The last several years have seen an increased focus on the rise of neobanks and endless debate over their ultimate threat to traditional banks. These newly built digital-first banks often target conventional banking products with more cleanly designed experiences. In parallel, embedded banking services have seen an explosion in growth, and companies across all industries are working to build financial services products into their platform. These trends have also driven the increased need for data “connectors” such as MX, Plaid, and Akoya, enabling consumers to share their data cross-platforms. Despite all this progress, banks are seeing a vital component of the banking relationship slip away, and it has a disproportionately negative impact on smaller regional banks and credit unions. They are losing the small business customer.
Small Businesses Drive the Economy
One of the largest revenue sources for smaller FIs is interest spread – that is, the difference between the interest rate that a bank charges a borrower and the interest rate a bank pays you to keep your money there. FIs can’t just collect deposits and earn revenue from Debit interchange and fees to thrive. They need to lend large amounts of money to drive profitability and growth. For most small FIs, this means lending money to small businesses, and those small businesses are increasingly consuming financial service products from non-banks.
The evolution of embedded finance has increased the availability of products provided by non-bank providers. As small businesses shop for these products, they often find that a product they are already using, such as their accounting software or shopping cart provider, offers lending and other more tailored products. This isn’t just about better experiences. These products often offer more relevant features or customized pricing because they are provided by companies with a more holistic understanding of their customer’s business needs.
Additionally, the ubiquity of mobile means many small business owners want to be able to increasingly manage their business via their phones. The landscaper seeks to send an invoice while wrapping up a job onsite or the owner of a cleaning service wants to send a quick quote for a custom cleaning. These new methods of engagement are shaping the behavior and expectations of small business owners, and banks are not keeping up.
Digital is Taking Over
For many FIs, the small business customer can be hard to reach. With 98 percent of small businesses having fewer than 20 employees or being sole proprietorships, these businesses often look like retail customers in bank systems. This lack of visibility into the customer means there can be a limited ability to target SMBs and offer them financial products that they may find helpful. The good news is that many smaller community banks and credit unions have utilized their local community engagement to build strong customer relationships and identity needs. Until recently, that typically meant offering lending, merchant acquiring, or insurance services. Meanwhile, larger FIs developed marketing programs to target potential customers and bring them into the bank.
The challenge is that these traditional methods are starting to lose their effectiveness with businesses. Increasingly, the digital trends mean that SMBs spend less time talking to their banker and more time interacting digitally. This has made them more inclined to explore a solution from an existing product or service they are using and optimize for convenience and value-added features over relationships with their banker. The FIs are losing their grip on the customer.
According to Industry Analyst Ron Shelvin’s Cornerstone Advisors survey from 2020, SMEs spent more than $500 billion on accounting/bookkeeping, invoicing, bill payment, and payment acceptance services from third-party providers. Banks generate more than $11 billion from accounting and payments services provided to small businesses, yet only 6% of small businesses get their accounting and payments services from a bank. Ron nicely pointed out the opportunity for banks to drive additional revenue. Still, I think the shift in the industry has moved this from a revenue opportunity to a business imperative, especially for smaller FIs.
Perhaps the most significant opportunity is for FIs to use the data they already have about their small business customers to more proactively drive value-added services. All FIs have information such as when you typically pay recurring bills, your typical income pattern, how you have managed your cash flow over time, and how the business is growing. Yet very few use this information to offer products such as short-term loans, bill prepayment, auto loan payoff, and additional cross-selling opportunities. Instead, non-traditional financial services providers like Shopify and Quickbooks are starting to leverage data aggregation services to scrape the data from banks and use it to offer these services themselves. This trend is eroding the FI’s relationship with the customer.
Many smaller community banks and credit unions don’t have the resources to build these products internally. The good news is that advancements with APIs and the embedded finance movement mean more options than ever for FIs to offer modern products to their customers. Banks can use companies like BankiFi to provide cash flow management and AR/AP services, Modern Treasury to extend payments facilitation services or nCino for a modern lending experience. These are just a few examples of fintechs targeting banks with products that enable banks to offer a broader set of services to their small business customers and maintain customer relationships.
Change is Necessary
We won’t know for some time whether the neobanks will ultimately prove successful; however, we have seen their impact on the industry. Consumers continue to expect lower-cost banking products, fewer fees, and more services from their banks. It would be easy to argue that it will become increasingly challenging for FIs to make money from the retail bank consumer. This emphasizes the need for FIs to bolster their small business customers and utilize them to drive more substantial revenue across lending and other products.
To do this, FIs will need to identify their small business customers, offer them the digital experience they have come to expect, and use their insight into the customer to offer additional products and services. This means FIs need to stop evaluating small business product business cases based only on net new revenue and consider looking at them by avoidance of asset erosion from lost lending opportunities. Banks that aren’t able to make these adjustments likely will not survive.