Big Answers are Needed to Solve a Huge Problem for Small Businesses
The sole trader painting bespoke Christmas baubles in their garden workshop. The brothers making natural shampoo bars to sell through their website and an online marketplace. The independent seaside coffee shop known for the best carrot cake in town. The marketing agency with 30 international clients. The gym chain employing 230 staff.
Each of these is categorised as an SME, yet each business differs enormously from the others. Some are seasonal, some are international, some are online only, some require an injection of cash upfront to purchase stock before making revenue or profit. No single traditional banking solution can possibly meet all the financial needs of every one of these small businesses – there is no one-size-fits-all solution.
Traditional banks, faced with increased scrutiny, are unable to provide the flexible banking and lending solutions SMEs need, at a price they can afford, or in a timely manner to keep up with the fast pace of today’s market.
In fact, it is not just the big banks that have shied away from investing in SME solutions. Compared with the number of retail banking providers, few FinTech or challenger bank solutions cater specifically or successfully for the needs of SMEs.
This leaves most SMEs trapped in a space somewhere between retail and corporate banking offerings, with neither option meeting their needs. And worryingly, the gap between what SMEs need from their financial services provider and what has been traditionally offered is steadily growing, leaving SMEs underserved and financially excluded.
And there’s another factor that is slowly but surely excluding SMEs from the right financial solution for their enterprise. Cost. While interest rates may remain relatively low, charges, fees, commissions and collateral requirements for lending continue to rise. Such financial exclusion is not just an inconvenience – it can have a catastrophic effect on a business.
At Banking Circle, we recently commissioned MagnaCarta Communications to carry out further research into these issues, to supplement the findings we published in our June 2019 white paper, ‘Financial Inclusion for Europe’s SMEs: Building a Circle of Trust’. The second round of research included interviews with some of the people working right in the midst of the challenges and the solutions hitting the market today. In this way, we have been able to get first-hand expert insights and experiences, to help us find a way towards better financial inclusion for businesses of all sizes, stages and models.
We have published the results in a mini-paper we have called ‘Circle of Trust or out of the loop?’, which complements the in-depth report published earlier in the year. The latest report, which will be launched at Sibos 2019, uncovers where changes are happening, where opportunities exist, and where barriers are beginning to come down to increase SME financial inclusion. It paints an inspiring and exciting picture of the future of SME banking.
- More providers are recognising the gap in the market and realising the size of the potential benefits if they work to fill that gap
- For businesses willing to use non-traditional providers, there are affordable, accessible options available for all their financial requirements, but businesses need to take that step to move away from the traditional option of using a single banking provider for all their banking services
- Banks need to offer solutions independently, flexibly, rather than requiring a business to move all their banking to a single institution in order to access the services they want and need
- So far, formal directives have focused too much on access to funding rather than access to a broader suite of financial services
What the experts said
David Selves, founder of The Selves Group, summed up the problems in two categories. Firstly, delays caused by payment clearing as we move away from a cash society, and secondly, the increasing difficulty of maintaining a personal relationship with a banking professional who understands the specifics of a small business.
David explained: “Pubs, for example, take most of their money over the weekend, pay in the cash on Monday but have to wait up to five days for the money from their card payments. Most breweries charge the pub landlord once a week, on a Tuesday. If you have cash that’s great and you can pay, but if it’s on cards, you may not be able to pay. But that is being addressed, and the problem is receding.
“However, the other major problem is having nobody to talk to. You can’t go and natter with your bank manager, you can’t explain to someone who knows you and your business that the transaction is approved, and the money is on its way but just hasn’t cleared. Automated systems will turn down applications or reject direct debits because the funds are not in the account.”
Kent Vorland, CEO of SmartTrade, explained why this is such a serious issue: “Smaller merchants tend to have normal people problems. By that I mean that the problem isn’t that they want money so they can go on holiday or go out for a nice dinner. They need their money so they can feed their family, complete the jobs or orders for their customers, or to purchase stock for the customer who has ordered it. If they don’t have access to the finance they have legitimately earned, they might not be able to feed their family or themselves.”
The experts who took part in our study agreed that some categories of SMEs are better served than others. Valentina Kristensen, Director of Growth and Communications at OakNorth Bank said: “Smaller SMEs and start-ups are generally well served, but the next stage – profitable businesses needing extra finance to expand – is not served well at all. Banks will only lend ‘this’ amount, it must be secured against property; ‘you must draw down everything on day one’; ‘we won’t offer covenants or structures that will work specifically for your business’. ‘It’s an off-the-shelf solution and on top of that we won’t keep you up to date, we won’t tell you if you’re successful in securing the loan, you won’t get it for typically 2-4 months for a ‘no’ and 4-6 months for a ‘yes’. The opportunity cost of that delay is extremely detrimental to a small business.”
Roger Vincent, CEO of Trade Ledger added: “The next level up is where firms really need help – above a turnover of £1m, banks will flick businesses over to corporate banking from retail, and that’s the gap where companies are massively underserved.
“SMEs are the driving force behind the UK economy. If we don’t start to tackle the problem of financial exclusion, we will be a long way behind the curve against other industries or other countries who are tackling the problem and stimulating growth within their countries.”
