Barriers to traditional funding
The Q2 Funding for Lending results showed that despite a slight improvement on previous quarters, overall net lending was negative. With the scheme coming to a close at the end of January 2015, many are questioning its value in helping to lower the barriers to funding for businesses.
The initiative has been a notable effort on the part of the Government to stimulate banking sector lending post-financial crisis, and the scheme has no doubt highlighted the important role that banks have to play in business lending, but many factors have affected their appetite to do so. Capital requirements, ever-increasing complexity of the regulatory environment, and more rigorous lending criteria, amongst others, have a negative impact on liquidity in the market and the bigger participants in the banking industry have not met market requirements.
So while banks have been focusing on building up their capital reserves and placing more stringent criteria on their business lending, who has stepped in to bridge the gap for small businesses looking for funding?
Plugging the gap
The market forces and resultant demand for business funding have seen a new generation of business financing models emerge, to address this lack of liquidity as the economy in the UK recovers. Often encompassed in the catch all term ‘alternative finance’, perhaps unfairly, these firms represent the financing mainstream to a greater and greater degree. Also, these lending models can offer particular benefits for businesses such as less red tape and a shorter turnaround time to obtain the finance.
Traditional models, such as invoice discounting and asset-based lending, have seen substantial growth in recent years, while newer unsecured lending, peer to peer and crowdfunding models have captured the imagination of businesses sorely in need of capital and of investors on the hunt for investment income.
In the first half of 2014, £850m was lent to UK small businesses by alternative lenders. The total figure for 2014 is expected to be significantly higher, however it is likely that it will still fall well short of desired growth.
Alternative finance providers are still facing challenges to growth such as lack of awareness, negative perceptions, and looming regulatory scrutiny. Market saturation is also becoming a reality. This may seem a contradiction as we know businesses need funding, but much of the issue centres on a growing reticence to apply, often connected to previous rejection by the banks or a perception that cost is too high or that the process is too complex. The SME Finance Monitor has noted a significant increase in “permanent non-borrowers”, describing businesses who are eschewing external finance in favour of personal funding or even support from family and friends.
Looking ahead
In addition to the Funding for Lending scheme, much more could be done to raise awareness across the business community on the variety of financing options available from traditional and newer sources. There is a need to build confidence and trust within the SME community to nurture the positivity required to encourage them to invest in their business to achieve growth.
Non-bank finance companies also need to think about their long term sustainability in order to improve perceptions of their offering and cement their place as a legitimate and attractive option. Robust financial and risk management processes must be beyond question, as well as strong controls and regulatory compliance. There is a need to be alive to the ongoing prospect of new or increased regulation and a requirement for flexibility in the face of continuing economic and geopolitical unpredictability.
What is certain is that the business lending environment will continue to develop, with more innovative providers entering the market looking to broaden the options available to businesses. Healthy competition amongst providers would improve choice for businesses and nurture a strong customer service focus which could only help our business community to thrive and therefore benefit the wider economy.
Anil Kapoor, Director at BDO LLP
