The British Business Bank does not live up to its name and is not fit for purpose, argues Greg Taylor. What SMEs need is a proper nationwide small business bank.

Banks have long struggled to make a profitable business out of serving small and medium-sized enterprises (SMEs)—arguably to the detriment of overall economic growth, productivity and employment. There are a number of reasons for this.

One is, as McKinsey explains (“How banks can use ecosystems to win in the SME market”), that “finding the optimal balance between providing great customer experience and managing the cost to serve has…proven to be difficult”—i.e., small companies can pay only small fees. Another is that the credit quality of SME assets tends to be uneven, so credit losses are potentially high.

• Why Banks Will Be the Future of Funding
• Why Britain’s SMEs need a Proper Small Business Bank
• What do SMEs Contribute to the UK Economy?
• Which Bank is Best for SME?

Why Banks Will Be the Future of Funding

What tech knows

Technology can help overcome those difficulties:

First, it allows lenders to analyse companies that do not fit pre-existing credit models by using “alternative data” and alternative sources of data. That should broaden the scope and cut costs.

Read Also: Which Banks are more Profitable, Domestic or Foreign Ones?

Second, technology can give lenders access to low-cost, real-time data on company performance and outlook, which not only helps support near-instant credit analyses but also advice and networking services.

Third, lenders could use “big data” to build realistic models of the world in which an SME operates now and might operate in the future. Artificial intelligence and machine learning could then, in principle, be used to help small companies solve problems such as finding new opportunities, being sustainable or hiring the right staff.

What banks know

Really powerful solutions for SMEs are still in the future. This is partly because banks have always had a privileged data position: they know what the financial “ground truth” of a company is. Cloud accounting and open banking can now make bank client data available to non-banks. However, they also make it easier for banks to access and use data from any customer in the market.

Alternative data, such as from a payments hub, can be used to see cashflow and, so, to build lending models—but nothing beats the actual numbers. That is why alternative credit-scoring companies such as LendUp, which provides loans to individuals, “seeded” their algorithms by making small loans. That was the only way for them to be sure that non-financial data gave accurate enough insight into likely credit behaviour.

One of the challenges for incumbent banks is that, although they have “ground truth”, their systems were not built to expose that data to the analytical tools used now.

“It can be easier for some banks to access and model their own data via the external facing open banking APIs than it is to access it from their own platforms directly,” said Jonathan Holman, Head of Digital Transformation at Santander.

Why banks are needed

There are some big-tech platforms that look as though they should be better positioned than fintechs—or even small lending banks—when it comes to analysing SME performance. Amazon, for example, has data on cashflow, inventory, website ranking, the speed of response to customer requests and many other parameters.

Amazon uses that data to price loans to the merchants on its site. In theory, that should work well. In practice, Amazon Lending struggled—and is set for a relaunch this year.

What went wrong?

There were reports that Amazon couldn’t really assess creditworthiness because its view of an individual SME’s business was too narrow. In its 2018 annual report, Amazon said that the allowances for “doubtful accounts” in its lending program were US$237 million at the end of 2016, $348 million at the end of 2017 and $495 million at the end of 2018, with additions on top of $48 million, $111 million and $147 million, respectively.

However, Amazon is not leaving the SME market. It announced in its fourth-quarter 2019 results that it will invest US$1 billion in helping MSMEs (micro, small and medium-sized enterprises) in India get online. The aim is to “enable” $10 billion in cumulative Indian exports by 2025. As of early February 2020, there were press reports that it is going to cooperate with Goldman Sachs and other banks on providing SME credit.

What SMEs want

Many SME founders have little more financial knowledge than the general public. That can make wrestling with the intricacies of getting funding or handling accounts a time sink. Ideally, a bank would take that burden away. However, that is not always what has been on offer.

“SMEs need to focus on running their business, doing business day to day. Banks support this best by helping the management do business, not by helping them do banking. For some, this is a mindset shift in the industry,” Holman explained.

