A Digital Approach to SME Banking is Essential

Years of low interest rates, difficult consumer, corporate, and investment banking business conditions, and a tricky macroeconomic environment have squeezed many core areas of business for banks. In this context, previously overlooked segments are worth revisiting. Small and medium-size enterprises (SMEs) in Europe represent one such opportunity for banks seeking to grow. European Central Bank (ECB) data highlight that for 20 percent of SMEs in Europe, access to financing is their most urgent problem. The same data shows that one in five SMEs is unable to access the credit it was planning to use.

Despite the demand, the opportunity remains elusive for banks, which have struggled to serve SMEs successfully. The challenges from a bank’s perspective are many: smaller business clients demand a higher intensity of bank attention with limited returns—and a higher (perceived) cost of risk. Even quite small businesses can have complex and rapidly evolving needs, along with an unsteady risk profile; and yet, they often expect premium service. And there is no one-size-fits-all approach banks can apply to these clients, given the variety of needs, business types, and decision makers.

Structurally, SMEs as a group fall between the cracks of retail and corporate banking, so from a banking perspective, there is often no natural organizational “home” for them as clients. SMEs also represent a broad range of business sizes: those at the micro end of the segment share similar dynamics to a personal or affluent consumer, while those at the larger end have profiles and requirements more aligned with commercial-banking clients. This uncertainty is illustrated by the fluidity of many banks’ “organigrams,” whereby the SME business is pinned, and re-pinned, to different parts of the business—finding a home in neither the retail nor the commercial-banking segments.

However, while many of the challenges outlined above will continue to be a factor for banks considering serving the SME segment, banks now have access to tools and capabilities that can alter the equation to a point where SMEs can be served well and also served profitably.

Time for a new look at SME banking

The SME sector is the backbone of economic activity and employment in most countries, leading governments, business groups, and regulators to highlight SMEs as an area of opportunity for banks to serve better. Programs such as Small Business Saturday, interventions from national business organizations, and increased scrutiny (such as the ECB reporting on SMEs) are among some of the efforts highlighting the importance of these businesses.

For banks, the timing is opportune because many of the historical challenges to serving the segment well and profitably can be addressed through digital technology. Banks can also transfer the capabilities and lessons they have gleaned from providing digital services to their retail banking customers over to their SME banking clients. Given that many SME leaders themselves are today more fluent in digital engagement for their personal banking, they are now more likely to be comfortable with similar solutions for their business needs.

Nobody said this would be easy

Banks, of course, are encountering stiff competition for their retail banking customers, and are likely to experience the same challenges in the SME arena. Sophisticated, agile, and well-funded organizations—including fintechs and large nonbank digital firms—are seeking to engage SME clients, either through full-service or selective-service models. Other players (for example, accounting software providers) are seeking to disintermediate banks by migrating upstream and taking control of SME banking selection; payment platforms are broadening their solutions and locking in their clients with financial and reporting products.

As alternative banking and financing options multiply for SME business leaders—and as their other suppliers offer richer, holistic solutions supported by sophisticated real-time, always-on, digital solutions—the traditional-banking proposition begins to seem very dated. Compare, for instance, the global real-time tracking offered by a logistics company on delivery status with a 15-day payout period for an agreed loan.

From their side, banks carry three legacies from their past engagement with this segment that make it difficult for them to maneuver nimbly. The first is a business model predominantly defined by interest income and some reputational challenges to fee charges. The second is a cumbersome legacy IT infrastructure that affects processes including risk, products, and servicing. Third is an obsolescent mindset on how SME clients are to be served, which seems out of step with modern competition and client expectations.

Despite these challenges, there are banks that are succeeding in the SME segment.

What are the winners getting right?

A number of banks have been able to achieve a significant uptick in performance with SME clients. McKinsey benchmarking data show that top-performing banks in Western Europe generate more than 30 percent higher revenues per SME customer than average banks, driven both by higher lending and cross-sell revenues. The combination of higher lending margins with more revenues from less capital-intensive cross-sell products yields a significantly higher capital efficiency for these market leaders. They have also found ways of balancing income streams more toward fees than interest margins.

At the same time, these leaders have reduced their cost-to-serve by migrating a high share of customer activities to digital channels. Advanced digital banks in small-business banking, for instance, have increased the number of clients they onboard digitally to roughly 80 percent, while reducing onboarding times by up to 85 percent. They also activated all their customers online and almost half do so on mobile platforms.

Banks seeking to serve SMEs at the level of the leaders described above will need to make purposeful strides forward in their capabilities, service model, and SME value proposition. Most of these successful banks have achieved this through real transformation rather than by tinkering with and optimizing their existing operations.

What SME clients want

Unlike large commercial clients, where decisions are made based on more established organizational terms, SME decision makers frequently use their personal experiences to set their professional expectations. So, the challenge for banks is that they are competing with the fully evolved digital experiences offered by online retailers, payments platforms, or logistics companies.

In general terms, research on SMEs highlights the importance of customer service—regarding both satisfaction and customer loyalty. For instance, a recent McKinsey survey of German SMEs shows that good customer service is the number-one reason SMEs choose their main bank (approximately 36 percent of respondents), followed by convenience of branch location (approximately 34 percent), and an enhanced online channel (about 26 percent). Moreover, SMEs tend to be loyal to their bank: in the United Kingdom, for instance, as few as a quarter of SMEs switched their main bank in the five years leading up to a McKinsey survey. Key drivers for switching are better pricing (23 percent) and better online service and functionality (23 percent).

There are, of course, vast differences in the behaviors and needs of the decision makers at leading SMEs, their organizations, and their industries. Traditionally, banks have addressed this range of preferences and needs with a relationship-managed service proposition—and in some cases this model still makes sense. But for most banks, SME relationship-manager (RM) client portfolios are in the hundreds, and the average RM time in role is fewer than 36 months. In some cases, RMs may only meet a client once or twice before changing roles. In these cases, the concept of “relationship banking” is a somewhat hollow promise, as banks end up relying heavily on standardization, system-supported decisioning, and industrialized process discipline that results in treating all their clients alike even if their needs are different.

Digital tools, such as proactive diary management, automated meeting notes, data mining with AI-driven prompts, integrative RM workbenches, and digital assistants, can provide parts of a holistic answer to these challenges. Counterintuitively, advances in banking systems, data analytics, and customer relationship management capabilities mean that a digitally led service proposition can be significantly more personal and engaging than an RM-led approach.

SME decision-making dynamics are also important for banks to understand: the larger the organization, the more removed from consumer expectations it becomes. However, for the more than 90 percent of SMEs that are closer to the “small” end of the spectrum, there is a strong “consumer” component to the decision process. In contrast to most larger corporations, where there is a shared organizational set of expectations and norms, expectations at SMEs are often set on a more personal level by one or two leaders.

Importantly, while there are still business decision makers who do not keep pace with the latest consumer trends, even digital laggards are now seeing the benefits of new ways of working, and generational shifts mean that the younger, digitally native generation is taking the lead.

This information was extracted from McKinsey’s official website.