SMB Lending: What the Economist's Survey Says

I'm your host Jim Young, senior content strategist at Q2, and I'm joined today by a whole host of guests. So I'll take them in alphabet order.

 

We have Greg Demas, Q2 VP of global sales, Ali Khan, managing director of Q2 ANZ, and Ian Nelson, managing director of Q2 EMEA. And the reason we've got such an international cast is because the report we're discussing today drew its data from all over the globe. It's based on the survey conducted by The Economist and jointly sponsored by Q2 and Salesforce. And it's called, "What is shaping the ecosystem of small business lending?"

 

There are a lot of interesting findings in the report and we'll have a link to it in the show notes, but today on the podcast we want to get together. These experts from different regions see what they thought about the topics covered in the survey and what the respond is. Lenders from both traditional financial institutions and fintechs, what they had to say.

 

And, I won't make all of you guys talk over to each other to respond to my greeting, so I'll say sort of a general thanks to all of you for joining, and we'll just dive right into the questions.

Greg, let's start off with you. This report starts out with going over some familiar ground about why small business lending has always been difficult market for banks, given the thin margins and modest loaning amounts. And now you add in incursion of fintechs and, at the risk of ending this before we start, is this market worth the trouble, so does speak for traditional financial institutions?

 

Yeah. Thanks, Jim. Thanks for the question and thanks for having me on today. I think for any bank that wants to be an integral part of their community, they don't have the option of having a small business arm or not, small businesses make up the backbone of global communities, whether that's in EMEA, Australia, New Zealand, the US, or elsewhere. So I think for any bank that wants to have a community presence, this is a space that they have to play in.

 

Now that's not to say that this has to be a loss leader for them and you're right, banks have struggled for a long time on not only how to profitably operate in this segment, but also where this should exist within the segment. It's kind of a hybrid between a consumer retail operation and a middle market large corporate commercial type of operations.

 

So, there is kind of this no-man's land feel to it and yes, with small loan amounts, margins can be challenging. So, I think banks have to be committed to this space. We're seeing banks doubling down on this space and to your point, we're seeing fintechs coming in and changing the competitive landscape, so.

 

Where you've seen banks historically try to combat those profitability challenges by [inaudible 00:03:39] their underwriting function, and trying to auto adjudicate types of things. And I think you're seeing a lot more of that happening now, as they try to control the cost front.

 

The interesting thing that's happening now and the article did a good job of touching on this is how fintechs are coming into the space and using alternate data sets to ultimately just have straight through processing and totally upend the way that a traditional bank would've been underwriting this.

 

So, I think a lot of banks are grasping onto that, and I think that's kind of the answer to the question that, banks are seeing that this is a space that they need to stay in and they need to keep investing and operating, but they need to totally change the way that they've historically done it.

 

OkayAli?

 

Just leading on from, I guess what Greg said and the points that he made valid. In Australia, obviously we've got about 2.4 million SMEs. There's 7.4 million people that are employed. There's a significant area for the banks to be participating in.

 

Now, the report tells us there's a gap of 120 billion in the region, particularly here in Australia and around, for financing gap that the banks are not catering for. And for the points that Greg mentioned above, because it is expensive for the banks to do business in that area, it is considered a lot more riskier. So yeah, definitely. I think it is an area and market segment which has a gap, which has a large number of businesses that needs to be catered for. So the big banks do need to play in that area.

 

The report also talks about a concentration of debt finance towards corporate level. So, by spreading that out and allowing more SME financing, it would be a better scenario in a financial situation. So, I think this is definitely a segment that the big banks need to be participating in. Not only participating in, but as you know, this is an area where they are focusing on now as well.

 

Yeah. If I could just maybe step in there, you guys mentioned really good points. I think when you compare it to the sort of European flavor of this, and this is a space that the banks have recognized that they have to tackle, you're absolutely right, part of the fabric of the European markets and the marketplace of clients. But, when you touched on it right at the very beginning Jim, it's a cost to serve. And it's always proved to be a very, very expensive cost to serve market. The income and the interest that's generated in that space, allied to the bad debts that comes with it at times, it sometimes don't balance themselves off. But, I do think that they are looking very closely now at technology and how that can and how that can help them.