That gap in the market, together with the rise of online businesses and “alternative data”, has opened up potentially lucrative opportunities for non-bank financial-services firms to offer cost-effective and supportive services for SMEs—including full-service banking.

A number of fintechs—including Coconut, Countingup, Mettle and Tide—have launched in the United Kingdom to support SMEs. Big tech is equally interested in the segment, even if players such as Amazon have not done well in the United States and Europe to date.

A better partnership

SMEs can clearly benefit from speedy access to well-priced financing. Back-up support around taxes, accounting and strategy also has obvious value. What may be less beneficial is having to provide a large competitor with details—even in part—of the company’s performance.

A company like Amazon could, after all, use the information it has on the performance of small companies on its platform to move against them. It could, in theory, also offer that data to third parties that compete with those SMEs. The core business of big-data platforms is, after all, data—not bookselling or financial services.

Banks, in contrast, are pure financial-services providers. They do not compete with their clients, and keeping data private is central to what they do. They are also large-scale, regulated, deposit-taking institutions. That gives them not only reach but lower cost of funds.

“Alternative finance providers struggle to match the cost of funds of banks and therefore the price of financing they can provide. Thus far they’ve been able to justify this premium in speed of execution, enabled via their often superior technology,” Holman explained.

Banks and Open Banking

But what if all potential lenders had great technology and access to the “ground truth” of bank data? Open Banking in the UK and PSD2 (Revised Payment Services Directive) in Europe give SMEs (and individuals) the right to allow providers other than their banks direct access to their bank data.

The regulations were designed to spur competition and innovation in financial services. The idea is that those third parties could merge financial and other data to develop completely new services. Strong take-up of Open Banking could, in theory, blunt the edge that financial data currently gives to bank lenders.

As of the end of 2019, there were one million users of Open Banking in the UK, according to UK Open Banking, so the service is still nascent. It might still do great damage to the business models of incumbent banks. However, it is not only fintechs and challenger banks that can benefit from broader access to bank data. Banks can, too.

Big banks are not usually perceived as offering innovative fintech services, but that is changing. Some are setting up stand-alone fintech challengers—as Royal Bank of Scotland (RBS) has done with Bó—and some are innovating on top of existing platforms.

Innovation will be the way forward, according to Holman. “Banks need to offer value-add services, to SMEs, on top of open banking to encourage data permissioning.”

Large banks already have trusted brands, a big customer base and lower funding costs. Access to the bank data of even more companies should enable them to leverage those further. To help banks to do this, we at LIBF have just launched a new qualification—a Level 3 Certificate in SME Lending and Alternative Data.

Why Britain’s SMEs need a Proper Small Business Bank

At present SMEs looking for funding face a perfect storm. Blanket credit policies from the banks, the fact that some SMEs are overleveraged due to the CBILS borrowing they needed to survive the pandemic, issues with liquidity within many alternative peer-to-peer lenders, and the banks’ current lack of lending appetite, have all combined to make present circumstances very tough for SMEs.

They need help urgently and the best solution would be to establish a new government-backed bank to rival the main high street and investment banks and to replace the British Business Bank.

The British Business Bank doesn’t perform a banking role but simply helps introduce other commercial lenders to SMEs to help them obtain finance. Unfortunately, it fails in this task.

Its website simply points potential borrowers to the sources of lending that may be appropriate, but most of these are commercial moneylenders with their own terms and conditions. It takes a huge amount of time to work through these in applying for finance and any small business owner could find pretty much the same information by a simple web search.

Small businesses in the UK are being let down because it’s still very difficult and time consuming to raise even small sums of money at a fair rate of interest.

The BBB also plays an intermediary role administering the Coronavirus Business Interruption Loan Scheme (CBILS) and performs poorly here too. Several UK banks and lenders have identified the BBB as the intermediary that has been obstructing fast access to COVID-19 emergency cash, citing the BBB’s lack of resources and complicated processes as the main problems.

