Why Embedded Finance Is Critical to SMB Lending

In 2018, Amazon jolted the banking industry by announcing that it had provided $1 billion in merchant cash advances to merchants selling on the firm’s platform in 2017. Industry pundits jumped on this news as proof that Amazon was getting into banking and would disrupt financial institutions. 

The more important consideration should have been to question why so many merchants turned to Amazon for cash advances instead of looking to their banks for other funding options. The answer: data. 

Amazon had data about merchants’ cash flow and perspective on how any individual merchant’s business performance compared to other merchants in that particular space. Armed with that knowledge, Amazon could offer cash advances to merchants who were most worthy of the advance and do so before the merchant even requested it. And this is where financial institutions should take their cue.

Banks must become embedded into small businesses’ everyday operations to achieve the speed and agility needed to compete with new competitors.

Monthly phone calls to small businesses to inquire, “How are things going?” aren’t going to cut it. Banks need to bundle small business back office and merchant services with the more traditional deposit management and lending services they already provide. These services provide a win-win for both the bank and small business:

• Integrating online receivables to a standard small business checking account makes the account much more valuable for the small business, and more profitable for the bank.  

• Digital bill pay combined with an automated bookkeeping entry helps small businesses eliminate the time it takes for batch reconciliation and/or the cost paid to a bookkeeper. Banks benefit because small business owners are willing to pay for the service. 

• A common deposit transaction is more valuable to a bank when it is applied to a small business’ profit and loss (P&L) statement, and more convenient for small businesses when they can use an integrated financial reporting tool within a bank’s loan application.

• Every type of small- and medium-sized enterprise (SME) will need their own ecommerce platform moving forward, not just Amazon sellers. A contractor that does a job in person will benefit from managing the receivable process and record keeping online just as much as someone that solely transacts online.

The opportunity for financial institutions to meet small businesses’ digital back office needs can deepen relationships with small businesses and tap into a new, lucrative source of revenue—and produce additional loan volume and revenue, as well. 

Back-Office Opportunities

According to research from Cornerstone Advisors, small businesses spend more than $530 billion each year on accounting/bookkeeping, invoicing, bill payment and payment acceptance services from third-party providers (Figure 1). SMEs with more than $10 million in revenue—who comprise just 4% of small businesses—account for a quarter of the spend (Figure 2).

Figure 1

Source: Cornerstone Advisors survey of 1,265 small business owner and executives, Q1 2020

Many small business owners and executives—particularly those from larger enterprises—are interested in getting accounting and payments services from a bank. Roughly four in 10 small businesses with revenues greater than $5 million said they would “definitely” consider a bank for accounting, invoicing, bill pay and payment acceptance services (Figure 2).

Figure 2

Source: Cornerstone Advisors survey of 1,265 small business owner and executives, Q1 2020

The revenue opportunity for accounting/bookkeeping, invoicing and bill payment services are each just shy of $100 billion, with the payment acceptance opportunity at roughly $76 billion. For each of the four services, about 44% of the total opportunity comes from SMEs who said they would definitely consider banks to provide accounting and payments services.

Small businesses who expressed a definite interest in obtaining accounting and payments services from a bank represent lending opportunities for banks. Among these SMEs, 62% expect to borrow an average of nearly $2 million in the near future, in contrast to just one in five small businesses who aren’t interested in back-office services from a bank. 

More importantly, 85% of these small businesses will consider borrowing from their primary bank, and roughly seven in 10 would prefer to borrow from their primary bank. In contrast, among SMEs that aren’t interested in getting back-office services from a bank, only about half (51%) would prefer to borrow from their primary bank (Table A).

Table A

Source: Cornerstone Advisors survey of 1,265 small business owner and executives, Q1 2020

Deciding to provide—and then actually deploying—accounting and payments-related services to small businesses is a major strategic decision for a bank to make. But surveying existing small business customers to gauge their interest in getting those services from the bank not only helps a bank determine the potential viability of providing the services, it helps them identify small businesses who are more likely to be in the market to borrow money, as well as more likely to turn to the bank to get those loans. 

In a recent Forbes article, Scott Harkey of consulting firm Levvel warned banks that non-traditional financial services providers like Shopify and Quickbooks are leveraging data aggregation services to scrape bank data and use the information to offer small businesses short-term loans, bill prepayment, auto loan payoff and other services—a trend that is eroding small businesses’ bank relationships.

As Harkey pointed out:

“Financial institutions 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.”

There are strategies banks can deploy to fight this erosion. Even some basic market research can help uncover hidden opportunities.