It takes Three to Help SMEs: Banking, Finance & Accounting, and Technology
August 18, 2018
Are the SMEs finally going to get their dues with the evolving banking services driven by technological advancements after years of being under-served? Or will this innovation be driven by neo-banks and FinTechs?
Let’s start with banking. Banking’s progressive shift began with the evolution of several retail-banking innovations, largely because of the added value proposition offered by these superior, AI-driven FinTech experiences. The last 5–7 years have seen the emergence of various business models designed around making the retail banking experience seamless – talk about PFM, instant payments, wallets, recommendations, chatbots, and so on.
SMEs, despite being such a crucial component of global economic growth, have been trailing when it comes to innovations tailor-made for their needs. Business banking has mostly skewed towards the interests of large corporates due to the high-profit margins and bigger loan books. The reduced risk appetite of banks for SME lending, lack of access to API based payouts for SMEs, accounting and taxation challenges, etc. – are some of the key indicators of how SME banking has been trailing behind retail and corporate banking in terms of intent and the innovation quotient from the incumbents’ perspective. Moreover, the emergence of the gig economy, freelancers and early-stage startups have brought these gap areas out in the open, resulting in a timely reaction from the FinTech innovators.
FinTech business models, sensing the opportunity here, are driving the momentum shift as the innovations are slowly trickling down to the SME banking space. Over the past few years, many FinTechs have launched offerings focused on SMEs. From 5-minute account openings to SME lending and to invoice financing, these FinTechs, and digital banks are now driving the innovation in SME banking.
To get a clear perspective, let us have a look at some of the major problem areas/use cases in SME banking and see what the current landscape has in store for solving these problems.
Banking and accounting should (ideally) come together
One of the biggest operational challenges that almost every small business faces is accounting. Small businesses have traditionally been juggling between banking and accounting dashboards to check for payments against invoices. The lack of automated, intelligent accounts receivable and invoicing systems for automatically matching invoices against incoming payments brings in huge complexity, which results in a lot of overhead costs, tiring manual reconciliation efforts, and the dangerous prospect of human error messing up the numbers. Since small businesses deal with low value, high volume payments, the complexities get compounded, resulting in inefficiencies.
Source: DBS and Xero
SMEs need to make sense of their expenses
In order to keep track of their cash flows and thus ensure financial stability, SMEs need to have a holistic, transparent view of their expenses – including operational, business expenses, and payouts. Travel costs, unauthorized bookings, improper receipts, and data entry errors can bring in complexities and pose challenges.
Since small businesses do not have proper approval policies and procedures in place for managing their expenses, malpractices such as expense padding, fraud, and inefficient reporting can create serious challenges for their P&L and balance sheets. Moreover, the limited financial analysis capabilities with manual expense management make financial decision making a challenging affair.
Cross-border payments are a complex and costly affair
Small businesses deal with low value, high volume payments in the space of trade/vendor-supplier payments, freelancer payroll, etc. Bank wire transfers prove to be very costly with their high transaction fees and hidden costs. The FX rates keep fluctuating, resulting in significant market risks. Also, the poor settlement speed across several trade corridors results in delayed payments.
The complexity of taxation and related compliance challenges
As opposed to large corporates who have dedicated teams of advisors and accountants handling their taxes, SMEs find themselves at the wrong end of taxation and the related compliance challenges. Goods and services tax (GST) in India is an example, where small businesses are still struggling with issues pertaining to the input tax credit, frequent rule changes, and steep penalties for late filings.
Some of the other key use cases in the SME banking space are SME lending, invoice discounting, trade finance, etc. That’s another huge source of pain for SMEs and a big topic in itself that we will cover in another article in the coming weeks.
While these are some of the major challenges associated with the traditional way of SME banking, the newer innovations in this space – driven largely by the FinTech and software providers – are ushering in a new wave of SME banking, with innovative solutions across three major categories:
**1. Ground-up neo-banks offering bundled solutions: **Several digital only banks for SMEs have incorporated their in-house solutions pertaining to the challenges in accounting, taxation, cross border payments, expense management, dashboarding, etc. as a bundled capability within the banking app. Some examples being:
Open (Bankopen.co) provides integrated invoicing, recurring billing, payment gateway, and reconciliation capabilities. It’s a non-licensed neo-bank in India.
Holvi provides taxation, invoicing, expense management, reconciliation, and bookkeeping capabilities. It’s a Finland-based neo-bank duly licensed as an authorized payment institution in Europe and was acquired by BBVA in 2016.
Starling, Revolut and the Ireland-based non-licensed neo-bank Fire, provide free of cost, cross-border money transfer with real exchange rates.
2. API-driven Marketplaces: Many of these digital banks, as well as some FinTechs and software companies, provide marketplaces which enable SMEs to integrate their existing accounting/tax/expense management systems onto their banking platforms, or choose from a list of partner solutions listed on these marketplaces.
Some digital banks with marketplaces are Starling, Open, and Hufsy.
Xero is an interesting example, as it provides end-to-end accounting and other capabilities such as account payables, account receivables, taxation, invoicing, expense tracking, reconciliation, inventory management, etc. These solutions can be integrated with these marketplaces (e.g., Starling, Open, Hufsy) via APIs. Also, Xero has its own marketplace with 700+ tools which can be seamlessly integrated with the SME banking systems.
**3. Software-based (B2B) modular solutions: **There are numerous FinTech players as well as large software providers, which provide modular solutions for each of these use cases. Several large banks are now partnering with such solution providers. E.g., Bank of America partnered with Viewpost to extend its online invoicing and payment capabilities to SME customers. Numberz is another example of a FinTech startup providing software solutions for account receivables.
There are a plethora of FinTech innovators looking to disrupt the way SMEs avail their basic banking services. These FinTech innovations are driving efficiency and productivity gains by enabling SMEs to have efficient accounting processes, easier reconciliation, cost-effective and faster cross border payments, better access to capital, cognitive insights on their expenses and cash flow, and other capabilities. SMEs getting empowered through access to better banking and financing services will augur well for global trade and economic development and thus will result in a vibrant business landscape.
Given the number of SMEs worldwide and the complexity of their needs, we see this space continuing to grow with innovations to suit every size of business.