Open Banking's potential in revolutionising SME financing

Big corporations dominate economic headlines any given day but it is small and medium enterprises (SMEs) that essentially power economies and societies. According to the World Bank, SMEs account for 90 percent of the world’s business and create 50 percent of employment worldwide. SMEs comprise 97 percent of all businesses in New Zealand, employing more than 679,000 people or 29.3% of all New Zealand employees and generating a quarter of the country’s GDP.

Notwithstanding their critical role, SMEs struggle to access credit and are generally underserved by traditional banks. This has much to do with their lack of credit history; SMEs are often complex entities that make it difficult to assess their financial health and thus they do not get the required service fast enough for them to be able to snap up business opportunities.

Conrad Ford of Allica Bank pointed recently to reasons why banks have struggled to serve SMEs. Speaking to FintechOS Evolv podcast, Ford said a significant proportion of small businesses in the UK use their personal credit card as a source of finance. Medium-sized firms, however, are too complex as entities to be dealt with in the sphere of consumer banking and are too low value as customers for big banks to devote resources that they would ordinarily deploy for bigger businesses.

As a result, he says, SMEs below a turnover threshold tend to get lumped in with the personal banking segment (within the bank’s service architecture); they don't get a relationship manager and instead have to deal with a call centre. That, Ford reckons, eventually affects the kind of lending products that banks offer to their customers – they end up offering a “dumbed down banking service for what’s quite a complex business.”

The broader economy suffers as a result. A survey by MYOB of more than 1,000 SMEs in New Zealand showed that firms rely on “bank overdrafts (50%), personal loans or mortgages over the family home (41%) or their credit card (36%)” for access to finance. It also revealed that “while a large number of local SMEs have never attempted to access business finance, almost a third have sometimes or frequently struggled to secure additional funding.”

Open banking and challenger banks have the potential to change that scenario rapidly. Open banking allows customers to share their banking data with third party fintech providers – who are able to generate insights from unstructured data to be able to provide quicker access to services like credit or budgeting tools. Technology can now use online sales, utility payments or supply chain records to “uncover credit signals” that banks have previously missed whilst assessing a firm’s financial health.

This enables customer onboarding and decision-making on credit to be a lot quicker. The seamless mining of customer data has also allowed the emergence of innovative, specialised financial products for SMEs, like invoice finance – whereby outstanding invoices can be used as “collateral for short-term financing.” In one application of invoice finance, businesses can “sell their outstanding invoices to a third-party provider in exchange for a percentage of the invoice’s value upfront.”

A Deloitte survey in 2023 of 10 digital banking service providers provides a helpful overview of the range of services on offer to SMEs (and those the latter require) as competition heats up in the sector.

Service providers are essentially focusing in two spheres – as noted, one that is customer-oriented, which takes charge of the lending process, including onboarding, verifying identity, managing documents for loans, credit decisioning and loan disbursement. The other body of work is helping firms with business finance management (BFM), dealing with cashflow management through tools such as historic and current cashflow visualisation, insights and predictions. The survey flags invoice management, travel management and expense management as additional adds-on that banks can provide to stay competitive.

Analysts argue that keeping in step with an SME’s evolving complexity and offering customised solutions would be the key to success.

Ford says that somewhere along an SME’s journey with a bank, "It's no longer a single player bank account, it's a multiplayer bank account… you want your credit controllers to be able to check whether invoices have been paid but you don't want them seeing salaries; you want your financial controllers to be able to raise payments but not give the final sign off and you want to be able to do complex bulk payments rather than single one payments – so there's a certain point at which you become a multiplayer bank account and that's when the traditional banking model breaks down because it's a consumer bank account they're trying to use” [for such outcomes].

Open banking technology can help in responding to such situations. Fintech can also provide services to SMEs that they may be unable to afford. Ford says that “SMEs in the UK are missing out on £9 billion of interest” which is “either sitting in non-interest bearing accounts or sitting with a big bank who pays miserly interest.” The reason he says that that’s the case is because corporates can hire a CFO or a treasurer who works the money, which SMEs cannot.

So there is a case, in his view, for developing a virtual CFO-like functionality that doesn't come with a quarter of million-pound salary price-tag.