain. SMEs are diverse and because of that, are quite complicated to serve. Many banks don’t tailor products to subsegments or match them to business life stages.

SME’s want better product offerings and less friction and so the demand for better digital banking services is there. Due to demand and competitive pressure from digital challengers, banks are beginning to refocus on this market and attitudes to SME’s are starting to change with institutions now wanting to understand their needs and demands.

Banks have still not found a quick and reliable way to help small businesses thrive – why?

The onboarding and loan process is cumbersome and fragmented – it takes a very long time to have a loan approved. SME lending was very much a paper-based or in-branch process. Now, due to COVID-19 with the need for banks to digitize, this process has become even slower. There is clear evidence from the numbers of SMEs asking for government relief in a huge amount of countries over these recent few months.

What pain points should banks focus on addressing for SMEs?

“Traditional SME banking has no shortage of problems: from inflexible products and rigid processes to customer friction and legacy tech blocking change, there’s a lot to put on the transformation agenda.

Personalize – One major reason why SME’s don’t benefit from the same banking innovation is because of how diverse they are. SME’s can be anything from one man band freelancers to a 200-person strong company, but many banks don’t tailor products to subsegments or match them to business life stages, this is where the importance of personalization comes in.

Overcoming legacy – Manual processes are often long and laborious. There is a lot of complexity and friction when it comes to front and back-office processes which are usually adapted from retail or corporate models, so SMEs experience long, complex, and friction-filled customer journeys. Legacy systems also block change and remain a massive hurdle for SME banking transformation projects.

Improve access to finance – Access to finance for SMEs remains complex with long delays when applying for loans. This can be a major drain on an SME’s resources. In Europe, more SMEs face obstacles to getting a loan than large companies. 8% of SMEs say accessing finance is the biggest issue facing their business, this is double the figure for larger enterprises (4%).

What opportunities are there to innovate in this area?

“With so many pain points to address the opportunity to innovate in this area is huge. Adopting digital analytics tools can help banks get to know their customers better enabling them to tailor products. Integrating APIs to collaborate across platforms can help expand product offerings that banks can provide. The ongoing pandemic has made the funding situation worse for SMEs too. Traditional sources of funding have often become slower due to the lack of face-to-face meetings and bank staff working remotely.

Fintech lenders – agile, digital, innovative, and unconstrained by legacy systems – have the advantage here over established banks and it’s beginning to show. Fintech lenders account for most of the flow of new SME lending in the UK over the past half a decade, according to Andy Haldane, Chief Economist at the Bank of England, and even though it is only around 10% of the total, it is set to grow.

Digitization needs to be at the heart of the next wave of SME banking services. If banks innovate here, they can improve customer experience and grow market share. After all, an improved customer experience is a legitimate differentiator in an increasingly competitive environment.”

What are the challenges to innovation?

“As a segment, SMEs have some of the most varied needs and they are continuously evolving, which creates challenges for banks. Credit risk challenges, high risk assessment costs and poor economic conditions are just a few challenges banks in this market face.

Many of these challenges can be solved through digital transformation, but banks are getting this wrong. Fierce competition from digital natives and rapidly changing customer behaviour is putting pressure on financial institutions to adapt or lose out. This pressure is making banks approach digitization as a standalone process with a start, middle and end – which is fundamentally flawed, and is the reason why billions spent on digital transformation goes to waste.

There are many reasons why digital transformation projects often fail. A lack of alignment between top-level management and teams deploying new capabilities, structural processes, lack of talent, focusing on products rather than customer journey, not understanding customer needs – the list goes on.

To address this, banks need an approach that connects legacy systems to front end applications delivering digitisation without the need to rip and replace. This is the way banks can confront the threat of nimble, digital-first challengers to offer more tailored solutions to meet SMEs needs and lay the foundations for a service model that generates new sources of revenue.”

Is SME lending becoming a growth area for banks?

“SME lending is an incredible growth opportunity for banks and the right technology could help banks serve a wider range of SMEs. This is further helped by government initiatives encouraging banks to lend in big economies such as Germany, France, Italy and Spain.

Access to affordable, flexible business finance could mean the difference between a small business failing or succeeding, expanding, and exceeding its potential – benefiting the global economy as it does so, something that is now more important than ever to ensure a rapid recovery after the impact of COVID-19.

However, this area will not be without competition, take the UK as an example, with challengers like Monzo, Tide and Starling, these digital players have the customer centric culture and agility to serve the unmet and evolving needs of SMEs. To be successful, traditional banks need to implement the technology that allows them to adapt to rapidly changing customer expectations and match the speed and flexibility of fintech startups with personalized products and services, in weeks rather than months or years.”

How has Covid-19 impacted SME lending?

“Before COVID-19, lenders took an average of 90 days to deploy capital for SMEs. Furthermore, 57% of all SME credit applications are abandoned because they are too difficult to complete or are ultimately rejected.

The pandemic has accelerated and exacerbated everything even further. SMEs need faster access to cash, and banks need to improve their processes to accommodate this need. Banks and lenders have faced heavy criticism for the slow delivery of the coronavirus business interruption loan scheme due to the arduous application. In April only one in five UK businesses who formally applied for government-backed loans were granted emergency funding.

The sudden drop in SME revenues has created acute liquidity shortages, threatening the survival of many viable businesses. The pressure on banks to address the funding needs of SMEs is only going to increase over time. Governments who have put up billions to support small businesses threatened by the impact of the pandemic are now looking at ways in which to ensure these companies recover and drive growth – and they expect banks to play their part.

Banks can and must help but to do so will need smarter technology and more actionable data. These are the kinds of solutions offered by digital technology providers and the kinds of technology already being used by nimble newcomers in the SME lending market.

Without these changes, traditional lenders in the sector will be left behind. New arrivals will continue to snap up customers and eat into market share. And, perhaps most importantly, the future for millions of SMEs will remain uncertain.”