Under the terms of the CBILS loan scheme, banks make their own decisions about which customers to lend to, but the Treasury requires them to book those loans with the BBB. Banks across the country must follow BBB rules in order to qualify for the Treasury’s 80 per cent guarantee of the money lent under the scheme, but banks and other lenders say that the BBB is following Treasury guidelines far more rigidly than support schemes in other countries.

Meanwhile traditional high street banks and other big financial institutions are not covering themselves in glory either. They are often not prepared to take the trouble to understand the characteristics of particular firms and don’t empower their staff to make judgement calls, instead relying on sweeping judgements about whole sectors.

Many SMEs with long-term potential will therefore find themselves locked out of funding.

We’ve seen many examples during the lockdown period of good businesses that can’t access the funding they need from high street banks. One example is a coach company that has been frozen out of accessing vital funds to keep the business running during the pandemic because its industry sector code (SIC Code) is “Travel & Tourism” and it has a high level of hire purchase.

This is a business with a long history, strong financials and growth, and no more debt than you would expect to see any similar business possess: in short, it’s a good business. Yet it can’t get the funds it needs because the banks deem the whole sector “high risk” and are not looking for the good businesses that need support within that sector.

What we need is a bank prepared to back deserving companies over the long term that is free from ordinary shareholders with vested interests. The government could invest in the bank directly, or, if funds are to be raised from private investors, they should be in the form of bonds or other instruments that insulate the bank from short-term pressures.

Staff should also have expertise in specific business sectors, so they have the confidence to make a judgment call about a company’s prospects for long-term success, rather than relying on crude metrics (like credit ratings) or generalisations about certain sectors. We need a “central” UK bank that will actually provide funding directly to a growing company at a fair and reasonable rate, rather than through associates.

There is already a precedent, as until 1990 the UK had a viable postwar model in 3i, Europe’s most successful venture capital firm, and its precursor, the Industrial and Commercial Finance Corporation (ICFC). ICFC was set up in 1945 and backed companies with sound business fundamentals regardless of short-run fluctuations both politically and in the markets.

It had a public purpose and it was decentralised because it delegated authority to local branches, where staff were expected to develop a real understanding of their client businesses. Its commercial success came from growing alongside its borrowers, rather than profiting from them. It proved to be a successful model that paid off for the ICFC as well as its clients.

Ball and chain

The UK government should act now and establish a new institution similar to the old ICFC before lack of funding becomes a ball and chain around SMEs. Indeed, if it misses this opportunity, we may never get another. We have a credible prospect of a reset that enables both a successful recovery from the pandemic and the levelling up that is fundamental to the future of the country.

The financing model of the past three decades has not worked for the SMEs, especially in the regions, and there is no basis for expecting it to do so in the more hostile environment after COVID-19.

The UK needs to think urgently about reviving the ICFC model, or COVID-19 and the lockdown will do a great deal of damage to our SME sector which could be avoided. What small businesses really need is a proper British Business Bank.

What do SMEs Contribute to the UK Economy?

SMEs are generally thought to be the backbone of any healthy economy; they drive growth, provide employment opportunities and open new markets. According to one study, which was carried out by Santander, SMEs contributed to 51% of all turnover generated by the private sector in 2018.

SMEs are undoubtedly a central piece that bridge the UK economy. When it comes to financing start-ups and small businesses, we cannot underestimate their significance in today’s economy.

Small businesses and startups positively contribute to the growth of innovation. The SME industry is a foundation for entrepreneurs to grasp an idea and see it into fruition. More importantly, they spur competition generating new metrics of doing business. The best example are so-called digital/innovation disruptors like Uber, Airbnb or Funding Circle who shook up their respective industries and created new ground for competing and building businesses.

According to Market Inspector, the UK government has a record of encouraging growth in the domestic FinTech industry. The number of FinTech investments in the UK is one of the biggest worldwide. Although China is the leader when it comes to investment, the UK became the most prominent hub for FinTech players.

New findings by the Hampshire Trust Bank (HTB), SMEs in the top 10 cities in the UK are forecast to contribute £241bn to the economy by 2025, a 19% increase from the £202bn contributed in 2016.

