By Martijn Hohmann, CEO and co-founder, Five Degrees
The SME sector
Small and medium-sized companies (SMEs) contribute in excess of £200 billion a year to the UK economy, which is set to grow to £240 billion by 2025 according to the Centre for Economic and Business Research.
The sector is made up of a variety of different businesses and enterprises, from sole traders and start-ups, to medium-sized retailers and manufacturing companies – each with a specific set of needs and requirements.
As a highly profitable sector, you would expect the SME market to be well-serviced by the banking and finance community. However, traditional banks and financial institutions are failing to seize the SME market opportunity in Western Europe due to a variety of factors.
Why are SMEs neglected?
The first reason is the onboarding process, where in the majority of cases the ownership structure is complex, leading to problems around initiating relationships with SME businesses.
The second reason is the traditional bank’s growth model: a checklist of criteria that determines the value of the business opportunity. This poses problems when it comes to granting credit facilities to SMEs, as they are seen as higher risk for conducting business with than larger organisations.
Thirdly, banks follow bigger sources of revenue and SME profitability is lower than larger organisations, leading to the de-prioritisation of small and medium sized businesses.
The final reason is the legacy software systems of large financial institutions that prevent them from servicing SME customer demands which go beyond core services. For example, a SME might have a desire to integrate P2P lending, blockchain, mobile wallets, and accounting and legal functionality all as one end-to-end service – this is not possible with a traditional legacy offering.
Although we’ve seen attempts in recent years to support the sector, including the introduction of mobile and cloud technologies, banks continue to underserve the SME community. Coupled with the context of economic uncertainty, SME banking is seen as too risky or challenging to engage with.
The rise of technology challengers
SMEs are becoming frustrated by the difficulty in accessing banking services quickly, and are increasingly turning to non-banks to access loans, make payments and manage transactions.
Transforming operations of big incumbent banks can be a slow, grinding change that takes a lot of effort. Startup competitors have the advantage of a very narrow focus that ensures progress. Everything they do is dedicated to this progress. Furthermore, the mindset of a startup is that it is attacking incumbents, with nothing to lose.
Technology challengers are seizing the market opportunity due to their ability to scale quickly and keep costs low, providing services that are fully digitised and don’t require physical branches to operate. Challenger banks eliminate a ‘death by a thousand cuts’ approach to onboarding, instead of a combination of paper and digital processes which increases inefficiencies and approval timings.
An example of a bank that is capitalising on the SME market opportunity across Europe is Knab, a Dutch digital-only challenger that specialises in working with entrepreneurs and small businesses allowing them to begin banking on the same day. The company is also embracing marketplace banking, opening up their APIs to enable customers to access additional services provided by third parties. The services can be viewed across one dashboard rather than having to go via multiple providers to access information, saving customers time and improving user experience.
Stay relevant or get left behind
Changing customer needs and behaviours mean existing banking propositions are losing relevance, creating an erosion to the credit relationship between banks and SMEs.
Traditional banks need to stop reeling from the credit crisis of over a decade ago and abandon nostalgic ways of working. To fully harness the SME market opportunity, banks need to focus on the future by catering to a diverse range of customer requirements, enabled by Marketplace banking also known as ‘Open Banking.’
‘Open Banking:’ the opening up of customer data to third parties, will transform digital operations and help make onboarding and the delivery of services to SME customers more seamless. Banks will meet the demands of SME customers by working with these ‘outlier’ companies to enable the integration of new services through interconnected application programming interfaces (APIs).
Smart collaboration the key to survival
The Uberisation of many other industries has resulted in start-up challenger companies taking large shares of the market. This has made traditional banks wary of collaboration with FinTechs. However, banks have the advantage of being the orchestrator of services, and they can use partnerships with FinTechs to effectively provision for difficult market segments, such as SMEs. This ensures they can harness the right technologies and capabilities that will keep them relevant, streamlining the onboarding and authorisation processes.
At the same time, changes to regulations around data sharing such as GDPR and PSD2 is also making it a necessity that banks collaborate with third parties, to ensure they are not caught out by non-compliance penalties.
It’s clear that establishing smart collaborations with FinTechs is the key to the future success and survival of banks and financial institutions. The traditional view of a bank ceases to exist in Marketplace banking, becoming open to developers that can build additional applications to provide an enhanced customer experience. Across Europe and on a global basis banks are beginning to sign deals with fintech players and embracing API banking.
For the majority of traditional banks, it is inertia and fear that is holding them back from capitalizing on the SME market opportunity. Banks must now apply innovation across the entire value chain to keep them on the same playing field as their challenger competitors.
