Small and medium businesses (SMBs) are the backbone of our economy and need robust banking and financial support to thrive. Yet, according to McKinsey, technological advancements and shifting demands have changed the balance of power among the financial institutions that provide these services:
“McKinsey’s research shows that revenues in the fintech industry are expected to grow almost three times faster than those in the traditional banking sector between 2023 and 2028.”
Fintechs: A new paradigm of growth
McKinsey & Company, October 24, 2023 | Report
Recent instability in the banking sector has accelerated this transformation. As reported by Cornerstone Advisors, SMBs are reconsidering how they bank, particularly in light of the Silicon Valley Bank run in 2023:
- In the weeks following the SVB collapse, more than seven in 10 SMBs reported having two or more deposit-related bank accounts, up from fewer than half in Q1 2020.
- Between January 2022 and March 2023, over 50% of surveyed SMBs opened new checking accounts and credit cards, and 35% even selected a new payroll provider.
- Even among SMBs using a major or regional bank, over 20% said they prefer peer-to-peer payment options, like Zelle, over their business debit card – indicating that SMBs are eager to adopt new payment technologies, particularly with low fees.
In part, these businesses are choosing to adopt new technologies – and opening accounts with neobanks and fintechs – to save on fees. In that same study of SMB owners:
- 41% would consider opening a new bank account to save on fees or get better rates.
- 34% would consider opening a new bank account to get better digital banking capabilities.
- 31% would consider opening a new bank account to get better treasury and cash management features.
The emergence of digital tools and fintech solutions has marked the start of a new era. Digital platforms can offer a more tailored and interactive approach that has already reshaped business banking.
Why Small Businesses Look to Fintech Solutions Beyond Business Banking
In a recent study by McKinsey, “35 percent of the small and medium-size enterprises (SMEs) in the United States considered using fintechs for lending, better pricing, and integration with their existing platforms.”
“Everything for small businesses is disconnected. You have a bank account, credit card, payable management tools, expense management tools, etc. Most enterprise solutions that offer the full 360, they’re not selling to people who have five or ten employees. And most bottom-up tools in the market aren’t thinking about connecting to each other. What if we could remove the cost of having all of this disconnected information by providing our own product experience for small businesses [with] the bank account being the hub?”
Eytan Bensoussan, CEO and Co-Founder of NorthOne
And it’s not just data interoperability. As reported by JD Power, although more than three-quarters of surveyed SMBs are interested in receiving financial advice from their bank, just 15% receive comprehensive advice. One major area where SMBs are looking for advice is in reducing fees – which provides an entry point opportunity for fintechs.
These findings speak to the rise of specialized SMB lenders and financial platforms like Bluevine and Nav, which have gained market share within the financial landscape for small businesses. These fintech providers aim to provide a more tailored approach to meet the unique financial needs of small and medium-sized businesses, including flexible business lines of credit, invoice financing, credit monitoring, financial management tools, and personalized insights.
“Small businesses are vastly, vastly underserved. It’s true across banking, software, and so many other industries out there.”
Herman Man Chief Product Officer, Bluevine
That said, the decision to use a fintech solution or a traditional bank doesn’t have to be mutually exclusive – SMBs can and do use both in tandem. After all, per Cornerstone, 90% of SMBs still have a checking account at a major national or regional bank. And, as reported by Accenture in a different study, 44% of SMBs would prefer fintech platforms to offer these digital-first services in partnership with a traditional bank.
Embedded financial services can make this scenario a reality, by allowing traditional banks to meet SMBs with a digital-native experience where they are – in the applications they use daily to run their businesses, like delivery apps, time and attendance tools, and more. Conversely, banks can use the opportunity to embed those services into their digital offerings.
“The beauty of embedded fintech lies in integrating multiple services easily via APIs,”
Keri Gohman, Chief Executive Officer, CARET.
And that evolution is happening quickly. As reported by McKinsey, eighty of the top 100 banks have aligned themselves strategically with at least one fintech service to serve SMBs better and accelerate their digitalization.