London, which has the largest number of SMEs of any city, contributes the most to the UK economy with a gross value added (GVA) figure of £152bn in 2016, forecast to rise by 19% to £181bn in 2025.

SMEs generate lots of employment opportunities across the UK

They also create a group of skilled and semi-skilled workers to support future industrial and business expansion in the country. The stability of the UK economy relies on low unemployment rates. Workers – who themselves provide goods and services – earn a wage which they then spend on goods and services.

Consumer spending is the factor that most affects economic growth and GDP (or gross domestic product). The latter is the total market value of all goods and services within a country; it’s one of the primary indicators used to measure the economic health of a nation. Businesses won’t invest in capital and labour, or try to expand to meet consumer demand if people aren’t spending.

Currently, SMEs employ around 16.3 million people, contributing to 60% of all jobs in the UK. It’s been reported that SMEs have created over 2 million jobs in the past 5 years.

In the study cited above, SMEs were found to be especially important to the local economies of South West England, Wales and Northern Ireland; in these areas, SMEs account for 70% of jobs within the private sector. Small businesses are particularly effective when it comes to supporting local economies; they bring growth, prosperity and innovation to areas outside of our main cities, which facilitates the equal distribution of income and wealth.

SMEs generate competition and encourage further innovation across a range of industries

They provide the economy with a healthy supply of new skills and ideas, and make the marketplace more dynamic. If we think about the success of startups like Uber, Deliveroo and Airbnb – all of whom have shaken up their respective industries – it’s clear that SMEs have a firm foothold at the moment, thanks to advances in technology. Entrepreneurs are identifying new markets and setting up SMEs to open up these new markets.

SMEs can respond and adapt more quickly to changes in the economy

Because they’re usually more customer-orientated or understand the needs of their local community, small businesses are more likely to survive economic downturns too.

Currently, SMEs account for at least 99.5% of businesses across every main industry sector. SMEs are recognised as being vital to the UK economy, and the government has identified that they could be the key to increasing the country’s productivity, which has continued to fall in recent years.

As such, there’s been more investment in funding to support small businesses. Whether you’re a business owner looking for some sound advice or an entrepreneur in need of a start-up loan, there are plenty of initiatives worth looking at.

Which Bank is Best for SME?

If you run a small business, a bank account isn’t an option, it’s a requirement. Every business should have its own dedicated checking account, and possibly savings, credit cards, and other accounts, to keep cash safe and build a financial record for the business.

But don’t just head to the closest bank and think they will offer the best deal or even all of the features you need in a small business bank. It is important to do research to choose the best bank for your unique business needs.

When reviewing accounts, consider some of these features, which may or may not matter for your business: cash deposits, mobile check deposits, free ATMs, keeping all accounts at one bank, interest-bearing checking accounts and in-person customer service.

And while keeping in mind that business bank accounts tend to charge higher fees than personal accounts, you should still seriously consider the costs of a bank account. Major fees for business bank accounts include monthly account fees, excess transaction fees and excess cash deposit fees.

Because every business is different, there is no perfect account for small businesses. Some small businesses may be happy with an online-only bank that does not charge any monthly fees. Other businesses care more about frequent cash deposits and will never need to deposit a check from their phone.

The only universal desire in small business bank accounts is low fees, so be on the lookout for fees that you may be charged unless you meet specific criteria to avoid them.

Now that we have all that out of the way, let’s take a look at the best banks for small businesses.

Chase

If you want the traditional bank experience, Chase is your best option as a small-business owner. Chase has locations around the country, offers business checking with no fee as long as you maintain a $1,500 minimum balance, plus one of the best online banking and mobile banking systems available.

Chase is also a great bank for business credit cards. Chase Ink Business Preferred, for example, offers high-value rewards you can use toward free and discounted travel. If you have your checking and savings accounts at the same place, it is easier to manage everything with one online banking login.

