Alternative data and SME lending: know your customer

12 March, 2021Ouida Taaffe

More SMEs used fintech services in 2020 than ever before. Policy makers want to drive innovation for them through the increased use of alternative data and open banking. Ouida Taaffe looks at recent developments in UK and the MENA region and how financial data may be used in future.

Computer data on a screenSmall to medium enterprises (SMEs), as a group, are the biggest employers globally. And they are important customers for retail and commercial banks.

They typically hold larger balances than retail customers and they also buy more lucrative products. That provides banks with both with deposit funding and revenues.

If economies are to recover well from Covid, banks will need to back SMEs.

But SMEs can be challenging customers. Traditionally banks have struggled with:

  • the cost and difficulty of getting complete, up to date information on the performance of small firms that want to borrow
  • reluctance at SMEs to take out products that require a lot of paperwork
  • the inability of some SMEs to provide collateral for loans.

Because of those difficulties, banks have not typically rewarded loyal SMEs with enhanced levels of service.

Fintechs started to fill this gap in the market a few years ago. One of the first in the UK, for example, was Tide, which launched in 2015.

Tide promised to take all the stress out of managing the finances of an SME with ‘smart financial admin’, delivered via mobile phones. No more form filling.

Tide wasn’t a bank. It worked with Iwoca to provide credit, but it met a real need – it provided SMEs with easy access to banking services.

Access to data

Tide was possible because of smartphones. The first smartphone – the iPhone – was launched in 2007. By 2015, 75% of UK adults had a smartphone.

In MENA, by 2017 around half of mobiles were smartphones. That majority usage makes new services viable and creates a lot of non-bank ‘alternative data’.

Alternative data can’t replace credit history when it comes to assessing lending risk. But it can create a bigger picture of an SME for a lender.

And banks value alternative data.

Gartner, the research firm, reported in February 2021 that banks see advanced data analytics as one of the most likely areas for investment in the next three years.

Advanced analytics ranked more highly than either artificial intelligence (AI) or blockchain.

But data is often siloed. That’s why the February 2021 Kalifa Review of UK Fintech, which was commissioned by the UK Treasury, advocated a “cross-sectoral approach” to data access.

It noted, “If firms that hold very significant amounts of data (such as large technology companies) are not brought into the fold, this could create an un-level playing field.”

It wants data standards that “create an enhanced environment for fintech”.

Open banking and open finance

The UK was the first jurisdiction globally to mandate access to financial data. Open banking launched was launched there in 2018.

It allows individuals and SMEs to share their bank data through application programming interfaces (APIs) that financial firms set up.

Open banking is now starting to get traction.

According to the Open Banking Implementation Entity (OBIE), there were 301 regulated providers in its directory by the end of 2020 – up around 50%, year on year.

The Open Banking App Store, which launched in July 2020, now has 101 offers. And the number of end users doubled during the first nine months of 2020 to two million.

In MENA, Bahrain was the first jurisdiction to launch open banking in November 2020. It won’t be the last.

In 2020, Abu Dhabi Global Market (ADGM) said, “Open banking is a key component to support digital transformation in the banking sector by facilitating collaboration between financial institutions with fintechs.”

Open banking is also likely to be just the first step toward much broader usage of financial data.

The UK has said it wants to launch open finance to drive innovation and growth. That’s a pattern likely to be seen globally.

Fintechs already see the opportunities.

In the UK, Tide and ClearBank, for example, intend to make ‘beyond open banking’ data available through a Tide API. They also have plans to tackle ‘more complex lending’, including at the angel and venture capital stage of SME growth.

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