uk digital london

SMEs have largely been neglected by banks, despite playing a critical role in fuelling economic growth. However, this is beginning to change in the UK as digital challengers step in to give the sector the attention it warrants. 

Small and medium-sized enterprises (SMEs), or businesses with fewer than 250 employees and turnover below £50m ($63.7m), are significant contributors to the UK economy, often hailed as the country’s growth engine. In 2018 there were 5.7 million UK SMEs, making up more than 99% of all businesses, employing 16 million people and accounting for £2000bn of turnover, according to the UK Department for Business, Energy and Industrial Strategy.

Despite their importance, SMEs have been woefully underserved by banks historically, especially in areas such as financing and supporting services. This is predominantly due to banks’ ever-shrinking risk appetites and the high cost of serving this segment. The problem became more acute when banks scaled back the concept of having an experienced banker as the local branch manager, a situation that has only worsened with the recent rash of branch closures.

Stuck with the big five

Yet until recently there was no alternative and SMEs were stuck with an oligopoly of major high street banks. The UK's ‘big five’ banks – Barclays, HSBC, Lloyds Bank, NatWest/Royal Bank of Scotland (RBS) and Santander – account for about 75% of the business current account (BCA) market, according to EY’s December 2018 report, ‘The future of SME banking'.

But the landscape is changing, driven by developments in three interconnected areas: emerging technology, including cloud, artificial intelligence (AI) and open application programming interfaces (APIs), developments which have increased efficiency, allowed greater segmentation and lowered the cost to serve; UK government initiatives such as the Alternative Remedies Package (ARP) and Open Banking, both aimed at increasing market competition; and the entry of new players, which in turn has pushed incumbent banks to step up their game.

Simon Healy, industry director for financial services, Europe, the Middle East and Africa, at global IT company Unisys, believes there has been an awakening among new players as to the opportunities in the SME space. “Now there is a vast array of providers looking at this market, from fintechs to challenger banks and building societies,” he says.

State support

Recent government initiatives have also helped to raise awareness. For example, the RBS-funded £700m ARP is comprised of: a £425m Capability and Innovation Fund (CIF), made up of four fund pools, aimed at encouraging challengers to develop and improve financial products and services available to SMEs; and a £275m Incentivised Switching Scheme, to encourage SME customers to switch their BCAs.

To date, Metro Bank, Starling Bank and ClearBank (in partnership with Tide) have been awarded £120m, £100m and £60m, respectively, from the CIF’s Pool A. Nationwide Building Society has been granted £50m and Investec Bank and Co-operative Bank £15m each under Pool B. Pool C and D have yet to be allocated.

Also with the aim of encouraging greater competition, in January 2018 the UK government launched Open Banking, which allows consumers and SMEs (with a turnover of up to £6.5m) to grant third-party providers (TPPs) real-time access to their transaction data via open APIs. While take-up has been slow to date, many think that Open Banking will give SMEs flexibility to use multiple banks, and banking between banks and TPPs could become much more seamless. In addition, proponents believe that it is a more secure, reliable and frictionless way of sharing data.

Beyond the external forces at play, Mr Healy highlights the changing nature of the SMEs themselves. “The growth over the past decade has been almost exclusively at the smaller end of the scale, such as contractors, consultants and one-man bands. The majority lack the time and savvy-ness to engage in their financial affairs. Many are only a business because they must be for tax purposes,” he explains.

These microbusiness owners are typically also younger, more mobile and comfortable with doing everything online. “Technology facilitates doing things differently and SMEs – more than consumers – are willing and prepared to pay for services because they recognise the value add to their business,” says Mr Healy.

A technology play

Many new challenger banks are deploying cutting-edge technology to deliver a more differentiated and personalised service to SMEs. For example, Starling Bank built its core banking platform from scratch entirely in the cloud using Amazon Web Services (AWS). “We offer a state-of-the-art retail proposition that scales with the customer, which means SMEs don’t need to move platforms as they grow,” says Starling CEO Anne Boden.

Starling, which received a banking licence from the Financial Conduct Authority (FCA) in July 2016 and has 46,000 SME customers, provides transactional current account banking for SMEs, unlike other challengers that focus on retail or SME lending. “We are one of the first [to offer BCAs] and that is why we qualified for Pool A [of the CIF],” says Ms Boden. Starling has also committed £94.8m of its own money to building new infrastructure and customer experiences.

According to Ms Boden, it will focus on simplifying the user interface, as well as providing digitally enabled customer support and intelligent tools for managing cashflow and working capital. The bank has already created the Starling Marketplace, which allows customers access to a chosen selection of third-party financial services, such as cloud-based accounting software provider Xero, small business insurance broker Zego, and receipts and loyalty partners Tail and Flux. In April, accounting software provider FreeAgent, which is owned by NatWest, also joined the marketplace.

Tide, another challenger providing BCAs, also built its technology stack on AWS. “It’s all modern, with no legacy,” says Tide CEO Oliver Prill. “We agilely develop technology but also have an agile approach to ensuring that everything we develop hits either a strategic objective or an immediate member need.”

It is a ‘curated platform’ and partners with other fintechs, including Xero, small business lender Iwoca, and ClearBank, to strengthen its proposition. “We want to be the go-to place for SMEs,” says Mr Prill. “We want to be the banking and administration layer, which includes payables, accounting, the things that the SMEs have to think about but are a distraction from their actual business.”

By the end of 2018, Tide – which does not have a banking licence – had captured 1% of the BCA market, a key milestone for Mr Prill, and was opening 10% of all new business accounts. As a result of winning the ARP bid with ClearBank, Mr Prill has his sights set on cracking the switching conundrum. “Our game is about breaking the oligopoly of the big five and encouraging competition,” he says.