 

I think that the pressure from the alternative finance sector has made them re-look at how to serve this marketplace and actually the pandemic as well, made them look very, very closely at the processing in all sectors. And the one area where particularly the tier ones and the SMB bank looked was on the costs and the lack of process in this space. And I think that's where we will see and we are seeing now in Europe, a number of the tier ones looking at how they can do an element of their SMB bank on a straight through process basis so that they can carve out elements of the business. Maybe it's the one to five, maybe it's the one to 10 million bracket depending on their credit appetite risk. Then, I think that's where the winners in this space will come from, that can use technology to carve out bits of the market that they can satisfy in a much more technological, but much more cost effective basis.

 

One thing I'm kind of curious about Ian, and you brought this up with the pandemic and, it seems to me that, yeah an argument for it, definitely you need to upgrade. If you're going to try to get serious in this area, you need to upgrade your tech, you can't use your old processes. But at the same time, we're still in the pain pandemic and one of the stats cited in there was, 44% of the lender said dealing with the economic fallout from the pandemics, that's our greatest challenge right now.

 

And, so I'm curious all three of you guys at some point, I'm sure, have had some version of a conversation with a potential customer in which they say, "Really interested, but I've got a bunch of stuff essentially on fire right now. I've got to deal with the short term of people and probability to default and what's what risk profile of my portfolio looks like."

 

I guess one of you guys, raise your hand to jump in on this and tell me, what do you reply back in that situation if someone tells you, "I get it. I understand this is important for down the road, but right now I can't deal with it right now," I guess. Is that an option?

 

Well, I'll take that one. I think that I've spoken a few times on panels like this, around the potential tsunami of debt that could come down the track on the back of the pandemic. And, it's fair to say that I don't think any of the regions have really seen that to this point. So, I think to answer your question in some way, it's perception over reality. So, is there a ton of debt on its way? Are the bad debt protected by some of the schemes that have been placed in place by the government's in different geographies?

 

I think that what we shouldn't forget though, in the technology business is that technology is a true end to end provider for clients. And as much as the banks of members look very much at the front end and client engage in terms of technology, there's no reason at all, why they shouldn't be able to look at technology at the back end of the businesses as well, in terms of how that can help them alleviate some of the stress points, some of the volumetric side of it, if there are large elements about debt and still allow them to concentrate on their core businesses of lending.

 

Jim, let me just jump into, or let me let say this now so you can actually use this in the thing. Jim, if I can jump in a bit on the topic of profitability of small business banking for banks. We've been looking the whole time through the lens of lending, and there's the ages old adage in banking of being a relationship bank and the concept of privacy, which we've talked about on this podcast before, and things like that.

 

The article was very much focused on lending and the margins that are available to lending and small business, etc. But, there is also a lot of talk about personalization, which I think we'll probably perhaps talk about a little bit if we get to that part later, but the concept of profitability from small businesses, shouldn't just come from lending.

 

A big trend that we're seeing is small businesses that are typically owned by wealthy consumers, right? So, the merging of small business lending with private banking for example, is a way to generate a lot of profit on the wealth management side that is tangentially associated with small business. The concept of offer personalization for payables and receivables, which are typically a need that a small business has too. So I think as banks look to double down in this space and make it more profitable for them, they can't just be looking to loan margins that they're generating. They need to look at it a lot more broadly than that.

 

It's a really good point, Greg, and it actually really segues nicely into the next question I had, which was, I wanted to kind of dive into, and there's again, a ton of different data points in this piece. I definitely urged people to give it a read, and again, will have that link on the site.

One of them that jumped out to me and Ali, I want to throw this one your direction, it was around personalization. And the statement was, "Personalized interactions will remain vital to build customer loyalty." And more than 90% of US and European lenders agreed with that statement, but only 28% of lenders from ANZ agreed, and 55% of them disagreed with that.

Any thoughts as to why that's such a wide gap there?

 

Yeah, Jim. That's actually an interesting one and I noticed that as well, and it kind of just stood out and maybe in a way also kind of implied that here in ANZ, we are not pro going digital, or there's a hesitance in digitizing as much as I guess, in some of the other areas. Or, maybe we are not adopting the new technology as fast, but that's certainly not the case.

