The alternative finance sector has been waiting for the mandatory bank referral scheme to get going for over two years. Then business secretary Vince Cable first hinted at the scheme in March 2014, at the inaugural AltFi Europe Summit. Former chancellor George Osborne later confirmed the government’s intention to realise the programme at the launch of Innovate Finance in August 2014.
But its implementation has been protracted by a multitude of logistical pain points. The mechanics of how and when a bank should refer a business to the alternative finance sector has proven anything but straightforward. The answer ultimately emerged in the form of the neutral finance platforms – online matchmakers which receive data on a loan applicant directly from the banks and then connect those applicants to lenders that are better suited to their needs. The government decided that these portals were to form the nexus of the referral scheme. The British Business Bank was tasked with picking the winners – and there were a fair few portals to pick from.
The Springtime Budget 2015 revealed that the BBB would begin accepting expressions of interest from designation candidates. A number of those candidates were then shortlisted in July 2015. The shortlist, as it turned out, was not especially short, featuring a wide variety of companies – from specialist referral platforms, to well-established peer-to-peer lenders. Three companies were earmarked for designation in the Budget of March 2016: Funding Options, Funding Xchange and Bizfitech. The official designation of these three outfits will occur with the advent of the referral scheme itself.
When the scheme goes live next quarter, designated banks will be required – with immediate effect – to refer rejected loan applicants to the three designated finance platforms. Should they fail to do so, they will be “breaking the law”, according to Funding Options CEO Conrad Ford (pictured above). SMEs themselves must give their permission for a referral to take place – and designated finance platforms must protect the anonymity of small businesses until then.
“Participating banks will refer applicant data to all three of the designated platforms,” explained Ford. “In reality, expect most designated banks to send a daily overnight batch of all SME referral requests that they've received that day.”
“As such, although I can't speak precisely for the processes of our peers, I'd characterise it more like the SME waking up to emails from 2-3 platforms each offering the SME the ability to view their lender matches; it's then for the SME to decide which (and how many) platforms to engage with, and of course which lender(s) to engage with.”
“The next question that always arises is: can an SME be offered the same lender match by more than one platform, to which the answer is yes; that said, we will each be curating our own lender panels, so I'd expect only some overlap on which lenders we all offer.”
Olly Betts (pictured above), CEO of Bizfitech, explained how he expects simultaneous referrals to play out, saying that referred businesses will be contacted by the designated platforms at roughly the same time, and that the process is “largely automated”. It’s then for the small business to pick a platform to engage with; they could choose one, or they could choose all three.
Katrin Herrling (pictured above), CEO of Funding Xchange, outlined the basic process for SMEs that are referred to her platform. “We know that businesses want to have a clear understanding of all the offers that are available to them – so that they don’t waste time applying to providers who can’t fund them,” she said. “To be able to provide quotes, we ask referred customers to complete a quick funding request that captures essential information and allows us to validate that commercial funding options are available to them. Of course, we use the data provided by their bank to streamline the application process but also allow customers to provide validated data, e.g., by extracting relevant data from cloud-accounting software. We get a rich understanding of the customer but it takes less than six minutes to complete the request.”
Herrling continued: “The majority of referred customers will receive instant quotes after submitting a funding request. But we also provide finance providers with the opportunity to review individual requests and submit manual offers. This is particularly relevant for more complex requests – but means that some offers can take a day or two to be available in a customer’s account. The benefit we offer is that customers receive a broad range of quotes and can choose what’s right for them – whether this is based on the amount of funding offered, how quickly it completes or the cost of funding.”
Each of the three designated platforms features a slightly different mix of lenders to the next. Funding Xchange works mostly with short-term online lenders, but also with Macquarie, which offers its own form of specialist finance. Funding Options is integrated with a broader panel of firms, featuring a sizable contingent of incumbent lending businesses, such as HSBC and Bibby.
Each of the designated finance platforms operates its own distinct commercial model. These cannot involve charging small businesses for using the bank referral scheme. The standard model is to charge a facilitation fee to the end-lender.
The British Business Bank recently opened up a second round of the assessment process, which may well lead to more neutral finance platforms being designated in 2017.
The designated banks – which must by law participate in the scheme – are spread across the UK and Northern Ireland. They are: RBS,Barclays, Lloyds, HSBC, Santander, Clydesdale & Yorkshire (CYBG), Bank of Ireland, Allied Irish Bank and Danske Bank.
Funding Options believes that the banks will be far more willing to participate in the referral scheme than is often assumed. Concerns such as adverse outcomes with alternative lenders and the risk of engaging in regulated credit broking activities have to date forestalled most banks from working more closely with alternative lenders. But Funding Options says that the mandatory referral scheme directly addresses these concerns, “firstly via the regulatory comfort of legislation, and through the thorough government assessment process on the infrastructure, proposition and compliance of designated finance platforms”.
In terms of the sheer scale of the referral scheme opportunity, the UK’s largest four banks currently account for over 80 per cent of primary banking relationships for small businesses. Many small businesses only approach the largest banks when seeking finance. In the case of first time SME borrowers, the rejection rate is around 50 per cent. A report from November 2015 by GLI Finance and the Cambridge University Centre for Alternative Finance estimated that a lack of awareness around alternative finance options could cost the UK economy as much as £20bn by 2020. Meanwhile, a British Business Bankers’ Association (BBA) report from December 2015 revealed that more than 40 per cent of SMEs would seek to take advantage of the referral scheme, were it to go live.
But Katrin Herrling has her doubts about the immediate impact of the scheme in terms of volumes. “It is very difficult to project expected volumes for the referral process,” said Herrling. “We do know that other countries have struggled to motivate business owners to use ‘second chance’ processes. There are two key reasons: Firstly, businesses owners that have just been declined for funding often feel dejected that a bank does not think their business is fundable. The psychological impact of hearing ‘No’ is often that they abandon their quest for funding. Secondly, banks often take a few weeks or months to decline a request. At this point for many businesses, particularly those seeking working capital, the need for funding has gone away (Christmas has passed – so don’t need additional inventory), they have found alternative sources of funding (often their own personal bank account) or they may even have gone out of business.”
Olly Betts added that the rules relating to exactly how an offer of referral must be made are somewhat unclear. What is clear, however, is the timeframe within which a referral must be made. Furthermore, offers of referral must be made via the same communication channel that was being used between a bank and customer prior to that customer's rejection.
On the subject of volumes, Ford has identified a potential game-changer buried deep within the pages of a paper on comparison services by the Competition & Markets Authority (CMA) – written as part of a broader investigation into retail and SME banking. “The CMA has said that to drive competition it will require the major banks to display prominent hyperlinks to us on bank websites, a measure which could put bank referrals on steroids," said Ford.
But how will alternative finance platforms themselves react to the launch of the scheme?
"Too many businesses are unaware of the options now available to them when searching for finance, so it's important that traditional and alternative sources of finance come together in the best interests of customers,” said David De Koning, head of global communications at Funding Circle, the world’s largest marketplace lender for small business. “We believe that direct lending platforms such as Funding Circle are complementary to traditional lenders, which is why we launched formal referral partnerships with Santander and RBS in 2014 and 2015 respectively.”
Paul Haydock, CEO of DueCourse, the Manchester-based invoice finance platform which recently clinched £6.25m in funding, also weighed in: "A reliable introductory source, the funding platforms provide us with the opportunity to offer viable businesses a flexible and convenient finance solution. The bank referral scheme is a major step forward for SME borrowers, many of which have been denied access to the funding they've needed to grow and expand in recent times. The scheme will contribute massively in raising awareness of alternative lending options, ultimately driving innovation and growing the UK economy."