Why digital lending is the future for banks and SMEs

European Banks can better serve and understand SMEs through a digital credit process, that is data-led and can deliver funds fast.

In brief

• As SMEs look to invest after the pandemic, 66% want access to faster credit. If banks can’t provide this, then businesses will turn to FinTech or specialists.
  
• Banks can revolutionize their credit offering using automation, enhanced data and analytics to simplify and speed up lending decisions.
  
• Getting lending “right” will also be a critical springboard as banks look to develop more financial and non-financial ecosystem services.

Banks have never been so diverse in the range and scope of products and services they offer customers. Yet they must not lose sight that lending is central to their profitability and relevance, and is a foundation to attract and start deeper relationships with customers. Lending can then act as a springboard and allow a bank to offer a wider ecosystem of financial and non-financial services. Banks need to get the “basics” right before investing in non-core services.

Lending is an area ripe for banks to rethink and retool how they serve their customers. Borrowers want change. The EY Global SME survey found that the most requested service was guaranteed access to faster credit. This includes fast approval processes and the certainty that funds are available when needed.

While retail banks embraced digitalization some time ago, corporate banks are only now coming to terms with the power of digital. While we focus on small and medium-sized enterprises (SMEs) lending in this article, banks need to act across their entire credit offering. They have the opportunity to pivot to truly digital lending that serves borrowers better while increasing revenues.

Nigel Moden, EY EMEIA Financial Services Banking and Capital Markets Leader says, “digital lending is a key opportunity for competitive differentiation. This is not just about speed of decisioning and fulfilment (the important basics) but also about delivering personalized customer journeys on a scale never seen before.”

Several drivers are changing the lending picture

As well as evolving customer requirements, the SME lending landscape is being disrupted by several other factors, accelerated by disruptive technology:

Demanding customers

As in most areas of banking, SME customers value speed and convenience. They want a seamless, end-to-end, consistent lending experience that delivers instant decisions and immediate availability of funds.

Disruptive technologies

Banks need flexible, open, real-time, and easy-to-integrate solutions. They now have access to application programming interface (API) enablement and the use of external data sources to streamline front, middle and back-office activities. We would then expect data analytics, artificial intelligence (AI), machine learning (ML) and automation to enhance the offering.

Competitive environment

Small businesses have a wide range of credit options, from FinTech to BigTechs, as well as specialist SME niche lenders. These “challengers” are acquiring SME customers through fast credit scoring and offering loans directly via digital platforms. They can then expand products and services beyond lending to capture other revenue streams.

While banks remain the preferred choice for many SMEs, the COVID-19 pandemic has changed expectations, with SMEs increasingly looking for digital-led, simpler and faster lending. An increasing number of SMEs are looking to FinTechs if their bank cannot meet this demand.

63% of SMEs still prefer traditional banks for their financial needs. But the use of competitors is increasing – 56% of SMEs use a banking and payments FinTech service. (Source: EY Global SME Survey)

Decreasing revenues and operating margins

Banks can no longer rely only on cost optimization for profitability. They need to focus on generating new revenue. Corporate banks are increasingly realizing the revenue potential from the SME sector (particularly the middle-market clients), especially if they can simplify the lending process through extensive digitalization and automation.

A standing start

As banks look to react to the opportunities around lending, they will have to overcome some significant existing barriers in their current systems and processes:

Slow process

Some lenders continue to rely on employees to review and manually enter information from physical documents such as financial and payroll statements. This is something that could be easily automated to be faster and cheaper.

Poor user experience

Banks require a wide variety of documents, often in paper form and in different tranches, compromising the customer experience. SMEs would prefer a simpler credit process, using standardization and more user-friendly technologies.

Lack of data-driven processes

Given the unique characteristics of each SME, banks find it difficult to assess creditworthiness, depending on detailed commercial plans, profit and loss sheets, or financial forecasts. That can lead to an increase in default risk. Today, lenders can enhance credit models by using real-time data and alternative data sources.

Low understanding of SME business

Lenders are often not meeting the needs of SMEs – products are not attractive enough and lack customization. Banks can use more data from new regulations, such as Payment Services Directive Two (PSD2), and leverage open banking to obtain detailed credit data. They can then analyze and adapt their offerings as needed.

Below are some of the key steps that have been core to successful transformation to digital lending. This has been the case for EY client banks of all sizes across Europe:

Case study: How one bank revolutionized its lending offering

A large Central European bank approached EY teams to help it build a digital-first, end-to-end process for unsecured customer loans. EY teams work led to a mobile-first, AI-enabled digital platform that significantly enhanced the bank’s lending processes. The modular platform allows a full set of digital processes, including identification, innovative credit scoring, anti-fraud and an electronic-signature system.

Once implemented, the new digital process saw customers receive funds in an average of 30 minutes. Including rapid feedback loops and prototyping also helped boost customer engagement and increase the bank’s understanding of its customers, further improving its services.

Read more here.

Enhanced information 

Banks can enrich the data that sits behind the credit scoring model. Lenders can integrate internal customer data with broader and more innovative information retrieved from external sources (local socio-demographic data, web data, PSD2, etc.). This allows the bank to unlock financing for creditworthy but rejected SMEs and offers predictive, tailored solutions (using AI, ML and data analytics).

Scalable and open-banking technology

Leveraging APIs and the cloud allows banks to offer more complex and targeted services and be faster and cheaper to run.

If banks really want to digitally transform their lending, they must look at changing not only the customer journey but the underlining processes. Many digital enablers, applications and systems can accelerate digitalization, all through the credit process. The challenge for banks is finding a combination that most efficiently replicates their credit life cycle, making integration easier.

Leveraging the full power of the bank

Lenders should work with all business units across their products and services and tap into distribution channels and after-sales services. This helps build an agile operating model with clear governance to operate across the bank at high speed.

Customer experience first

Ensuring customers have a seamless journey across different products and services, with a clear end-to-end journey, builds satisfaction and loyalty, as well as lower drop-out rates as banks become more relevant.

Best in class

Working with third-party solution providers ensures a wide, deep and up-to-date offering in line with the banks’ long-term vision.

Working with organizations, EY teams have also seen some common problems they have faced on this journey. For example, many SMEs want to apply for credit on their phones, so any solution needs to be designed to be mobile-friendly. Also, given that loans are often negotiations (around term length, amount borrowed and rate), any system needs to be flexible enough to adapt without forcing customers to restart the entire process.

Digital lending – a revolutionary change for SMEs and banks

The pandemic showed SMEs the advantages and potential of digital banking services. How banks respond to that demand is key. While there are many interesting non-core services they can develop, they must not lose sight of getting lending right. A fully digitalized lending offer can allow banks to make fast decisions while giving a frictionless and easy process for time-busy SMEs. Critically, it also means banks can obtain rich, real-time data that can help them better understand SMEs’ needs and design new products accordingly. It can also be a step towards hyper-personalization that can create bespoke offers for each SME.

EY teams have seen several lenders (and even digital banks) look to enhance their digital lending and run into problems. The key to success is ensuring the underlying systems and the customer journey are changed. That means using the right digital tools at the right stage of the credit cycle, such as a credit decision engine.

Banks will need to understand where they can stand alone and where they may need to partner or use white label solutions. We are already seeing several banks partner with FinTechs to accelerate their digital transformation in this space.

It is a crucial time for banks to land their SME lending proposition. Many SMEs are looking to invest post-lockdown to either digitalize further or use their enhanced digital presence to expand overseas. At the same time, rising interest rates make lending more profitable and will attract non-bank lenders to serve this sector. With branches closing, those banks that can deliver digital lending for SMEs will have a clear competitive advantage.