 

So, it'd be interesting to understand what exactly was the true definition of personalized interactions, that was provided to people. And I think it just comes down to their understanding of it in my view, but the gap is significant. And like I said, it kind of almost reflects that here down under, we are not really ready for digitization, but throughout the report and the server that was done, there are a number of indicators which shows ANZ leading.

 

There's a question I believe it's 15, which talks about what is the biggest trend that's going to be impacting your business. A name that stands out on the AI, the new technology indicator. It is above the global average of people in Australia who really consider that new technologies are going to be in impacting the business greatly. So, I believe it is a bit of a mix of, I guess, the cultural aspect of providing that personal service as well. And Joseph Healy from Judo, the CEO of Judo in the report sums it up quite well. He talks about high touch and high tech, and he talks about whether they use technology, but a lot on with technology, as soon as the technology has played its role, the relationship manager goes out and does a site visit to actually see, kick the tires and touch the bins and see if everything's there.

 

So, I believe it is a combination of those aspects that the market here in Australia is looking at. We are still very pro branch networks in the sense that there should be branch networks for banks, for example, but with a digital lean towards it. There are examples where traditional banks have shut down branches, but set up small centers, which provide digital output for its clienteles, provides a digital experience so to speak. Much like you would have with the apple smart bar where you go in, take your laptop and they give you some advice around it. So, it is that whole human plus technology element that is really, really tied into it and I think that's what kind of reflected in that survey. But, there is a significant gap in there, but I don't think it's kind of implying what it is supposed to be there. There's a little bit more to it in my view.

 

Got it. 

 

If I could just give a view on that, the number was very high and it stood out, but I think it probably dictates a little bit of the maturity of digitalization in the region. There is a maturity in digitalization in the region at the front end so, the client engagement side. There's been a huge amount of investment over previous years in the region on engaging with clients. And I think the perception as I go around the market and speak with banks is that, they recognize the investment they've got in there, but they see it as an enabler to the relationship building with their clients, not taking away the relationship with their clients. And I think that's where in my view, that's where that perception comes from.

 

And, we've seen a disintermediation really of being able to use technology to remove the bits of the journey that they can do quickly and easily, but still allows them to spend more time in the more complex, more detailed areas where they do need some more hand on to be able to manage clients requirements a lot better.

 

So I think to me, that's why that number is quite so high in this region.

 

Yeah. And Ian, I was struck a little bit too, that there was another sort of question around the tech where it seemed like the European audience was a little bit less enthused about the impact of it over the next couple years, but was more enthused about AI. And, the way I sort of interpreted that was, and again, I think this bears itself out in various forms that Europeans are a little bit farther out on the tech curve than the American or ANZ audiences. And so to them, new tech is maybe not as flashy this point, but the tech that they are interested in is the stuff that's even farther out on the tech curve, which the other audiences are a little bit more.

 

And I know, I've seen this from U.S. conversations from a few years ago, when you would mention AI and they would immediately kind of pull back like, "Well, that's way out there."

So, I wondered if that answer was a little bit of a reflection of where Europe is sort of a little bit farther out on the tech curve?

 

To a degree, I would say, I would agree. I think there's been investment in the front end in terms of digitalization engagement with clients, at the front end. I think behind, it's been a little bit more fragmented. It's a little bit more of a patchwork quilt. So I do think that the thought process within Europe is how they backfill some of that fragmented architecture in the background that sits behind the shiny front end.

 

And AI, I think one of the reasons why that has come up is if you do look at the pandemic, even if you just look at something like credit. If you look at credit today of a borrower, if you put the additional sort of algorithms and thought processes around how you would view them, how many clients would stand up to that post pandemic? Their turnover will have dropped. They'll have had to lay people off. They'll have furlough people. The dynamics of businesses and consumers will be completely different over the next few years. And consequently, the credit skills need you to be able to determine who are the good credits, and who are not. I think has a different dynamic too.

 

We're seeing in a lot of AI coming into that space that can really aid banks and link into them to aid them in that journey. So, I think in my mind, it probably, I agree with you, it's about the maturity of the front end digitalization. But, it's probably more about what it left behind in the back office a little bit and how they could use technology to fill some of the gaps that maybe the pandemic has brought forward into that.