Patty Zuidhoek, Director of Business Banking at Triodos Bank highlighted the difficulties faced by banks, with the European Central Bank enforcing upon banks more stringent gatekeeping requirements. “All these checks and balances can be discouraging. A lot of large banks withdrew from SMEs because they want to take a standardised approach, which doesn't work in this sector.”
Paul Townsend, non-exec director of Vitesse PSP Ltd confirmed: “There are certain client groups where a bank is perfectly acceptable and works well. Where it becomes more challenging is when the client becomes more complex, requiring FX and cross border payments, having a small balance sheet and low number of employees. This brings concerns around cost-to-serve. I believe the reason the Banks are struggling is because they have large offices, complex and old computer systems, large expensive structures to run. They need to make decisions on who they support, and the barrier to entry is going to rise.”
Broadening SME banking horizons
Although most alternative banking solutions in the market today cater to consumers, there is an increasing provision targeted at SMEs. OakNorth’s Kristensen commented: “SMEs are still not top of the agenda for most financial services providers, but many are waking up to the benefits.
They are realising that if they get an SME on board, they will be loyal and bring multiple cross-selling opportunities within the business, amongst the business owners and there is potential for employees to become profitable retail customers too.”
All the experts interviewed by MagnaCarta Communications recognise the benefits of ecosystem models, rather than the traditional model of vertically integrated ‘whole-of-banking’ relationships. As our report shows, bringing about real change and better financial inclusion for SMEs requires not only top-down directives from state authorities, but more of a grass-roots movement. This requires participants to work together and develop joint solutions, building bridges between individual innovations already in the market.
Vincent of Trade Ledger commented: “We are creating a new ecosystem of financial services providers, in partnership with other providers such as Banking Circle, to establish a new era of financial services which will better service customers and SMEs in the banking space. If we better serve the banking space through the incumbents, then the SMEs will benefit greatly as they can access the services they want. In this new ecosystem we can provide a new environment to better serve the SME financial services space.”
Banks are also recognising the potential of the ecosystem model and are facing a choice ahead between two strategic moves. They can build their own ecosystem platforms, or they can design interoperable services and solutions to be distributed through other ecosystems. Either way, we are seeing a distinct shift away from exclusive relationships, in favour of a more shared approach. Undoubtedly, banks must be involved in the conversation regarding the way forward – they are perfectly-placed to lead on areas of strength and build collaborative solutions to fit the diverse sector, working together to help build a larger marketplace from which everyone can benefit.
The latest edition of the European Central Bank’s survey on the access to finance of enterprises (SAFE) paints a positive picture of financial access for European SMEs. The European Banking Federation reports improvement in SMEs’ ability to access bank lending and the EIB has shown a steady increase in approval rates for bank financing over the past five years. Clearly, change is happening, inclusion is increasing.
But, whilst it has been increasingly recognised and discussed that change is needed, it is overdue and, as yet, has been small and slow.
Why have we yet to see a significant shift in the industry?
Vorland of SmartTrade believes the market is more than ready for a better SME funding solution. “100% of the merchants I have worked with over the past three years would be overjoyed, thrilled, to have access to their cash instantly, and would willingly pay a small fee or interest on the loan, or a certain percentage of all transactions to pay back a settlement or loan they needed.”
Not only that, he believes the solution could be delivered now. “I can assure you, every financial institution on earth could put together a risk structure that would allow these companies to have access to that finance. And on top of that all insurance companies in the world would be happy to insure those liabilities, so the risk wouldn’t necessarily even lie with those offering that financial inclusion. All in all, there is a long line of companies that would benefit from being given that level of flexibility.”
However, as our latest report shows, the progress and achievements will remain limited until further collaboration, communication and joined-up thinking becomes commonplace within the financial services industry. As Selves, of the Selves Group commented, the potential is huge. “A bank who took the bull by the horns and really went in to support SMEs would clean up.”
And as Trade Ledger’s Vincent points out, the impact is far wider-reaching. “The UK entered the Open Banking journey 18 months ago, and we’re seeing other countries follow us into this revolution. If we can connect countries via these open banking programmes, like we should see through PSD2 across Europe, it will facilitate better trade.”
But whatever strategies are applied, the key is that increased financial inclusion brings increased trade, and global economic benefits. It is vital for sustained growth in the new global economy.
Click here to register for the new Banking Circle Insight Paper which will be launched at Sibos 2019.
About Anders la Cour
Co-founder and Chief Executive Officer of Banking Circle, Anders la Cour is a hands-on leader driving innovation to facilitate more inclusive, efficient and cost-effective banking, lending, payments and FX. He was also instrumental in arranging the $300 million acquisition of Banking Circle by EQT VIII and EQT Ventures in 2018.
About Banking Circle
Next-generation provider of mission-critical banking infrastructure, Banking Circle, is underpinning the service proposition of Financial Tech businesses, PSPs, FX providers and banks. Banking Circle is increasing financial inclusion, helping financial institutions provide their customers with faster and cheaper banking solutions, including local and cross border payments, banking accounts and lending.