As the banking industry begins to view small and medium-sized enterprises with a renewed passion, the way banks manage SMEs is changing, with many accepting that the one-size-fits-all approach of the past is no longer viable.
Banks that pulled back on lending to small and medium-sized enterprises (SMEs) during the financial crisis are increasingly re-examining how to approach this sector. The current environment has opened up opportunities for lenders that can cater specifically to SMEs and fill the gap left by those who exited the market as a result of the financial crisis.
However, many banks are facing a dilemma of how to categorise SMEs and where to place them within their operations. Where SMEs are viewed as an extension of the individual retail banking customer base, processes can be industrialised. However, some needs unique to SMEs, such as the need for advice on how to run their business, can be overlooked. But SMEs are too small for the bespoke and tailored services of the corporate banking world. “The poor SMEs are often left in the middle,” says Phillip Monks, chief executive of Aldermore, a UK bank that specialises in lending to small and medium-sized businesses.
Separate systems
Part of this division arises because the core banking systems of banks' retail and corporate divisions are separate. In North America, for example, banks typically have two separate systems, explains Darryl Proctor, product manager for corporate banking at Temenos, a banking software company. Retail banks have a large mainframe system that has been designed for a high volume of transactions, whereas corporate banks have complex bespoke systems. The difficulty for SMEs is that their needs fall somewhere between these two systems.
When asked whether SMEs have been neglected because they have fallen between the gap of retail and corporate banking, Mr Proctor says: “It’s not that the banks did not want to deal with them; they did not know how to deal with them.”
That, however, is beginning to change and SMEs are now emerging as a segment in their own right. Banks are considering whether to create a third platform for SMEs, disguise the division between corporate and retail, or move to a single platform where the divisions between the segments can be seamless.
New approach
The advantage for new entrants into the market is that they are not burdened by legacy systems. They can set up a single software platform catering to a range of customer types. With such a system, the treatment of SMEs is one of categorisation rather than having to transfer them from one platform to the other. To the customer, the divisions can be seamless. With such back-office systems there is the capability to offer products that have previously served the large corporate banking world, such as cash management or trade finance, as SMEs become more sophisticated in their demands and savvy about the range of banking options available to them.
Aside from the core banking platforms used, the general approach to SME customers has often been inconsistent. “The way banks are organised does not help them with SMEs,” says Charles Wendel, president of Financial Institutions Consulting, which works with banks in the small and mid-sized business space. He argues that banks are often geographically focused, which can mean that they often have different strategies for SME banking, depending on the approach of the regional head.
Philip Monks, chief executive, Aldermore
In the case of Santander, for example, the growth of SME business in the UK has a different history from the development of similar operations in other markets, such as Spain and Portugal. The bank’s SME business in the UK was built from scratch and through acquisitions of lenders such as Abbey and Alliance & Leicester, and the department had to be reconfigured to bring it in line with Santander’s approach.
Steve Pateman, Santander’s executive director of corporate and commercial banking in the UK, says the bank's approach in the UK had to be different. Santander was reinventing the wheel by building an alternative to the major banks that dominated the UK market. Mr Pateman says that the bank could not simply copy the model that was used by Santander in Spain: “You cannot just paste it, the markets are different,” he says. He gives the example of overdrafts, which are commonly used by SMEs in the UK, but not in the rest of Europe.
Classification issues
While there may be differences in how a bank approaches the SME segment across the regions where it operates, there are also wide differences in where banks place their SME customers, and inconsistency over whether SME banking is seen as a subset of retail or corporate banking. “Sometimes every few years it gets reorganised,” says Mr Wendel.
This is what happened at Barclays. Steve Cooper, managing director of Barclays Business, says the small business division was moved six times in 10 years between the retail and corporate divisions of Barclays.
“Five years ago we decided we would keep it in retail. With the volume of customers you have to manage it like retail,” he says, adding that the core underlying architecture is the same as the retail division but it can be tweaked to deal differently with SME customers. “I manage SME banking like a retail entity, but I treat the customers like business customers,” he says. Barclays Business is focused on SMEs and the clients typically have a turnover of up to £5m ($8m), which means that they do not get distracted by larger corporates, adds Mr Cooper.
Size segmentation
There is a huge range of definitions of what an SME actually is, and classification being determined by the company’s turnover is common. The problem with this, however, is that companies of the same size can have totally different ambitions as well as banking needs.
“Nobody really knows where the cut off is,” says Mr Monks of Aldermore. Typically the customers at Aldermore may be regional in focus, have between 10 and 100 employees and an annual turnover that is typically between £1m and £25m.
