Even in 2022, online lenders continue to gain ground over traditional banks. Time is running out for small and medium enterprises (SMEs) as they need capital to thrive and prefer to operate with a digital lender and in doing so pay a higher rate for a faster 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 happening. While companies like OakNorth, Shawbrook and Redwood – the newest challenger banks in the UK – focus on the SME market, there is no challenger bank laser that is focused on serving SMEs when it comes to exchange (FX). It is for this reason that we have seen an almost biblical migration of SMEs away from traditional banks to seek better foreign exchange and international payment services elsewhere. There is an opportunity here for traditional banks to take advantage, and they must do so before it is too late.
If companies like Alpha FX or Corpay got a banking license, they could start lending to SMEs, start positioning themselves as an SME lender, and integrate services into their offering. Then, with their market-leading proposition and reputation as the de facto experts as an SME, gain traction and, over time, revenue.
For a tier-one bank, managing, maintaining and producing a foreign exchange facility and outbound payment infrastructure through an established correspondent network is costly, and providing a full range of management services risk involves a fair amount of risk.
Banks must also consider customer sophistication. For corporate clients, standard foreign exchange, risk management, derivatives and options go hand in hand, and are therefore reserved – not quite rightly so – and rolled into one service for their larger, more sophisticated clients. . With proven scale and sophistication, these clients guarantee volume and provide a more certain return on products and, in turn, a higher return on investment in proposals in the first place.
What tends to happen, therefore, is that SMEs that do not necessarily need advanced risk management or sophisticated options products, the return on investment for a top tier bank does not not worth it – in their opinion. This is the problem. The big banks are not ready to cut back on their business and enterprise solutions for SMEs. Doing this for an SME market is a risk. No one has taken the bull by the horns and created an FX-centric value proposition just for them. Too often we find that as the size of the customers decreases, the quality of the product and the service also decreases, which leads to an increase in the margin at the expense of the SME.
When considering currency providers, they typically use a banking partner’s wholesale currencies to pass to their underlying SME customer. They very rarely undertake the element of FX trading in principle. Although the aggregated volume of all their clients gives them access to nice margins, I wonder if this advantage is really passed on to their clients consistently. This is the challenge and the opportunity today.
Also, while we’re seeing a digital transformation of domestic payments and we’re starting to see a digital transformation in the cross-border market, what we don’t see is a bank’s ability to get started, to create and to maintain a cost-effective FX mechanism that is consumable across their entire ecosystem of clients.
The main obstacles preventing banks from setting up their own mechanisms still exist. Consuming an expensive SWIFT service and managing on-premises hardware and software with regular patches is a burden. Moreover, developing and maintaining a network of correspondents for a product that is little consumed by customers makes little economic sense.
Having to maintain high margins to ensure that the small business that is being run is profitable seems unethical. Additionally, working from ill-adapted legacy client interfaces that make FX execution complicated and time-consuming, makes for a very poor client experience.
However, an interesting alternative exists. Using APIs and using an established 3rd party FX mechanism, some key FX market makers are opening their proposals via API to break down these barriers and participate in the FX space. This allows an incumbent to launch an FX proposal and start proving their use case for certain matching corridors very quickly. Subsequently, 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 solid solution.
A number of new developments have emerged over the past few years, and whether it’s real-time system interoperability, central bank digital currencies (CBDCs), card networks, or perhaps a new service independent of the existing infrastructure, I think we will see an aggressive move towards creating global real-time settlement.
This will evolve into a continued drive to increase price transparency, and FX will become more integrated into a payment flow because the margins will be so thin.
There has been a real shift, especially in cross border and FX, but what we are seeing is a real desire for transparency and a real desire for fairness from clients. There is an opportunity for banks to jump in and create revenue-generating propositions very, very quickly here.