SME banking and cross border payments: how banks can win back market share

Thought Leadership· 3min November 17, 2022

Even in 2022, online lenders continue to gain ground over traditional banks. Time is of the essence for small to medium sized enterprises (SMEs) because they need capital to flourish and would rather operate with a digital lender and in doing so, pay a higher rate for a quicker turnaround. While traditional lenders may offer a better interest rate, a lengthy application process is also often a deterrent.

A very big shift in market appetite is occurring. While businesses like OakNorth, Shawbrook and Redwood – the brand-new challenger banks in the UK – are laser focused on serving the SME market, there is no challenger bank laser focused on serving SMEs when it comes to foreign exchange (FX). It is for this reason that we have seen an almost biblical migration of SME’s away from traditional banks to seek better FX and international payment services elsewhere. There is an opportunity here for traditional banks to leverage, and they must before it’s too late.

If the likes of Alpha FX or Corpay got a banking licence, they could start lending to SMEs, start positioning themselves as an SME lender, and bolt services on to their offering. Then, with their market leading proposition and reputation as defacto SME experts, gain traction and over time, revenue.

For a tier one bank, managing, maintaining, and producing an FX mechanism and an outbound payment infrastructure through an established correspondent network is costly, and providing a full range of risk management services carries a fair amount of risk.

Banks also have the sophistication of the customer to consider. For corporate customers, standard FX, risk management, derivatives and options go hand in hand, and therefore they are reserved – not quite rightly – and packaged up as one service for their larger, sophisticated customers.  With proven scale and sophistication these customers guarantee volume and provide a more certain return on products and in turn higher return on the investment in the propositions in the first place.

What tends to happen, therefore, is that the SMEs that do not necessarily need advanced risk management or sophisticated options products, the return on investment for a tier one bank is not worth their while – in their view. That’s the problem. The larger banks are not prepared to downscale their corporate and enterprise solutions for SMEs. To do that for a SME market is a risk. No one has taken the bull by the horns and created a value proposition purely for them, focused on FX. All too often, we see that as the size of customers decreases, so too does the standard of product and service, resulting in the margin increases to the detriment of the SME.

When considering FX providers, they will typically be utilising wholesale FX from a banking partner to pass on to their underlying SME customer. They very rarely undertake the FX trading element in principle. Although the aggregated volume of all of their customers gives them access to fine margins, I wonder if this benefit is really passed onto their customers in a consistent manner. That is the challenge and the opportunity today.

Further to this, while we’re seeing digital transformation across domestic payments and we’re starting to see digital transformation in the cross border market, what we’re not seeing is the ability for a bank to spin up, create and sustain a cost-effective FX mechanism that is consumable across their whole ecosystem of customers.

The key barriers for banks to build out their own mechanisms still exist. Consuming a costly SWIFT service and managing on-premise hardware and software with regular fixes is a burden. Additionally, developing and maintaining a correspondent network for a product that is consumed infrequently by customers makes little economic sense.

Having to keep margins high in order to ensure the little business that is executed is profitable seems unethical. What’s more, working off of ill-suited legacy customer interfaces which make FX execution complicated and lengthy, makes for a very poor customer experience.

However, an attractive alternative exists. By utilising API’s and consuming an established FX mechanism from a third party, certain key market makers in FX are opening up their propositions via API to break down these barriers and participate in the FX space. This allows an incumbent to spin up an FX proposition and start to prove their use case for certain correspondent corridors very quickly. Thereafter, these more lucrative channels can be established by the bank in principle, while a balance between third parties, SWIFT and correspondents also develops into a very strong solution.

A number of new developments have emerged over the last few years, and whether it is real-time scheme interoperability, central banks digital currencies (CBDCs), card networks or perhaps a new service that is independent from existing infrastructure, I believe we will see an aggressive move towards creating real time global settlement.

This will progress into a continued drive to further transparency in pricing, and FX will become more embedded in a payment flow as the margins will be so fine.

There has been a real shift especially when it comes to cross border and FX, but what we’re seeing is a real desire for transparency and a real desire from customers for fairness. There is an opportunity for banks to spin up and create revenue driving propositions very, very quickly here.

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Written by

Andrew Frost Head of Cross Currency - Specialist Sales

Andrew is Head of Cross Currency - Specialist Sales at Form3, based in the UK.