By Shashank Pattekar, International Banker
At first glance, lending to small and medium-sized enterprises (SMEs) in the United Kingdom appears to be enjoying a resurgence, having reached its highest annual level since the pandemic. While one might assume that the banking sector sits firmly at the centre of this revival, it is a growing array of alternative lenders that is increasingly dominating the segment. As such, traditional banks are having to confront the stark new reality of a significantly more crowded, more fragmented and more competitive SME-lending space.
Indeed, the real story is not how much SMEs are borrowing, but rather who owns the lending relationship when they do. While the British Business Bank recently reported that gross lending to SMEs climbed to £68 billion during 2025, up 9 percent from 2024 and the second-highest level since 2012, more than two-thirds (68 percent) of SME lending came from challenger and specialist banks or nonbank lenders. “Compared to the highly concentrated market of 2008, which was dominated by a handful of high street banks, today specialist lenders, challenger banks, and nonbank institutions provide the majority of smaller business lending, giving businesses more choice and greater access,” the bank’s “Small Business Finance Markets Report” for 2025/26 acknowledged.
The conventional view that banks are ceding ground to fintech (financial technology) lenders, as they can make faster credit decisions, only partially explains this growing trend. While speed of service certainly matters, the upstream migration of financial services into the software ecosystems in which SMEs spend most of their working days is proving crucial. Payments, treasury management, foreign exchange, insurance and lending are increasingly being embedded in the digital platforms businesses already use to run their operations, making them available where they can be most conveniently accessed.
Today, a small business may never consult a traditional bank when applying for working capital. A retailer can obtain financing through its payment provider. A restaurant can access credit directly through its point-of-sale platform. And a manufacturer can receive lending offers inside its accounting software, based on real-time invoice data. This indicates that institutions that become rooted in influencing how businesses invoice customers, manage inventory, reconcile accounts, pay suppliers and forecast cash flows are positioning themselves advantageously to also control the distribution of financial products and services.
Oliver Wyman estimated that across continental Europe, almost half of SMEs already use embedded-finance services integrated directly into their business software, with adoption expected to accelerate over the coming year. “By using emerging technologies, embedded finance solutions, and alternative funding vehicles, modern fintech lenders design processes that are less costly, more efficient, while also offering a better user experience for SMEs applying for loans,” the consulting firm’s November 2025 whitepaper “The State of European SME Lending” observed.
The research also illustrates how rapidly this model is gaining traction. Almost half of SMEs across France, Germany and the Netherlands already use embedded financial products, while more than 40 percent have expressed interest in obtaining financing directly through the software platforms they use every day. While payments are often the initial entry point, lending is now emerging as one of the fastest-growing applications.
At the same time, SMEs themselves are becoming more demanding customers when seeking credit. For instance, they increasingly expect lending decisions within hours rather than weeks, digital onboarding instead of lengthy documentation and financing products that adapt to fluctuating cash flows rather than fixed repayment schedules. Traditional banks, meanwhile, continue to rely on fragmented legacy systems, manual credit processes and organisational structures that separate lending, payments, deposits and treasury into distinct product silos. The result is a widening mismatch between how banks are organised and how SMEs strive to operate today.
The growth of alternative lenders also suggests not only that fintech companies are building better technology systems than banks, but also that structural weaknesses persist not just in the traditional SME-lending model but in business lending in general. Indeed, a recent study by Boston Consulting Group (BCG) found that UK bank lending to non-financial businesses had fallen to 59 percent of gross domestic product (GDP), its lowest level since 1998 and far below its 2008 peak of 90 percent.
The economics of SME lending in particular, however, can help explain why many incumbent banks have gradually deprioritised the sector over the last two decades. A recent Bank of England (BoE) analysis estimated that SME lending generated the lowest average return on equity (ROE) of the major lending categories for large UK banks, even below lending to large corporates. Crucially, the study concluded that, relative to other corporates, capital requirements were not the key driver of lower ROE in SME lending. “Instead, differences are driven by higher impairment rates and operating costs,” noted the BoE’s June 19 report titled “What drives differences in commercial banks’ product level returns?”
It is no secret that serving SMEs has always been regarded as distinctly challenging. Unlike retail banking, in which products can be highly standardised, or large corporate banking, in which individual relationships justify significant resources, SMEs vary significantly in size, industry, financial sophistication and borrowing requirements.
What’s more, this lending challenge has become even more pronounced amid the post-2008 landscape of stringent banking regulation. While higher capital requirements, tighter regulatory oversight and more conservative risk management have undoubtedly strengthened banking-system resilience, they have also increased the cost of extending credit to smaller businesses.
This trend is further supported by Bank of England research showing that capital requirements can materially influence banks’ willingness to lend to opaque SME borrowers, particularly when information asymmetries make risk more difficult to assess.
This trend is further supported by Bank of England research showing that capital requirements can materially influence banks’ willingness to lend to opaque SME borrowers, particularly when information asymmetries make risk more difficult to assess. Analysing how risk-based capital requirements shape competition and credit allocation in the UK’s unsecured SME-lending market, the Bank’s June 19 working paper on asymmetric information and capital regulation in SME lending found that “regulation interacts with heterogeneity in information processing and costs to shape equilibrium pricing and credit allocation, with nonbank lending reflecting not only regulatory differences but also comparative advantages in screening technology”.
The fragmentation of SME finance has thus produced a new competitive landscape in which different providers specialise in solving specific problems rather than attempting to replicate the universal-banking model. Challenger banks have captured market share by building digital-first operating models with faster onboarding, streamlining credit processes and lowering cost structures.
Alongside them, specialist nonbank lenders have expanded rapidly by focusing on areas that conventional banks have often struggled to serve efficiently. Merchant cash-advance providers, invoice-finance specialists, asset-based lenders and revenue-based finance companies increasingly assess businesses using live trading data rather than relying primarily on historic financial statements or property collateral. This allows them to reach businesses that may appear “high risk” under traditional underwriting models but demonstrate strong operational performance.
Private credit has emerged as another distinctly important source of SME finance, particularly for larger or more complex transactions. As institutional investors have allocated increasing amounts of capital to private-debt strategies, nonbank financial institutions have become an important source of growth capital, acquisition finance and bespoke lending structures that many commercial banks are less willing, or less able, to provide.
Arguably, the most disruptive competitors are neither banks nor private lenders, but rather the software platforms that are steadily transforming themselves into financial distribution channels with accounting providers, enterprise-software vendors, e-commerce marketplaces and payment companies already possessing continuous visibility over customer transactions, cash flows and commercial activities. By embedding lending, payments and treasury services directly into their platforms, these firms eliminate much of the friction traditionally associated with accessing finance.
The competitive battleground has thus shifted away from physical branches and mobile-banking applications. Rather than asking businesses to apply for a loan separately, software platforms can present financing offers precisely when they are needed, making credit contextual rather than transactional. Winning the next generation of SME customers, therefore, will depend less on building better banking products and more on becoming indispensable participants in the day-to-day operations of their businesses.
The implications for banks of these momentous shifts are significant and unavoidable. Competition is no longer centred solely on pricing or balance-sheet capacity, but rather on who controls customer engagement, who owns the underlying data and who becomes embedded in the daily operations of the business. As financial services become progressively invisible within digital workflows, competitive advantage shifts away from institutions that simply manufacture financial products towards those that control their distribution.