The Future of Banking is Open – Time for SMEs to have their moment in the sun
It is often said that your relationship with a bank is likely to last longer than that with a spouse, a fact which was recognised in a report from the Competition and Markets Authority (CMA) in 2016. In its view, the UK banking industry was too dominated by large incumbent banks, with the ‘big four’ (Lloyds, RBS, Barclays and HSBC) responsible for 85% of all business lending and accounting for 75% of the business current accounts. Such dominance has historically provided little incentive to embrace innovation or to offer enhanced services to retain customers and has imposed a significant barrier to entry for challenger banks. Open banking, as proposed by the CMA, set out to shake up this status quo.
2018 has been a milestone year for the financial services industry and those it serves with open banking coming into effect. This has enabled both retail customers and SMEs to share their account information securely with other third-party providers and its implementation aims to create an environment of financial innovation, where client needs are more closely matched to services on offer. Fintechs have been given the opportunity to tap into banks’ captive customer-base to offer apps and platforms aimed at enhancing customer experience. Against this backdrop, the roll out of the Alternative Remedies Package will hand out significant sums of money – some £425m – carved out from RBS to encourage greater participation from challenger banks and fintechs in SME banking market, creating a perfect storm for change.
The Capability and Innovation, Alternative Remedies Package (ARP) is divided into four pools. Pools A and B, accounting for some £360m of the total, is aimed at challenger banks with, or planning to establish, SME offerings, with the remainder open to fintechs via pools C and D to improve payments and lending and to commercialise innovative technology respectively. While the £65m open to fintechs should provide a welcome boost to the sector, this should not be seen as the full extent of the opportunity. As challenger banks seek to enhance their application for funding by partnering with the most innovative players in technology, there is real scope for greater cross-industry collaboration. The net result of this should be a financial system that can provide products much more closely tailored to the specific needs of individual business customers.
While this new competitive landscape provides a once in a generation opportunity for challenger banks to increase market footprint, incumbent banks need not be left behind. Drawing on the technological disruption sparked by the fintech sector, they have the opportunity to fundamentally change their relationship with their SME clients.
SMEs form a significant part of the UK economy, contributing some £200bn annually, a fact which seems to have been overlooked by the financial institutions that serve them. Research from Aldermore and YouGov carried out in 2012 suggested that only one third of businesses felt that their bank had a good understanding of their needs and there is little to suggest that this view has changed over the intervening years. The British Business Bank’s report, Small Business Finance Markets 2017/2018 found that while equity and alternative finance recorded strong growth over the course of 2017, the banking sector’s share of lending remained relatively flat. Diversity in sources of financing is a demonstration of a healthy capital markets infrastructure but the fact that small businesses are less likely to turn to their bank to support their growth is indicative of a failed relationship. Rather than being content with being viewed as a mere account provider, banks have the potential to be central to business growth by partnering with innovative third parties.
So how can incumbent banks turn the environment of increased competition created by open banking to their advantage? The entrance of Deposit Solutions into the UK provides an example. Based in Hamburg, it is an intermediary platform between banks with strong balance sheets and other banks offering insured savings products. Product banks benefit from access to new channels of funding while client banks have the option to offer their customers a broader suite of enhanced savings options. This template has the potential of being replicated by a wide range of industry players putting banks – both established and challengers – in the position of providing niche offerings that can more closely meet the needs of their clients and in turn open new channels of revenue.
An overhaul of the banking sector has been long overdue and the fact that clients have felt increasingly underserved by their banks has perhaps precipitated a revolution. Yet this revolution, while ushering in a new age where challenger banks and fintechs can play a full part in the financial services ecosystem, does not necessarily mark the end of the old order. It presents a very real opportunity for established players to reassess the way they interact with their clients and to ensure the products they provide are fit for purpose.