Open banking: An SME perspective

Photo by Carlos Muza on Unsplash

Open banking is one of the key concepts to understand when looking at how fintech has transformed the banking sector. Until now, a lot of the attention has been centered around retail banking, but in the next phase of fintech and open banking, SMEs are set to take the center stage.

Although SMEs account for about half of all commercial banking revenues, banks have historically underinvested in servicing this segment. As a result of the global financial crisis of 2008 the banks’ inability to serve SMEs paved the way for alternative financial companies that use new technology to provide innovative services in payments and traditional lending.

Where open banking so far has resulted in incremental improvements in convenience, customer experience, and efficiency for the retail banking segment, open banking has true transformative power in the SME space. However, in order to understand the disruptive potential of open banking on SME banking, it is important to understand the fundamentals of open banking.

One of the key challenges for SMEs across the board is access to credit in their time of need. A key factor limiting SMEs’ access to credit is the information available to lenders to accurately assess a SMEs’ creditworthiness.

Open Banking is transforming the SME lending landscape by shifting ownership of transactional data from banks to the firms themselves, granting SMEs access and control of their own data. This marks a significant shift from the traditional setting where there was an informational asymmetry between the SME and their current bank who had access and ownership to all transactional data. With open banking, SMEs can now share their information with all relevant potential lenders. Thus, leveling the playing field for new players in the SME lending space, and potentially increase the alternatives and quantity of lending products available to a large number of firms.

In the European market, an important catalyst for this is the revised payment service directive, PSD2. Access to verified transactional data through mandated APIs has the potential to provide lenders with valuable data for new customers that were previously limited to the customer’s existing banking relationships.

Another area where open banking comes into play is customer onboarding. Proof of identity is a core theme for financial services, and banks are prohibited to as much as opening an empty account without going through the necessary Know Your Customer (KYC) and anti-money-laundering (AML) procedures. Onboarding is a nuanced and complex process, involving multiple stakeholders, piecemeal requests for stringent documentation, and manual inefficient processes. As a result, SME onboarding often results in undesirable delays and long time-to cash cycles for SMEs as well as increased costs for banks. With open banking, banks are able to streamline this process by accessing digital public records (if available) to perform the necessary controls.

With the rise of easy-to-use cloud-based accounting software, open banking integrations are becoming more of a minimum expectation rather than a selling point. Although banks have been exchanging data with accounting software providers for a long time, the shift from overnight file transfers cis sftp to open API integrations creates a flow of data that not only saves business owners valuable time but gives increased control over their financial position, current cash flow and future outlook through intelligent cash forecasting.  

For SMEs, payments and payment collection is still a lengthy process, still ridden with hidden fees and little transparency. The ability to initiate payments directly as an account-to-account payment under PSD2 may reduce the friction in B2B payments, and may also 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.

However, open banking for SMEs does not come without challenges. One is that banks will need to develop much more rigorous systems to continually seek consumer consent for data to be shared. Exposing APIs to third parties also increases operational and cyber security risk, as third-party API access is a well-known and widely used attack vector for hackers with malicious intent. 

Based on this foundation there is a wide array of potential open banking use cases for SME banking, but no one size fits all recipe for success. How you intend to leverage open banking for SME offerings is depending on your position in the customer value chain and digital maturity.

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