Open banking and the Revised Payment Service Directive (PSD2) are changing the game beyond the world of retail banking. There are also implications for small and medium-sized enterprises (SMEs) and, to a lesser extent, corporate banks. The new regulations require banks to provide third-party access to current account data and allow third parties to initiate payments on behalf of SMEs—altering the way small businesses bank, and the way they make and receive payments.
Underserved by incumbent banks and impatient with their lack of progress in improving services, SMEs are already turning to alternative financial service providers for a host of products and services, including lucrative ones such as payments and lending. PSD2 and open banking are likely to accelerate this switch unless banks can create products and services that solve SMEs’ pain points and improve their level of service. To do this, banks will need to do more than deliver their existing products better. They will need to enhance their digital and data analytics capabilities and develop an ecosystem of partners to improve personalization and deliver more value-added services beyond simply meeting SMEs’ financial needs.
However, banks will still remain at the center of security by defining the procedures for third-party requests for information or to initiate a payment—reinforcing their position as gatekeepers. Because SMEs value security, banks will likely hold onto their advantage if they shift their service offerings to keep up with emerging competitors. However, they will need to watch out for competing offerings from across the market, not only from challenger and fintech banks such as Tide, Coconut, and Holvi but also from diverse new entrants such as accounting platform providers Xero and Sage Pay as well as marketplace players such as Amazon, which could extend their position to disintermediate banks.
In this article, we look at the problems SMEs are facing with financial service providers and examine how new use cases and propositions, built on the back of PSD2 and open banking, can help overcome some of these challenges. Then, we discuss how delivering new propositions will impact banks’ operating models and capabilities.
SME banking challenges
Although SMEs account for about half of all commercial banking revenues, banks have historically underinvested in servicing this segment. In fact, in the aftermath of the global financial crisis, banks’ retreat from funding SMEs paved the way for alternative financial companies that use new technology to provide innovative services in payments and traditional lending.
Faced with declining satisfaction and SMEs switching to alternative companies, banks have started to invest in their SME interface and channels. Two factors have constrained efforts to improve services and deter the move to alternative providers:
Lack of access to data about SMEs outside of banks
- Banks have a limited ability to view an aggregated financial position so they can run advanced analytics and cash flow tools. Because SMEs need to manage their cash position tightly and optimize funding sources, this is a crucial deficiency.
- The choices of funding and financial service providers are limited. Because requirements and criteria differ across banks, there is no way to compare rates and terms without entering substantial information or uploading financial data such as recent transactions.
- Because of limited information, banks and alternative financial lenders are often unable to accurately assess an SMEs’ creditworthiness, price accordingly, or tailor products and services.
Lack of integrated technology
- Dedicated host-to-host connections with banks are typically offered only to large corporations. As a result, SMEs must work through portals that require manual uploads or fragmented online and offline steps.
- Managing business-to-business (B2B) payments is often a pain point for SMEs because of the manual effort involved (chasing, invoicing, and reconciling) and a lack of transparency about the timing of payment, which impacts working capital management. Limited integration of technology means the evolution of end-to-end solutions is also limited in the SME space, unlike the solutions that are available to large corporations.
Open banking and PSD2 are fueling a growing sharing of SME bank transaction data as well as standardization of application program interfaces (APIs), which can be used to integrate technology. Successful companies will bring to market solutions that resolve SMEs’ pain points and deliver value-added services.
Use cases emerging from PSD2
Open banking and PSD2 will trigger a shift to open data. When a customer opts in, banks and other third parties will have access to that customer’s current account data, which will enable an array of account aggregation and other open-data use cases (see figure 1):
Aggregate financial position. Consolidated accounts will show an aggregate financial position across banks or geographies with links to expenses such as insurance, card accounts, and leases. If this capability is combined with cash-flow forecasting tools and data analytics, banks can solve one of the main worries for SMEs around cash-flow and liquidity management. This new service can form the basis for a data-driven conversation with SMEs, allowing banks and other companies to position themselves as value-added advisors or a cockpit for management. Big banks are already offering solutions for businesses to monitor their performance with dashboards and other enhanced features. Barclays, HSBC, Lloyds, and RBS all offer SMEs and middle-market clients products for aggregated cash management. Others such as Tide, Holvi, and Coconut also offer aggregation solutions, mostly focused on accounting and bookkeeping, with payment tracking, tax calculation, and invoice preparation.
Enhanced credit risk scoring. Combined with real-time analytics, access to recent current account transactions (knowing how a company is using its accounts, credit, and payments) can improve credit scoring models that are traditionally based solely on bureau information. For example, Lloyds’ Business ToolBox offers unlimited credit checks on companies and directors in addition to account transaction data. This data will enable banks and alternative lenders to provide credit in a timelier manner, with more precise pricing and tailoring of products to suit individual SME requirements and credit profiles. Offerings such as a “credit passport” that combines balance sheets, bank accounts, and credit registry data will gain traction with banks and alternative lenders.
Peer comparison analytics. Companies can use open API to collect data from accounting platforms and sales ledgers, combined with data analytics, to provide peer analysis on aspects such as market share progression or spending on utilities. For example, Barclays’ SmartBusiness Dashboard offers marketing effectiveness tools as part of a customizable business dashboard.
