Beyond the bank
Spend time with owners of any of the UK’s five million small businesses and the conversation will inevitably turn to access to finance – or rather the lack of access. In the wake of the global financial crisis the inability to borrow in order to invest, already a cause of unease, became chronic. Many businesses were starved of capital post-2007 when lending declined and then stagnated.
Five high street banks remain responsible for more than 80 percent of business lending, prompting calls for greater market choice both from challenger banks and from emerging FinTech (financial technology) firms. However, the introduction of new platforms and new players raises questions of integration, innovation and regulation.
It was in this context, that Prospect and Funding Circle brought together a group of politicians, financial industry and small business experts to discuss these issues at the fringes of the Conservative Party Conference in early October.
Titled ‘Beyond the bank: how do we ensure that small business can fund their growth ambitious during times of economic uncertainty?’, the roundtable began with an explanation of peer-to-peer or ‘direct’ (P2P) lending. Much like Airbnb, Alibaba and eBay, Funding Circle provides a platform that connects independent parties – in Funding Circle’s case it matches those looking to invest capital with those businesses seeking to borrow. Just as Airbnb doesn’t own its own hotels or eBay doesn’t sell its own goods; direct lending platforms don’t loan their own money.
Launched seven years ago, Funding Circle has since hosted 70,000 lenders and is responsible for 2 percent of total UK business lending. While going head-to-head with the banks it is worth noting that Funding Circle is also growing the market. Indeed, one in five of its borrowers would not have been able to get a traditional bank loan, Funding Circle says.
“In terms of economic impact, Funding Circle claims it has helped create an estimated 70,000 jobs in the UK and every pound lent has generated two pounds in economic activity.”
The small business community appears to welcome the greater choice in borrowing partners. It pushed the coalition government, 2010-2015, to look at alternative finance as a serious option and seeks to create a better understanding among business owners about how FinTech platforms and challenger banks fit into the market.
Knowledge of the P2P lending market remains patchy, one of the participating politicians suggested. “My sense is distribution of borrowers is London and south-east centric.” For its part, Funding Circle insisted that while lending skewed towards the south-east, those seeking investment were spread evenly across the country. Indeed, there is above average direct lending in the north-east of England where bank branch closure has been greatest. Coincidence? Funding Circle suggested not.
“The disruption that has made the likes of Funding Circle possible is profound, as profound in its own way as Brexit,” said one attendee. But while newer FinTech market entrants were the first to take advantage of ubiquitous connectivity, cheap storage, cloud computing and, latterly, artificial intelligence to inject efficiencies into financial services, traditional banks soon followed. FinTech “set the tone”, the attendee suggested, but there has since been a “trickle down”.
A representative of the banking industry agreed. Banks needed to find their efficiencies, he acknowledged, but argued that they were having to do so while working under a stricter regulatory regime than their newer FinTech rivals. Regulators should turn their attention to these newer platforms, he said. “Suppliers of finance in the direct lending space are individuals and when the credit cycle turns, which it will, they will start losing money. They will be very reliant on the enforcement and collection capabilities of their platforms.”
In response, Funding Circle pointed out that while it operated a risk-based business it was a regulated business like other lenders. “The FCA [Finance Conduct Authority] regulates us and we’ve had loans securitized and rated by [ratings agency] Moody’s.” In order to mitigate risk, investors diversify their portfolio across as many businesses as possible. By doing so, 92% of diversified investors have earned more than 5% interest, with an overall average of 6.5%.
So what next for financial services? Will the disruptors get disrupted? Possibly. One attendee suggested that FinTech firms would soon be providing ‘white label’ versions of their services to traditional banks that would then offer those services to customers. Others suggested that the likes of Amazon and Google would provide the biggest future threat not just to banks but to today’s FinTech leaders. Amazon, for example, had the scale, the access to unprecedented volumes of business data and the customer-base to become a lender of choice for thousands of small and micro businesses. This raised the possibility of today’s FinTech platforms “falling prey to the Schumpeterian effect”, a reference to Joseph Schumpeter, the early 20th century Austrian economist and political scientist who coined the phrase ‘creative disruption’. “No one is safe from Amazon,” one attendee suggested.
Others offered a view of a more fragmented future, where Amazon might be the first port of call for micro businesses as they first start trading. Over time, however, the likes of a Funding Circle, a challenger bank or a conventional bank will become a lender of choice as the business grows.
Nonetheless, as one delegate pointed out, the spectre of dominant platforms creating monopolies was an area where the regulators should be looking on with interest. Consider that there are only three cloud providers that offer a service of global scale – Amazon, Google and Microsoft. “That’s a huge systemic risk: all our data being owned by three dominant providers.”
As for Brexit, many regretted the likely end of the UK’s involvement with the European Investment Bank, even if the relatively new British Business Bank may provide a ready-made replacement. In fact the Bank has already in part responded to uncertainty created by the referendum by committing a further £40m to UK small businesses through Funding Circle – a sign that governments are in fact increasingly ready to use direct lending platforms as a macroeconomic tool to stimulate the real economy.
Aside these specific issues, Brexit is not the number one issue preoccupying small business, according to at least one attendee. “The biggest thing they are facing is the cost of doing business – the national living wage, business rates, the ‘staircase’ tax, pension auto-enrolment among other things.”
With the support of Funding Circle, Prospect hosted a round table discussion at the 2017 Conservative Party Conference on what could be done to ensure that SMEs can fund their growth ambitions during times of economic uncertainty
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