At large banks, such as Bank of America Merrill Lynch, small businesses are subdivided into smaller segments and served across two divisions. George Smith, business banking executive at the bank, explains that SMEs can be served under either the consumer banking or commercial banking divisions of the bank.
Bank of America Merrill Lynch defines very small businesses, those with less than $1m in annual revenues, as having simple needs and deals with them in the consumer and small business banking division. Larger SMEs are served in global commercial banking and these businesses are subdivided further. Mr Smith points out, however, that these definitions are not cast in stone and how the SME is treated often depends on the range and complexity of the solutions they need.
Changing trends
In other areas of SME banking, however, the approach to segmentation is beginning to change. The most common way to segment has been based on turnover, while other methods have been based on the industry sector or geographical region.
Max Firth, managing director of business information services at credit information group Experian, comments on a changing trend in the approach to segmentation: “What has changed over the past year is there has been renewed focus on SMEs. The banks, in a positive way, came to realise what they always knew, but did not implement: that there are different types of SMEs and different types of need,” he says. “In the past there was a one-size-fits-all approach."
Now there is a new interest in segmenting SMEs by their behaviour, which enables banks to identify growth companies that have different needs and could potentially be held back if they were grouped in a segment that merely defines them by their turnover. It could be argued that if banks are able to identify the potential growth companies early on, and with the right systems in place, they can help their customers grow from humble SME to a large corporate entity.
Identifying potential
This is one of the goals that Swedish bank Handelsbanken has with its clients. However, the bank takes a different approach to segmentation; it does not segment its customers at all. The bank has a decentralised, flat structure and uses a model whereby the branch manager is given the autonomy and power to make lending decisions. The bank does have lending parameters and monitoring systems in place, but ultimately the decision is taken by the customer’s branch manager, who is responsible and accountable for the clients on his or her books. With no centralised collections department, the local branch is responsible for chasing the bad loans of its customers.
Simon Lodge, regional manager, Handelsbanken
Handelsbanken is perhaps unique in that it does not attempt to segment SME customers at all. “A customer is a customer – they all get served by the branch,” says Simon Lodge, a regional manager for Handelsbanken. Mr Lodge argues that there are extra overheads involved when credit decisions are automated away from the customer because of the layers of staff involved in the process.
“You have to understand each case on its own merits. If you remove discretion and are away from the frontline, you are saying ‘I know better about this business 300 miles away than this one in my town’,” says Mr Lodge. This approach relies on having skilled staff and so Handelsbanken focuses on hiring staff that intend to stay with the bank for the course of their career. Mr Lodge argues that the emphasis is not on products, but service.
Product evolution
The current environment for SMEs has meant that there is demand for certain types of products. There has been a general move away from overdrafts as these have been easily withdrawn by banks during a downturn, and now there is more need for secured lending. Also, many providers that catered specifically to the SME market, with commercial property loans, for example, have exited the market as many of them were reliant on wholesale funding, which dried up during the credit crunch.
Aldermore's Mr Monks argues that the large banks have not been lending to SMEs because of “balance sheet indigestion”. Many of the foreign banks in the UK that were supportive of commercial mortgages have now left the sector. Aldermore is focused on the SME segment and offers products that are specific to their needs, such as invoice finance, leasing or commercial mortgages. Mr Monks explains that the bank’s approach is to offer secured lending and focuses on valuing the underlying assets, such as machinery in the case of leasing, rather than providing an unsecured loan against the risk profile of a whole company.
Social lending
Another option for SMEs that has emerged in the wake of the financial crisis is Funding Circle, a peer-to-peer online lending service, which functions as a matchmaker between lenders (ie: savers) and SMEs in need of finance. Andrew Mullinger, co-founder and director of Funding Circle, explains that the site’s customers typically have an annual turnover of £1.5m and most of the customers are family businesses that have been operating for about 15 to 20 years, although Funding Circle’s minimum requirement is that SMEs have two years’ worth of accounts.
Mr Mullinger explains that the main attraction of Funding Circle is the speed with which a decision is taken and the funds reach the SME. Such firms are preoccupied with the day-to-day running of their business and lack the time for financial and strategy planning. Funding Circle gives the SME a decision on the loan within 48 hours and the funds reach the customer within four to 10 days.
Mr Cooper at Barclays, however, argues that lending is only one part of SME banking and sees Barclay’s role as helping SMEs to “start up, grow and survive” and offer them additional services, such as credit checks for their suppliers or assistance with chasing bad debts.
Regardless of the approach to SMEs, whether it is as a specialist provider or as a part of a division of the bank, the sector is gaining more attention. Those that succeed will be the ones with a consistent strategy and service that recognises the specific needs of the SME.