Account aggregation will become a commodity rather quickly. In fact, this is already happening in mature markets. For SMEs, the true value will be in the intelligent data analytics-based insights, recommendations, and automatic prompts that can be built on top of account aggregation (see figure 2). Additional insights from monitoring can enable banks and alternative lenders to be more proactive and offer pre-approved lines of credit in a timely manner. Many SMEs are willing to pay fees for data analytics-based value-added services that help them grow.
In addition to open data, open banking will trigger a shift to open APIs, allowing third parties to initiate payments on behalf of SMEs. This shift will enable use cases driven by payment initiation service providers (PISPs):
Integrated cash management. Companies can go beyond data aggregation and recommendations to initiate payments on behalf of SMEs between accounts to maximize returns and reduce funding costs. All of the big banks’ and third parties’ account aggregation solutions detailed above also provide automated payments, which is already a standard feature for business accounts.
Person-to-person (P2P) and person-to-machine (P2M) services. Financial companies, mainly banks, can provide wider, more cost-effective transaction services by offering disruptive ACH-based online and in-store payment options for SMEs, which find card payments expensive.
Streamlined B2B payments. PISPs can provide services to streamline B2B payments by capitalizing on real-time payments and the enhanced data that goes with it. This feature can be offered as an accounts-payable and accounts-receivable solution, optimizing working capital. PSD2 also opens the way for new use cases in cash pooling and foreign exchange across banks.
Emerging business models
New open-banking propositions and tools have implications for banks’ operating models and capabilities. Three business models are emerging beyond the traditional do-it-yourself approach, making a significant impact on the SME banking value chain and operating model (see figure 3).
Open banking allows third-party offerings to be integrated into a bank’s or third-party provider’s own offering via APIs and microservices. Banks that operate as integrators will continue to own the distribution of products and services, capitalizing on their established customer base and channels. They can expand their offering via partners that resolve today’s banking issues for SMEs, lighten their administrative burdens, or drive down costs. Several of these services have been discussed in the use cases above. These offerings include accounting and automated bookkeeping, invoicing and accounts receivable management, archiving and data management, tokenization services, travel management, spend benchmarking, and optimization of recurring payments, just to name a few.
The leading integrators will deliver an outstanding user experience and a compelling set of value-added services that tackle SMEs’ primary pain points. These offerings will capture new revenue streams and a larger share of wallet for those that manage to secure the customer interface and become the aggregation service provider of choice for their SME clients.
These banks will continue to develop and own their products and services but use third parties as distributors. Like an Uber ride, which you can order via other apps such as Open Table, Google Maps, or even an Outlook calendar entry, banks will be able to integrate their offerings through third parties. In some cases, banks are already being pushed in this direction because they can offer transaction information and payment initiation services. With seamless integration into the SME journey, banks will also be able to partner with third parties to offer point-of-sale loans (for example, for purchasing a car) or with timely pre-approved loans via a tie-up with accounting packages. Banks could also partner with person-to-person lending platforms to maximize market penetration and to deploy balance sheets with lower customer acquisition costs. One good example is Santander partnering with Kabbage to offer fast loans to SMEs, noted by the Financial Times as “the first move by a bank to outsource the provision of some of its client-facing banking services to a technology platform.”
Winners in this field will identify the most advantageous distribution channels (faster, more efficient, or better access to the customer base) and negotiate a co-branded offering that they can distribute effectively.
This will be the highest form of business model innovation, with banks acting as market intermediaries for customers, integrators, and producers. These banks can still maintain shares in both product development and distribution. One good example is Amazon, which owns and operates a marketplace that connects buyers and sellers. Amazon also uses this marketplace to distribute some of its own products, including the Kindle.
Successful platforms start by excelling at one core interaction or unique user experience, which attracts users. Several moves can create this gravitational pull:
- Provide regular updates and trigger frequent usage. For example, the user visits the platform frequently to get information or updates and is thus regularly exposed to the platform’s interface.
- Offer guidance in a non-transparent market. For example, when searching for a specific complex product such as tax, legal, or consulting services or to satisfy a need such as mobility, the user may need help selecting the right one.
Three factors determine the success of a platform strategy:
- Connection. How easily can others plug into the platform to share and transact?
- Gravity. How well does the platform attract participants, both producers and consumers?
- Flow. How well does the platform foster the exchange and co-creation of value?
It remains to be seen if incumbent banks will transform into platform players, changing their business models in a way that truly delivers value to both customers and producers. Although setting up developer portals and open API infrastructure may be enough to comply with PSD2, it will not be enough to succeed in an open banking market. Banks will need to decide on the strategy and operating model that will best serve their business.
Up next …
There is a long list of potential use cases and business models for banks to explore to serve SMEs in an open banking market. To build a successful offering, banks will need to find new ways of working, rapidly pretotyping offerings and testing them with their clients. Moving toward an agile test-and-learn approach to product and service innovation is the only way to shorten the time to market with solutions that customers actually want. Because customers may act differently than they say they will, it will be essential to test their actual behaviors.
Last but not least, banks will need to have a clear path to monetization from the beginning of the journey. Too often, new offerings are launched with two to three years of lead time and without testing the demand for new services with actual or prospective clients. The industry is being transformed, and banks will need to keep up or find fintechs or other third parties to partner with to better serve their SME customers.