Will 2024, the Year of the SME, herald a breakthrough in borrowing for smaller businesses?

It was declared the Year of the SME by the UK government, and 2024 has so far been rife with talk about the barriers that these companies, the backbone of the UK economy, must overcome.

We’ve also seen the launch of a series of new initiatives. In the middle of February, the new Small Business Council, designed to provide a forum for small business leaders around the UK to voice their concerns to policymakers, had its first meeting to discuss access to finance and removing barriers to growth. In March, the Financial Conduct Authority (FCA) published its somewhat disappointing response to the “supercomplaint” of the FSB (Federation of Small Businesses) regarding the excessive practice of banks asking for personal guarantees as security for loans to be taken out by small and medium-sized enterprises.

And most recently, on 15 April, the opening day of the 10th Innovate Finance Global Summit, Bim Afolami, the Economic Secretary to the UK Treasury, announced the launch of an industry-led open finance taskforce chaired by the Centre for Finance, Innovation and Technology (CFIT).

Taking open data beyond bank-based payments to bridge the funding gap

The first phase of the transformation in the banking and finance sector that aims to open up consumer data to innovation was launched six years ago.

The underlying concept of Open Banking was to assign consumers control over their own banking data, so they can share it with fintechs, expecting faster and more personalised financial services from them in return.

Encouraged by the success of Open Banking, the UK government and other stakeholders feel that the time has come to extend the scope of the open data approach beyond bank-based payments.

CFIT’s first task in this process is to identify the ways in which Open Finance can improve SMEs’ access to credit.

Although Ezechi Britton, the CEO of CFIT, has an extensive background in software development, fintech and venture firms, in an interview with Business Reporter at IFGS he identified the inaccessibility of SME data – rather than the lack of innovative digital technologies – as the main stumbling block to better SME funding.

Automated, ML-driven methods of borrowing already seem to be on SME leaders’ radar, though. In an EY survey, 31 per cent of participating SMEs indicated that they would consider a fintech provider and almost half of them showed interest in faster-credit-as-a-service schemes.

Nevertheless, the reality of SME lending on the ground still involves cumbersome manual processes and the approval or rejection of credit applications based on outdated financial data thanks to drawn-out decisioning processes.

But for SMEs to be able to take advantage of automated, low-cost and near-real-time credit underwriting, they need to be able to trust authorised lenders with a big chunk of their financial digital footprint through APIs.

Where should open data come from?

Data sources that – if shared with credit reference agencies and small business lenders through APIs – could improve SMEs’ creditworthiness include HMRC, Companies House and Open Accounting data. Some of these are already available digitally.

Thanks to HMRC’s Making Tax Digital for Business (MTDfB) Programme, which came into effect in April 2022, all VAT-registered businesses must submit their returns using MTD-compliant software since. Submitting quarterly updates of tax returns is also mandatory for these entities.

Meanwhile, the latest Companies House API provides access to all of the public data it holds on companies, which financial service providers can leverage to enrich their internal customer data in risk decision scenarios.

On the other hand, SMEs which adopt Open Accounting can also allow their lenders to access rich data sources digitally, such as their balance sheet, profit and loss account and cashflow information from their small business accounting systems.

If SMEs gave permission to lenders to access these diverse sources of information, which reflect the company’s financial soundness, risk appetite and market position, both bank and non-bank lenders would have a more granular and up-to-date picture of their creditworthiness. This would enable them to make decisions based on that data rather than having to play it safe and reject an application with not enough information.

Britton, however, acknowledges that convincing SMEs to trust a lender with this level of transparency is a challenging task.

CFIT’s opening coalition joined by 60 organisations from the industry has already demonstrated via use cases and data that Open Finance could create better outcomes for UK SMEs. According to Britton, the coalition has found that if SMEs made specific additional datasets available for lenders, substantially more lending would be made to them.

The coalition’s scenario analysis has also suggested that over 25 per cent of SME applicants who had been referred to manual loan underwriting and would have potentially failed to receive an offer of credit, could justifiably be given access to finance.

If this sounds a bit too theoretical, the task force is now working on making more specific business cases that can incentivise SMEs to open up their data to authorised third parties in the knowledge that they can trust them and see the benefits for themselves.

In an ideal scenario, the compelling use-cases can trigger a knock-on effect where the number of small businesses transitioning to Open Finance reach critical mass.

If, as a result of this year’s concerted efforts, the £22 billion funding gap for SMEs starts shrinking,  the chances are high that 2024 will be regarded as the year when the tide turned and the road for their accelerating growth paved.

To read more about what support is available for SMEs, see the UK government’s Help to Grow hub.