While many banks have an ambivalent stance toward small and midsize businesses, they should not abdicate the key role they can impact of technology in
While many banks have an ambivalent stance toward small and midsize businesses, they should not abdicate the key role they can impact of technology in banking sector pdf in this sector, and should not give up on healthy returns. But success requires making strategic choices from a set of options that feel radically different from one another.
We are known for our holistic perspective. We cross boundaries with our clients to create value. 3a A Guide to Winning SME Banking Strategies. Strong economic growth in many countries boosted demand and masked the need for hard choices. This dynamic proved very expensive for many banks after the financial crisis deflated SME profitability, drove huge credit losses and prompted restrictive regulatory responses. Many banks now have an ambivalent stance toward SMEs.
Large US banks, for instance, are making fewer small business loans than a decade ago, forcing small firms to turn to higher-priced alternatives. Banks have also been slow to invest in digital platforms for SMEs, focusing instead on their retail and industrial businesses. In emerging markets in Asia and Latin America, banks face different challenges, given that the SME business can be quite profitable in the context of high interest rates and relatively high fees. Some of these fintechs have quickly scaled up to a significant size. Private equity funds, pension funds and insurance companies also are stepping up their lending to midsize companies.
At the very small company end of the spectrum, merchant acquirers such as Cielo in Brazil actively provide financing to merchants based on receivables. Most of these alternative lenders have the advantage of competing outside of banking regulations, at least for now. Unless banks actively defend and seek to grow the business, they stand to lose a sector that’s important both to bank portfolios and to the broader economy. Europe, a huge profit pool.
Being a relatively complex business requiring a number of capabilities, it’s less susceptible to commoditization than retail banking and less price-sensitive than credit and ancillary services to large corporates. SMEs’ economic role, moreover, is substantial. US, companies with fewer than 500 people on staff employ nearly half of the workforce. In our view, banks should not abdicate the key role they can play, and they should not give up on healthy returns. But what if banks could evolve their operations in ways that cause the ROE to exceed hurdle rates? Such a model looks appealing on an ROE basis.
SMEs can, in fact, offer attractive returns, if banks take a more carefully designed, tailored approach. With many clients, it is difficult to meet the cost of capital and generate a healthy product through the anchor product alone—a transaction account plus a loan. Banks need to devise sustainable combinations of credit and auxiliary products and services, as well as a detailed understanding of customers’ needs, so that they become credible for cross-selling. They also must demonstrate to business owners that they can reliably provide convenient, fast, lower-cost processes. Banks face several challenges in this regard, starting with a low-interest-rate environment, only moderate economic growth, a tighter regulatory environment and rising customer expectations. Small firms want greater access to convenient, digital self-service and a better user experience. Larger midsize firms want specialized advisory services and an array of digital solutions, including bank systems that can be integrated with their accounting and treasury systems.
Some banks are turning the SME sector into a winning proposition by making strategic choices from a set of options that feel radically different from one another, rather than being a variation on a theme. The fundamental choices in setting one’s ambition lie along two dimensions. The first dimension of choice involves how restrictive or expansive a bank will be in participating in SME markets. A bank could reduce or expand its exposure overall, make selective investments in current positions, or at the extreme, exit the business altogether. The second dimension of choice involves the extent of disruption to the current business model.
Incumbent banks naturally incline to the status quo, making only gradual changes to their SME model and relying on cost cutting as a path to eventual profitability. But continuing to run a business as has been done for the past decade or two is unlikely to yield much better results. More likely, building a sustainable model that’s both profitable and prudent will require more radical measures. It’s useful to ask what the business should look like five years hence and work backward—which might mean departing from current choices about customer segments, products and distribution patterns.
One European bank recently defined an ambition to reignite its SME business. It aims to grow the overall exposure substantially and to reach leadership positions within select SME segments such as healthcare and professional services, more than doubling overall market share in the process. The first phase of the plan will rely heavily on investments in high-touch, branch-based advisory services tailored to the needs of the target segments. Once a bank has defined its ambition, it is ready to make deliberate choices about customers, products, distribution and value propositions. How should it segment the customer base, and which segments should it emphasize over others? What value propositions should the bank offer to the different segments? A broad-based portfolio, covering multiple segments with a full product offering, is increasingly vulnerable to digital competitors pursuing slices of the market.