 

That makes sense, definitely. Wanted to skip ahead a little bit in the report to the section about the concept of ecosystem lending. And to me, I almost thought about it more in terms of partnership lending with that partnership existing between traditional FIs and fintechs.

 

I mean, there's an obvious peanut butter and chocolate, or a peanut butter and jelly, or whatever your local food is that combination that makes sense. I may be revealing my American biases here but, there's some obvious things that work here. But I guess my question is, and Greg, I'll let you take first stab on this one, is this really that simple? Or is there a concern? And I think there was something voiced in there that some banks have got massive trolls of data that they've been sitting on.

 

So, are they giving away a competitive advantage if they partner with a fintech? Is there a downside here, and if there's not, maybe why isn't it happening faster?

 

Ecosystems are complex, right? And, I don't think that first of all, that's become such an incredibly cliche term, but it is probably the right analogy to strike here. But, there is all kinds of different players and dynamics, etc, happening in an ecosystem so, I'm not sure there's any straightforward answer to this question but, it is definitely here to stay.

 

You have your classic buys versus build model that every bank is going through right now, and simply put, they can get it to market a lot faster partnering with fintechs, rather than trying to build everything in house. I feel like from the biggest banks, the JP Morgans of the world down, I think almost every bank is publicly saying that we need to partner more, we shouldn't be trying to build everything in house. So, that's a great thing. Partnering with while also competing against the same things that is here to stay.

 

I think there's another important thing to think about here. A lot of banks don't exactly have a forward thinking, innovative brand perception in the market, right? In particular, to pertain to small business whereas if you look at the demographics of small businesses, it is a rapidly younger and younger population that are starting their own businesses and having their primary financial services provider be a bank that may have some legacy brand concerns or anything like that is something that is real and something that banks need to understand. So, partnering with fintechs, or even the concept of embedded finance, where perhaps the bank isn't even the front end and they're offering a lot of their balance sheet and process that the processes that they've spent decades building to a front end brand that may resonate more with a small business owner, those days are here to stay. I think that's a great thing.

But again, this is a very complex ecosystem and there's an infinite number of flavors of that. And, that's a good thing too, because it allows banks to kind of understand where on that spectrum they want to play.

 

Sorry, I'll let you go Ali. I'll step up.

 

Jim, when the FinTech boom happened, it was almost taking on the big banks and it was like, the fintechs are going to take on the big banks and the right big banks are going to perish and we're all going to have these fintechs that are going to be the new banks. But, that didn't happen. The big banks have a very significant role in all economies around the globe. The big banks control a significant size of the market even still.

 

So, what I think has evolved is that the partnership aspect between fintechs and the big banks, and the big banks realize that they're slow, that they're hard to innovate, they're hard to integrate, need new ideas through and through. So, what they started doing was started partnering, started buying there's significant M&A activity that happened.

 

They decided that, these are the areas that they wanted to invest in and they went out and basically got them. So yeah, this is definitely a play for an ecosystem. Here in Australia, after the pandemic years in the region, we've seen significant M&A activity happening in that space. And I'm sure Greg and Ian, would've seen that in their regions as well, the consolidation.

 

So, this consolidation coming in where medium fintechs are looking to partner or buy smaller ones and larger ones are looking to then acquire those medium ones and so forth and so on. So, that is happening. I think that is good for the ecosystem. It is good for the economy. It's good for people that are involved in these ideas. Generally they start really small from small businesses and startups and scale up. And then once you get to a certain size, they become very attractive for some of the big players.

 

So, I believe that is the dynamic that's going to be played out even more going forward. Something that I think we would probably see over the next few years around consolidation, more M&A, more partnerships in the ecosystem. So I think, yeah definitely this is how the landscape will probably evolve going forward.

 

Ian?

 

Yeah. I mean, I'm really passionate about this, really. The European markets are a little bit more fragmented than my colleagues' markets, and always have been. The influence of the banks have been a privacy type [inaudible 00:25:28] because it's slightly less in Europe, particularly in the SMB market. The opportunity to borrow monies via different methods, whether it's via ALT 5, whether it's via leasing, asset finance or trade finance or invoice finance, has been really wide and has provided quite a fragmented market.

