Even before Covid-19, banks have long struggled to service SME’s lending needs and faced pressure to boost customer service from digital banks entering business banking. Now, the unprecedented demand for the Government’s stimulus packages and Bounce Back Loan Scheme (BBLS) has further highlighted cracks in the traditional ways banks offer loans to smaller businesses. Lessons must be learnt from this and banks should embrace and participate in lending marketplaces which offer more flexible ways to connect borrowers to lenders.

Fintechs putting pressure on traditional lenders
The big banks have long struggled to service SMEs’ lending needs and this was only exacerbated in the 2008 financial crisis. Despite a period of prolonged low-interest rates since traditional lenders simply have not been lending to SMEs at the scale that was initially hoped after the crash. New Basel III rules put in place to maintain appropriate levels of liquidity, require banks to keep far greater capital reserves on loans, which simply made lending to SMEs a less profitable endeavour for banks that were already more risk-averse after 2008.

However, often it is simply the process of getting a loan which is the greatest pain point for smaller businesses. Applications for business loans with traditional lenders can be a clunky procedure and it is common for the terms offered to not provide the flexibility that these fast-changing businesses need from a loan. This means the sheer time it takes to get a loan holds business leaders back from focusing on the actual day-to-day running of their businesses.

This has opened the door to challenger banks such as Tide, Starling and Monzo to enter the business banking space. They have used the same playbook that helped them win customers in the consumer space, offering a purely digital customer experience to simplify the entire process of getting a business loan.

Teething problems with the Bounce Back Loan Scheme
The Government’s stimulus packages for businesses struggling during the economic lockdown caused by Covid-19 has been a herculean effort, with UK banks and alternative lenders paying out nearly 35.5 billion in state-backed loans to nearly 1.2 million businesses hit by the Covid-19 crisis. However, the unprecedented demand, with more than 130,000 applications on the first day of the Bounce Back loan opening, has identified cracks in banks’ lending infrastructure.

There were early reports of some banks’ online systems failing to support applications. At the same time, applications were being rejected for businesses experiencing temporary cashflow problems due to the pandemic but that were otherwise solid companies. This ignited criticism of the limited number of lenders included at the opening of the scheme – Barclays, Danske, HSBC, Lloyds, RBS, Santander and Virgin Money – and the old tensions between traditional lenders and smaller businesses.

As a result, the Treasury and British Banking Association have expanded the list of accredited lenders for the Bounce Back scheme including fintechs and alternative lenders such as Tide and Starling. However, these fintechs have faced their own set of challenges. Without having the scale of the bigger banks, they have reached their lending limits quicker and so have had to start slowing down the pace at which they give out loans.

A problem common with both digital banks and traditional lenders alike is that they have both only offered Bounce Back loans to existing account holders or at least prioritised their own customers. This has left many businesses scrambling to set up new business bank accounts with these accredited lenders, slowing the process at which they can receive these much-needed funds.

Embracing lending platforms
It’s clear that SME borrowers now, more than ever, need more flexible ways to access credit; and to be connected to the right lender that can meet their financing needs in the most seamless way possible. Traditional lenders, therefore, need to heed lessons from the challenger banks and digitize their own infrastructure, partnering with fintechs to help them innovate at speed.

Open Banking and the revised Payment Services Directive (PSD2) have paved the way for banks to participate in lending marketplaces, such as Loansquare, for the benefit of businesses borrowers and banks alike. This model allows businesses to apply for loans from third-party banks and alternative lenders through a single point of entry and seamless digital experience. Enterprises of all sizes can quickly access the funding they need, without being tied to a particular bank.

The benefits of a more open commercial credit market go both ways though; indeed, it will be vital to help traditional lenders digitalise and meet customers’ mounting expectations in a post-Covid world. By participating in lending marketplaces, banks can access a wider customer base beyond their existing account holders and make competition work in their favour. Businesses still like the security that comes from taking a loan out with a trusted name and big lenders can use their size to offer loans to business customers that fintechs may simply not be able to.

These new financing solutions also enable banks to improve their margins on standard bank loans and make the application process more frictionless, without having to invest in their own digital infrastructure. By managing all aspect of the loan process completely online, from next payment dates, to fee amounts and covenant clauses, it can reduce banks’ operational workload and risk and make loans more profitable and viable.

It’s clear that this crisis will shake up the lending market and accelerate the existing drive towards digitisation. This is a chance for banks to try new models and to explore ways that they can better service SMEs financing needs. While banks historically preferred to have complete ownership of the customer relationship, the benefits of a more open lending market are manifold, helping them fend off mounting competition from the digital banks and to boost the profitability of each loan.