Large amounts of data – alongside the processing power to analyse it in real-time – is changing how banks assess credit risk and manage their services for SMEs. Ouida Taaffe talks to Paul Gordon of Lloyds Banking Group and Arjan van den Berkmortel of HSBC about alternative data, automation and why incumbents have the lead over fintech.
The principal service that retail banks provide to society is ‘maturity transformation’.
They borrow short-term – from depositors and from the markets – and lend long-term. That enables homebuyers to get a 25-year mortgage and businesses to raise funds to invest.
Maturity transformation, however, is risky. Depositors can withdraw their money whenever they like, markets could refuse to fund the bank, and loans might not be repaid.
Banks, therefore, try to assess whether would-be borrowers can afford to meet debt repayments and whether they will also make those payments on time.
When banks are lending to big companies, they can gather a lot of data from:
- quarterly audited accounts
- previous lending relationships and
- the company’s ecosystem – its suppliers and partners.
That data allows the bank to assess credit risk.
Such companies also tend to borrow large sums and to buy other services from the bank – all of which provides additional data and makes it cost-effective to undertake a full risk assessment.
When it comes to small to medium enterprises (SMEs), however, there has sometimes been a knowledge gap. But banks are starting to use so-called ‘alternative data’ to fill it.
This is ‘unstructured’ data is not gathered in traditional databases but from online sources such as social media. And it is also structured data from, for example, specialist accounting software.
Incumbent banks have a lead on fintechs
Big banks do already have plenty of data on their SME customers and, importantly, it is financial data.
“They have the main banking relationship, all the payments data, data on liquidity, the relationship with the client and the quality of the management team,” says Paul Gordon, Managing Director, SME & Mid Corporates, Commercial Banking at Lloyds Banking Group.
“They can see the financial assets.”
Understanding how a firm deals with credit puts incumbent banks in a much better position than fintechs or bigtechs to manage lending to SMEs. That’s one of the reasons why Amazon partners with JPMorgan to lend to its online sellers.
However, Gordon points out that a bank may not have a full view of an SME’s banking relationships. This is because small business owners tend to prudently spread risk – and so data – between various banks.
That’s particularly the case for businesses with a turnover of over £25m a year.
SMEs also tend to rely on an accountant or on accounting software that does the accounts once a year.
“That gives a sense of the previous 12 months, but is too late for anything real-time. Getting hold of core accounting data from accounting software in real-time improves banks’ understanding of the needs of clients and allows for more timely interventions and suggestions,” says Gordon.
Additional data from open banking and ‘alternative’ sources helps fill out the picture further.
Automation and changing relationships
Banks expect deeper knowledge of their SME customers to change their relationship with them.
“The purpose of automation is to give the customer greater ability to engage with the bank as their trusted adviser,” says Arjan van den Berkmortel, Head of Business Banking, London Region, at HSBC.
“In the future, relationship directors will have more time to get to grips with more complex support and SMEs will get quicker and better resolutions of simpler queries.”
Van Den Berkmortel says HSBC UK has around one million SME customers and that, at the smaller end, not all have a relationship director. However, just being reactive isn’t enough.
The ability to use data analysis to be more proactive and to provide SME customers with more options will be “exciting”, he says.
Good for business
Helping SMEs – which are the main employers in all major economies – should also help the banks. McKinsey estimates that the Covid-19 crisis could lead to a “dramatic rise in risk costs [at European banks] that will really hurt”.
Potentially, this pandemic could be worse for banking economics than the 2007/08 banking crisis.
Using alternative data to tailor services to the customer is, however, one of the ways that banks can build on the move to digital seen in the crisis to develop new products.
McKinsey suggests, for example, that advanced analytics could be used to offer small businesses liquidity advice “as a subscription service”.
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