In summary, Chase takes the top spot because it offers everything your business might need, lots of locations, and options to dodge monthly service fees. Both small, solo businesses and brick-and-mortar businesses with many employees can easily find their needs met at Chase.

Navy Federal Credit Union

While it is not technically a bank, Navy Federal Credit Union offers top quality business banking services perfect for a wide range of small businesses. Those include business checking and savings, loans, credit cards, payment processing and even retirement and insurance for you and your employees.

Credit unions are not-for-profit entities. This means they tend to charge lower fees and offer higher interest rates on savings than for-profit banks.

To open a business bank account at Navy Federal, you’ll first need to become a business member. This requires you to join the credit union yourself as an individual first. You’ll also need a $100 opening deposit to get started.

Credit unions are typically geared more toward consumers than businesses​ but don’t overlook the big opportunity to save money with a business checking and savings account at a credit union.

Axos Bank

While Capital One put its Spark Business Checking on hiatus, Axos Bank jumped up to claim the spot for the best online checking account that is currently available for small businesses. Axos Bank is the oldest online-only bank in the United States with years of experience providing banking services for both business and personal customers.

The Business Interest Checking account is free with a rather large $5,000 average daily balance, otherwise, you’ll pay a $10 monthly fee. The account includes up to 50 free items per month, so it is not ideal for the busiest businesses with a huge number of transactions or a smaller business that keeps a low daily balance. But it does offer interest, currently 0.80 percent, and great online and mobile banking options.

Axos also offers a basic business checking account with no monthly fee, up to 200 free items per month and other goodies with no interest. Depending on your needs, this may be better than the Business Interest Checking account.

Axos also offers money market and savings accounts for businesses, CDs, and a full suite of cash management services. It’s pretty impressive for any bank, not just online banks. If you don’t need to work with cash but do need a serious bank, consider Axos Bank for your small business banking needs.

Wells Fargo

Wells Fargo is a hugely popular bank, despite some recent bad PR. It is the largest Small Business Administration lender for SBA loans and has more branches than any other bank in the United States.

Wells Fargo offers four different business checking accounts. These accounts all have monthly fees, but you can avoid them with a minimum balance requirement in most cases. For the Simple Business Checking account, the minimum is $500 to avoid fees.

Because Wells Fargo is so big, it offers virtually any service your business might need. That includes things like payroll, HR and business tax services. But you may pay more to get many of those services from Wells Fargo than some companies that specialize in those various services.

If your small businesses use a lot of cash, Wells Fargo is one of your best options. Not only can you deposit cash at the largest branch network, but you can also withdraw fee-free from its massive network of ATMs.

M&T Bank

If you live on the East Coast, consider M&T Bank for your small business banking needs. M&T has 690 branches in New York, Pennsylvania, Maryland, Washington, D.C., Virginia, West Virginia and Florida. But M&T stands out for more than its branch network.

M&T Bank offers relationship managers who do more than offer you bank accounts and help you with customer service questions. These bankers review your business finances inside and out to help you better understand them and achieve best small business success.

M&T Bank is a top 10 SBA lender and offers a range of bank accounts. There are five checking options that may be a fit for most small businesses, plus specific accounts for medical and professional services industries.

Read Also: How to Switch Banks Smoothly Without Missing a Single Payment

The biggest downside is that you need to maintain a big balance to avoid fees in most of those accounts. To avoid the $10 fee on the basic Simple Checking for Business account, you have to maintain a $2,500 average balance.

US Bank

US Bank isn’t quite as big as some of its competitors, but it still offers a large network of branches and ATMs around the United States. The biggest standout for small businesses is the Silver Business account, which offers checking with no monthly maintenance fee.

That account is great for smaller businesses with less than 150 transactions per month (you’ll pay .50 each for additional items). You can deposit up to 20 mobile checks each month with no fee and pay the same .50 for additional mobile deposits.

Like others on this list, US Bank offers additional services through a bundle including credit card processing, payroll servicing and invoicing. Other checking accounts have a higher number of free transactions, but require a large balance to avoid monthly services fees up to $25 per account.