In the last few years the alternative finance sector has been growing rapidly with the UK market more than doubling from £666 million in 2013 to £1.74 billion in 2014 (Nesta). The increase has been even greater this year, with the total originated by the sector reaching £2.59 billion in the first eleven months of this year (Altfi Data), a figure almost equal to the the total cumulative lending in all years before 2015. This dramatic growth is only expected to accelerate; research by Fiserv has projected that the UK alternative finance market will reach £10 billion by 2020.
With the growth of alternative finance continuing at this lightning speed and more and more businesses finding funding through online platforms, it seems that at some point the sector can no longer be considered ‘alternative’.
4 signs that alternative finance is becoming less alternative:
An obvious sign that the sector is becoming less alternative is that it has received government approval. Since 2012 the UK government-owned British Business Bank has invested £60 million via peer-to-peer lending platforms into smaller businesses struggling to get funding from traditional lenders. 2014 brought more government support for alternative finance with legislation introduced to match SMEs which have been rejected for bank loans with challenger banks or alternative finance providers to increase access to finance.
More recently in October this year at the Peer-to-Peer Finance Association Summit, the City Minister Harriett Baldwin praised P2P lending as a “brilliantly innovative new form of finance” and said that the government wanted to see peer-to-peer lending continue to grow and fill the funding gap for UK SMEs. Part of the government’s plan to support this growth will begin in April 2016 with the launch of the Innovative Finance ISA allowing tax-free investment in peer-to-peer loans. This is likely to increase awareness of peer-to-peer lending, with predictions that around 405,000 current ISA savers could choose to use crowdlending after April 2016.
The takeover of consumer credit regulation by the Financial Conduct Authority in April 2014 has played a big part in making alternative finance less alternative. The FCA has introduced more consistent regulation in the alternative finance sector, requiring platforms to apply to be authorized by them in order to continue trading. Part of this authorization process involves platforms being much more rigorous with protecting customer funds, including holding capital reserves to pay investors in the event of defaults.
These stricter rules in the sector are likely to increase consumer confidence in alternative finance as the risks are less high, which could encourage more individuals to become involved with alternative lenders. But they also make the sector less alternative purely because platforms cannot completely determine how they operate and must take regulations into consideration in a similar way to banks.
Decline of bank lending
An initial factor in causing the rise of alternative finance was the decrease in bank lending to small and medium businesses after the banking collapse of 2008. This is still happening; 50% of first time SME borrowers are rejected for bank loans (Department for Business Innovation and Skills) and over the past two years, 17% of business owners have had their overdrafts removed while 30% have had them reduced (AltFi Funding). This continuing lack of availability of bank loans and overdrafts to SMEs and the increased number of SMEs turning to alternative lenders is a sign of alternative finance gradually becoming more the norm for businesses. In 2014, nearly 80% of SMEs borrowing through P2P platforms had previously been denied a bank loan (Nesta), but it is likely in the future that the number of SMEs going directly to alternative lenders will increase.
Bank of England figures show the trend towards alternative finance becoming a mainstream option for SMES: in 2014 banks lent £400 million less to SMEs while the alternative finance market supplied over £1 billion of funding to businesses.
Collaboration with traditional finance
There has been much in the media about alternative finance being a threat to traditional banking. However increasingly banks and alternative finance providers are working together. In the UK, RBS and Santander have worked in partnership with Funding Circle and it is likely that we will see more banks approaching alternative finance companies to secure finance for their SME clients, or perhaps even launching their own peer-to-peer lending platforms.
Many finance brokers have also partnered with debt and equity crowdfunding platforms and are referring their SME clients. Along with the increase in institutional investors in crowdlending platforms providing more available finance to lend, these partnerships are increasing awareness and access to other sources of finance, making them less ‘alternative’.
So is alternative finance still alternative?
While alternative finance is bringing about drastic changes in the finance sector, particularly in SME lending, it has some more growing to do before it can be considered no longer ‘alternative’. The barriers to alternative finance becoming mainstream mainly lie in public awareness, both among savers, investors and SMEs. While the new Innovative Finance ISA will increase awareness among savers of peer-to-peer lending, the work that must be done on increasing awareness among SMEs is evident from a recent report which found that 56% of UK SMEs are completely unaware of any form of alternative finance.
With increased efforts to spread the word about alternative finance, could 2016 be the year that it is no longer considered alternative?