The Digital Transformation of Small Business Banking
Digitalization in banking isn’t merely a fleeting trend; it’s a strategic necessity. Small business banks now recognize the value of incorporating digital tools and fintech innovations to overcome the challenges posed by traditional relationship management.
Integrating banking systems, data analytics, and customer relationship management tools has paved the way for a more personalized and engaging service model than the conventional approach led by relationship managers. According to McKinsey, “Some banks are now taking a different approach. Instead of providing the front line with many tools for different tasks (at one bank, we counted more than 30), they are using data and advanced analytics (AA) to build a unified, easily navigable, and intuitive platform within the customer relationship management (CRM) system.” This shift introduces proactive diary management, automated meeting notes, AI-driven data mining, and digital assistants, fundamentally altering how banks interact with their SME clients.
“Companies are turning to embedded fintech due to its ability to offer multiple financial services efficiently.”
Prashant Fuloria, Chief Executive Officer, Fundbox.
Understanding the decision-making dynamic within SMBs is crucial. As mentioned earlier, SMBs want advice from their banking partners – and they want reduced fees. Embedded finance solves both these problems: by partnering with fintech companies, financial institutions can offer SMBs both guidance on running their businesses more efficiently with new technology and lower fees through digital-first tools.
The Role of Digital Banks and Neobanks
“Banks create value through smart risk-taking. At Mercury, we like building products. We’re not a bank building technology products, we’re a technology company building banking products. Every experience is crafted.”
Jason Zhang, COO and Co-Founder of Mercury.
Neobanks, fintechs that typically offer a streamlined banking experience, like Mercury and Brex are digital banks that operate without physical branches and use technology to streamline their operations and offer an enhanced customer experience. These neobanks cater to small and medium-sized enterprises and usually operate as fintech platforms backed by sponsor banks. Mercury offers business checking accounts and expense tracking, while Brex provides corporate credit cards, expense management tools, and solutions for high-growth startups. Fintech-driven neobanks are disrupting traditional banking models, and understanding their differences is crucial to grasping the evolving dynamics of the small business banking sector.
Critically, companies like NorthOne, Lili, and Found are targeting the SMB market explicitly and exclusively. They are building products and services meant to help businesses as they get started, with business formation, accounting, and tax products. This approach differs dramatically from what some more traditional financial institutions have done, offering a subset of their larger suite of commercial banking features for SMBs. But they are fundamentally different audiences that require tailored solutions.
“One of the biggest challenges, from a business owner’s point of view […] is that it’s mainly one individual that has to do everything.”
Lilac Bar David, Co-Founder and CEO of Lili
Why Small Business Banks Partner With Fintech Providers
“The challenge is people can’t afford an accountant, but they have a lot of questions. We want to make sure, using AI, that we can give them the answers.”
Lilac Bar David, Co-Founder and CEO of Lili
The rise of fintech providers in the small business banking ecosystem significantly altered the landscape. The robust collaborations between banks and fintech entities are essential for the popularity and widespread availability of digital financial tools. These partnerships merge the regulatory security of banks with the cutting-edge technology of fintechs, significantly enhancing how businesses manage their finances and ensuring more effective consumer service.
“We have to understand, deeply, what our partner banks care about [and their] obligations to regulators. We have to make sure we build our risk and compliance programs with those end needs in mind.”
Jason Zhang, COO and Co-Founder of Mercury.
Recent federal banking regulator guidelines further fortify these partnerships, offering clarity for banks seeking to adopt new technologies. Per Deloitte, regulation presents two paths forward for fintechs: either partner with an already-regulated bank, as nearly all have, or apply to become a bank, as SoFi and others have done recently. This regulatory framework acknowledges fintech’s role in responsible innovation and expanding financial service access.
For small business banks, these collaborations signify more than technological advancement; they embody a culture of compliance, prioritize customers, and commit to transparency and accountability. These principles form the basis for successful collaborations, enabling banks to leverage fintech capabilities for services ranging from FDIC-insured accounts to tailored lending solutions, bridging the gap between traditional banking and the digital realm.