Alternative lenders

SMEs face specific challenges when it comes to accessing finance, whether to expand their business or cover a cash shortfall. Despite traditional bank lending becoming less accessible to small firms, SMEs’ awareness of funding options is fairly limited, according to the Federation of Small Businesses' (FSB's) November 2018 report, ‘Going for growth’.

Many still go to their main bank for their financing needs, which is not always the best product or source of finance, according to Lorence Nye, FSB policy adviser for economy, finance and tax. “There is a big knowledge gap, therefore we need to think about education and directing SMEs to the right type of financing, how to make those applications successful and how to best serve their needs,” he says.

Challengers are also addressing the funding gap. For example, OakNorth, which received a UK banking licence in March 2015, has provided SMEs with £3bn of lending and received £500m of repayments. Its total loans increased 160% in 2017-18, to approximately £1.2bn of new lending in 2018. It is focused on established property developers and cashflow-positive, profitable SMEs that wish to scale up, and has not had a default to date. Chief operating officer Amir Nooriala attributes this success to its credit analysis platform, OakNorth Analytical Intelligence.

“Banks stopped lending to the SME sector because it is traditionally a manual endeavour to work out the borrower’s risk. It requires manual analysis and the margins haven’t justified it to the high street banks. So, we decided that technology was the only way to solve the problem,” says Mr Nooriala.

“The platform has different types of cutting-edge technology, all in-house built and proprietary. We don’t use any vendor software,” he adds. “It starts with open-source algorithms but then our intellectual property is in the training of those algorithms and the AI we use.” OakNorth licenses the analytics platform to banks in other jurisdictions.

Iwoca, which is regulated by the FCA and on the Open Banking Register, also built its entire technology stack, according to CEO Christoph Rieche. “We have automated the manual processes and significantly accelerated the processing time. Our personal best is three minutes and 26 seconds, from a customer registering with us to money deposited in their bank account.”

This is possible because Iwoca controls each step of the lending journey from application, data gathering and processing, decision making, onboarding and know-your-customer checks through to the triggering of funding and repayments. “That is a great illustration of the tech stack that we have built and addresses the critical point on speed,” says Mr Rieche. Iwoca’s best time was with a Tide customer, through a proprietary API connection. “It is the most advanced integration of its kind and shows that two great tech companies can come together to provide great services,” he adds.

According to Mr Rieche, Iwoca hit an important milestone in the fourth quarter of 2018 when it approved more customers for its credit facility than either HSBC or Santander did for small business overdrafts, according to data from trade association UK Finance. “Our challenge to the banks has been successful,” says Mr Rieche.

Traditional players

The incumbents are not sitting still, though. For example, CYBG, which owns Clydesdale Bank, Yorkshire Bank, B and Virgin Money, has committed substantial funds to its digital platform, iB, which acts as a testbed for new digital features and capabilities. “We launched in the SME world and created the SME lending facility to help customers access finance on both a secured and unsecured lending basis,” says group customer banking director Gavin Opperman.

CYBG has enhanced its business interbank banking capabilities, which can be accessed online or via the mobile banking app. It added a 24-hour chat functionality with a dedicated support team for simple and routine administrative queries. It also incorporated a money management app created by fintech partner Strands. “Internet banking starts to make it much more cost efficient for customers because we can easily bolt on new digital capabilities,” says Mr Opperman. “The biggest problem for SMEs is that they are time precious; they don’t have time to spend hours going to a bank.”

NatWest has gone a step further, spinning up an SME digital bank called Mettle, which will be in the app store later in 2019. “Our customers were looking for an app-based, digital-only proposition,” says Andy Ellis, NatWest's head of ventures. “Increasingly business owners are millennials and they want to work on the go, so building out our proposition from scratch using digital native technology was the right thing to do for a growing part of our customer base.”

According to Mr Ellis, lending is on Mettle’s roadmap and he points to another venture in his portfolio, Esme Loans, a digital lending platform for SMEs launched by the bank in 2017. Mettle will also include invoice financing through Rapid Cash, also part of the NatWest venture portfolio.

Mr Ellis is not concerned if Mettle cannibalises NatWest’s SME customer base. “If we build a better, more efficient bank that our customers prefer, then we are comfortable with that,” he says. “It is at an early stage, but we would much rather disrupt ourselves then get disrupted.”

NatWest’s approach to the marketplace concept differs from its competition. “Our marketplace will be primarily owned by NatWest,” says Mr Ellis. “For example, Esme Loans is NatWest's balance sheet, which leads to cheaper funding for the SME and the profit goes back into the bank. From a business model perspective, that means there is a route to profit and thereby sustainability.” He believes that marketplaces that plug in other players will struggle to reach the scale needed to be sustainable.

The game-changer

While the jury is still out as to whether UK government initiatives such as the ARP or Open Banking will make a fundamental difference to SMEs, clearly both emerging technology and new entrants are driving change in this space.

“Technology will be a key component in changing the face of banking, as well as the fintechs and challengers coming to market,” says Mr Opperman. “What customers require from banks is an end-to-end process in this new ecosystem that has evolved.”

Mr Ellis agrees, adding that the ‘killer app’ will be created by bringing together the cloud-based solutions for all SMEs’ financial and potentially non-financial needs, so that customers can have a seamless journey from one service to another. “Currently many SMEs toggle between spreadsheets and multiple providers, which is expensive and inefficient,” he says. “Bringing it all together in one place is going to be much better, and whoever that gets this cracked will be the big winner.”

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter