Recent studies have shown that small and medium businesses are finding it more difficult to get finance from traditional sources such as banks. The 2008 financial crisis has resulted in a perception that banks are reluctant to lend to SMEs, forcing many businesses to turn to alternative finance providers for funding. In this blog post Ian Cunningham, LendingCrowd’s Head of Credit, looks at the growth of alternative finance and the potential benefits for borrowers and lenders.
Across the world, small to medium-sized enterprises (SMEs) have traditionally been the backbone of regional economies and in recent years they have also benefited from increased globalisation, which has helped to boost their geographical reach into new markets.
However, since the 2008 banking crash SMEs have often struggled to raise the finance they need from the banks to grow and expand their businesses. The global regulatory response to financial crises through banking supervision regulations while designed to reduce systemic risk, has also constrained bank lending to SMEs.
All of this is happening at a time when banks are still repairing their balance sheets due to bad debt experience and a significant amount of customer compensation incurred as consequence of mis-selling products. Significant cuts have been made in staffing levels resulting in many seasoned and experienced relationship and credit underwriting staff leaving the banking sector. This has created a void in terms of the long-term banking relationships that many SMEs enjoyed.
For many SMEs there is a perception now that it is just too difficult to raise finance via traditional retail banks and they fear being refused. Therefore, it is hardly surprising that SMEs are turning to alternative finance providers to fund their business aspirations.
Over the last five years this gap in the market has increasingly been filled by the fast-growing alternative finance market of which crowdlending, or peer-to-peer (P2P) lending, is a subset.
Indeed, governments across the globe now recognise the need to provide different pathways for access to finance For example in 2010 Metro Bank became the first organisation in the UK to be granted a full Bank Licence in 100 years, which has paved the way for others to follow.
This is not to say that the regulators, particularly in the US and UK, are opening up the market to all and sundry. There is still a very rigorous process of diligence to be undertaken, but more and more players are challenging the traditional models of finance. This opens up greater access to funding across different channels such as peer-to-business lenders (crowdlending), start-up loan companies, equity crowdfunders and venture capital.
As SMEs looking to borrow money gain confidence in the crowdlending route to finance and investors see the potentially better returns, the ‘disruptive’ impact on traditional funders will become more readily apparent. From the borrower’s perspective, the ease of the application process, speed of decision making, transparency of interest rates and fees and the comparatively short time taken from application to availability of funds are major attractions. While in general the cost of funds to borrowers is likely to be slightly higher than through the more traditional routes, this is more than compensated for by the perceived ease of the process and, more importantly, the ability to raise the funding required to grow their business to take it to the next level.
Alternative funders need to embrace the basic tenets of good lending practice to establish their creditability and thereafter maintain it. Not tainted by previous experience they also have the opportunity to assess each proposition on its own merits rather than adopt a ‘one size fits all’ approach.
Further, by having greater flexibility in terms of technology solutions, alternative finance providers are not held back by legacy systems and processes and consequently can be fleeter of foot in terms of providing effective financial solutions for both borrowers and investors.
It is apparent that the potential for growth is significant and the key to how fast the global alternative finance market can grow lies in three key areas. Firstly, platforms will need to be nimble to respond to the fast-changing market place with the biggest challenge being the ability to build from scratch a flexible fit-for-purpose IT system. Secondly, players need to have the ability to raise sufficient finance from both retail and institutional investors to meet demands from prospective borrowers. Finally, in order to boost confidence in the sector in general, it is important that it is well-regulated, supported by robust underwriting processes and minimal and manageable default rates.
As the crowdlending sector develops, it is unlikely that the established banking sector will stand by and watch market share and profitability be eroded by alternative finance providers. To date they have been slow to react to this new phenomenon, but with the potential of alternative finance to become the new norm they will have to start to address their approach to this sector as it gains momentum. Because banks have to contend with the legacy issues of the 2008 banking crash and their ageing technology platforms, it will be interesting to see how they react to the new kids on the block.