“Contrary to the belief that fintechs and traditional banks are at odds, incumbents aren’t disappearing — they’re essential. And they need fintechs to thrive.”
Zack Miller, Tearsheet
From The SMB Innovator Podcast episode: A wake-up call to SMB banking realities with Zack Miller
Factors Influencing Small Business Banks in Fintech Partner Selection
Traditionally, partnerships between banks and fintechs centered around distribution and compliance: banks provide the regulatory compliance, licensing, accounts, and infrastructure, while fintechs provide the interface and a suite of services tailored to their target audiences. For example, a neobank may benefit by leaning on the compliance, stability, and FDIC insurance of a partner bank, while the bank benefits by growing its account base and assets under management.
Embedded finance, however, offers more: leaning on both partners’ strengths to deliver a truly unified experience to the end customer. This relationship goes beyond referrals or even data integration. There’s just one login and one app for the end customer. For SMBs, that might mean payroll integrated with their back office management tool, or within their bank’s website or app – where funds can be deducted automatically from their checking account when it’s time to run payroll.
As a bank evaluating a fintech solution, there are several factors to consider:
- Embedded or Integration: Embedded, seamless solutions offer a smoother user experience by connecting directly to the bank’s platform. Conversely, integrations are faster to launch but generally exist as two separate interfaces for the end user, even though data is shared between them.
- Value to End User: Banks must assess how a solution enhances the customer experience, whether by simplifying processes, offering new services, or providing superior convenience.
- Business Case for Fintech Solution: This solution includes understanding cost implications and anticipated ROI and evaluating whether the fintech solution helps differentiate the bank in the competitive landscape, attract new customers, or retain existing ones.
A robust due diligence process is critical in identifying a fintech solution that aligns with the bank’s strategy and resonates with its customer base. Assessing the solution’s features, financial stability, and regulatory compliance builds a solid foundation for a successful partnership.
Solution & Value Proposition
- Alignment with Bank Strategy: Is the fintech solution aligned with the bank’s objectives?
- Relevance to Target Customers: Has the solution been designed to meet the needs and preferences of the bank’s primary customer segments, such as specific industries, size, and technology adoption?
- Uniqueness & Differentiator: Are there any unique features or capabilities that differentiate the solution from competitors and enhance customer value?
Company & Execution
- Financial Stability & Track Record: Evaluate the fintech company’s financial health, funding, and experience. Look for a proven track record of success and stable leadership.
- Regulatory Compliance & Security: It is important to ensure that your fintech partner maintains strong compliance measures and robust security protocols to safeguard customer data and meet regulatory requirements.
- Scalability & Flexibility: Can the fintech company adapt to changes in the market and regulatory landscape, and scale to accommodate the bank’s future growth and evolving needs?
Partnership & Integration
- Open API & Integration Capability: Does the fintech partner provide open APIs and clear documentation for seamless integration with the bank’s existing systems?
- Commitment to Collaboration & Support: Look for a partner with a collaborative approach and dedicated support team that can assist with implementation, training, and ongoing maintenance.
- Data Ownership & Governance: Establish clear data ownership and governance policies for customer data handling and access within the partnership.
Additional Considerations
- Reputation & Customer Feedback: Research the fintech company’s reputation by gathering customer feedback and case studies to understand their experience.
- Pricing & Commercial Terms: Evaluate the partnership’s cost-benefit analysis. Negotiate fair and transparent pricing terms that align with the expected value proposition.
- Exit Strategy: Define a clear exit strategy for the partnership should circumstances change or objectives are unmet.
As a bank serving SMBs, selecting the right fintech partner is a pivotal decision that can shape a bank’s growth and innovation trajectory. Deciding whether to integrate with a fintech partner or embed their solution is equally important.
While quick integrations may seem appealing, embedded financial solutions ultimately help grow your business and provide valuable additional services like payroll to your SMB customers – ones they’re already looking to you to provide.