 

But actually, I get quite excited about it because I think it's quite a dynamic market. If you look at something like buy now, pay later, which is big news in Europe. There is a number of ALT 5s that have set up, that work directly with merchants to fund small value, to medium value goods on very, very short terms without actually having to do a huge amount of credit checks with very quick point of sale type finance.

 

And, in slight antipathy to Ali's point, actually, it is starting to eat the lunge of some of the bigger banks to the extent that they're bigger banks. And we were speaking to one or two or three now where they're having to look at their own capabilities to enter that marketplace.

And, what we're seeing is they find it, Greg's point, very difficult to move quickly and in an agile manner. So, it leads itself to an ecosystem to collaboration, to a marketplace where people coming off a lot more closer together. So, I absolutely feel sure that that's the way forward. And I do think that it's more than likely that you will probably leave the trend in that, just because it already starts from a more fragmented nature.

 

All right. And this is one of those things, again, we talked about it behind the scenes before we got on here, and we could go on for a long time on this one.

 

So, I want to find this sort of a stopping point here by simply asking a question for each of you to answer and kind of take your pick from after reading this report, did anything stand that we haven't already covered? I guess, stand for example, I know we've covered that sort of strange personalization number and ANZ, that sort of thing, but anything else stand out for you in the report? Whether it was something that surprised you or something you pointed your finger out and said, "Yeah, that's really important or that's really profound." And so to go ahead, someone tell me who wants to chime in first on this one here. Or I'm going to... All right, Greg, you go first.

 

I'll close with where I started, which is financial institutions, the concept of small business is woven into the fabric, to use what Ian said there of society. And they play a critical role in funding and in the success of effectively small businesses with a backbone of pretty much every economy out there.

 

So, the impact that this diversity that we're talking about, this collaboration that's happening from an ESG standpoint, which is really where the article closed is phenomenal. I'm with Ian, I think it's a thing we should all get passionate. ESG is the most important topic right now out there, and should be for a long time.

 

And I think that this diversification of options, this complex ecosystem that's being built with

banks and ALT 5s, and then working together and then competing against each other, is going to do nothing but further the whole concept of environmental, social and governments issues that we're facing globally. So, I just think that's really important. I was happy that the article touched on that to close out.

 

Ian and Ali have one more chance to chime in here. Ian?

 

So, just an extension to what Greg says. I have a sort of personal chip on my shoulder on this ESG thing, and that it probably doesn't go quite far enough.

 

It's about accessibility. We've spoken a lot here about how technology can help banks, but the technologies, it's how it can help their clients and accessibility to be able to enter and access that marketplace is probably the biggest. So, it's just an extension away from ESG in many respects. We saw it during the pandemic in the UK. I know it's not quite in the SMB space, but in the UK, during the pandemic, there was school children without laptops and connectivity with broadband to their skills for learning and a lot of technology is driven around having a laptop, having a phone or the latest technology. We develop all of our stuff to be the latest technology and accessibility for all forms of businesses and consumers is just an extension of that ESG piece for me. And just how we an industry can make that easier for people.

 

Yeah. Jim, I think particularly for myself, was exciting to read, was around the appetite received by alternate financial institutes and traditional banks for borrowing clients, and for lending in particular. It is evident that there is a new wave of new products, which are more risk friendly, so to speak. They are more consumer friendly, hence as well, and that is what the ALT 5 sector is bringing to the market.

 

Traditionally banks have been fairly risk-averse to land to this SME space for various reasons we've touched on, but it is clear that because of data, because of technology, there is an ability to reach to consumers with alternate products, which are easier to use, which are not so taxing on information that is required, which could be short term, long term could be tailored and at the same time, provide a real transparency to the funder, which is what they need in a transaction to cover their risk.

 

So, I believe that is the trend, which I'm particularly excited about. These are areas where ALT 5 alternate financial businesses and fintechs will bring a real benefit. The big banks will hopefully then catch on and hopefully change some of their product and credit criteria as well. And I think, that is going to provide a lot more working capital, a lot more financing in the SME space, which the report highlights throughout is a significant gap that is needed significantly. So, I think that is probably for me the most exciting area.

 

Great. Thanks to all of three of you for coming on today, to talk about this really, again, interesting report. And again, it's from The Economists, and Q2, and Salesforce, and it's called, "What is shaping the ecosystem of small business lending." And again, we will have a link to that in our show notes.