Conduct and competition in SME lending - Treasury Contents

6  Alternative finance

Crowdfunding/peer-to-peer finance

252. While much of this report has focused on competition in SME banking, not all competition in SME finance comes from the banking sector itself. SMEs are able to obtain funding from a variety of alternative sources. This includes both equity and debt funding. In this report, the Committee has focused on a relatively new form of disintermediated SME financing—crowdfunding and peer to peer finance.

253. Crowdfunding, a term sometimes used interchangeably with peer-to-peer finance, is a relatively new type of business funding that has attracted broader attention in recent years.[470] With regard to SME finance, crowdfunding/peer-to-peer finance encompasses a variety of models where small individual lenders directly fund businesses. Unlike saving through bank deposits, the risk is borne directly by the investor.[471] Crowdfunding/peer-to-peer lending can come in several different forms, including:

·  Peer-to-business lending, or loan-based crowdfunding, is a form of debt-based funding where businesses borrow small amounts of money from many small investors.[472]

·  Equity or "investment-based" crowdfunding is a form of equity based funding where "people invest directly or indirectly in new or established businesses by buying shares" or other securities.[473]

·  Peer-to-peer invoice financing, a form of asset-based finance where investors directly fund businesses through purchasing their invoices.[474]

254. As discussed previously in this report, there are few sources of official statistics on crowdfunding/peer-to-peer finance. Those that do exist suggest that, while alternative lenders appear to be small in comparison to established banks, they do exhibit a high growth rate. The think-tank Nesta, in a 2013 report, estimated that total finance raised by the sector—including lending to individuals, businesses and charities—"more than tripled from £309 million in 2011 to £939 million in 2013".[475] They also said that the "peer-to-business lending sector is more than doubling each year and the UK is the undisputable world leader of this alternative financing model".[476] In January 2015, the Liberium AltFi Index, an industry dataset on peer-to-peer and crowdfunding platforms, estimated that the total lent by alternative finance platforms had exceeded £2.7 billion. Of this, peer-to-business lending accounted for just over £1 billion, with an annual growth rate of approximately 200 per cent.[477]


255. Evidence to the Committee attributes the sector's growth to new technology and reduced confidence in traditional lenders following the financial crisis. Samir Desai, CEO and co-founder of the alternative lender Funding Circle, told the Committee that the "loss of trust and satisfaction with banks" was helping to drive growth in the industry. He added that "the costs of technology and being able to use technology have come down dramatically"[478] and that technology was beginning to disrupt status quo in the financial services industry:

    What we think is happening now—in the case of Funding Circle and the same with MarketInvoice—is that technology or the internet is starting to disrupt financial services. We have seen that disruption in the book industry and music, and what is happening now is that you have the digital equivalent of lending—digital loan and digital invoice finance—starting to take off. I personally think that is an unstoppable force.[479]

Anil Stocker, founder and CEO of alternative lender MarketInvoice, agreed, saying that new alternative providers could build business models which were leaner than traditional lenders:

    We have better data now than ever before. We have a chance to redefine completely how we think about these products. We can introduce new products. We are not saddled by branches, big bloated infrastructure, cost bases and people.[480]

256. Mr Stocker emphasised the speed, flexibility and simplicity of crowdfunding/peer-to-peer finance, saying that:

    When I look at the products that the banks have, there are so many negative features about them. There is so much lock-in. There are so many opaque things around the fees. Businesses do not understand what they are going to get charged, how they can exit and what collateral they have to give. Banks are constantly changing the goalposts. Right now I think there is a huge opportunity in the alternative finance market to make everything more transparent, faster and easier […].[481]

257. With regard to the speed of funding, MarketInvoice's written evidence said that initially it took 21 days to fulfil an approved application for funds, which it stated was similar to the level that "banks have been stuck at for 30+ years". The firm said it had improved this, so that it could provide funding "in a few hours". This reduction was attributed by MarketInvoice to its "need to innovate" as a result of the "competitive marketplace" in which it operated.[482] Funding Circle also claimed to be "faster and more efficient than a bank loan". It wrote that "on average it takes 12 days for a business to gain finance through Funding Circle, compared to ~15-20 weeks with a bank".[483]

258. The New Economics Foundation (NEF), a think tank, believed that part of the usefulness of crowdfunded loans was due to the unsecured nature of the loans, which it said was "particularly suitable for the SME sector where borrowers often lack suitable collateral". It said that, as a result, "borrowers who struggle to access bank finance, may be able to get credit and at lower rates than other sources of non-bank finance".[484] Mr Desai highlighted the similarity that crowdfunded lending has with sources of finance open to larger firms:

    […] if you look at big businesses, they do not have to borrow from banks. They can go to bond markets or equivalent syndicated loan markets and borrow the money directly from big investors. Platforms like Funding Circle allow smaller businesses to borrow directly from investors as well. If you look at bond markets or syndicated loan markets, they can be anywhere between 20% and 40% of finance markets, or even higher in the US. There is precedent for this in larger business finance.[485]


259. In written evidence, the British Bankers' Association said that UK businesses had a "traditional overreliance" on bank-sourced credit "with banks providing nearly 80 per cent of all credit".[486] RBS and HSBC said that crowdfunding and peer-to-peer finance were leading to greater competition. HSBC wrote:

    There has been a range of new entrants to the market over the last five years. These entrants include challenger banks, such as Aldermore Bank and Metro Bank, and a number of new innovative funding sources for SME customers such as Funding Circle. These new entrants are helping to drive competition in the SME banking market and have increased their lending volumes at a time when overall net lending in the market has declined.[487]

RBS wrote that it was "seeing increasing competition from alternative sources of finance" and "though still small in absolute terms, [this] has been showing extremely rapid growth rates". RBS said that alternative lenders were, "in some circumstances, better suited to the customer's needs than a traditional bank product or service".[488] Other organisations offered a similar view. The CBI wrote that "increased competition in the banking sector coupled with the impact of alternative finance providers indicates a positive trajectory for the market".[489] The ACCA wrote that "it would only take the alternative lenders four years to rival today's banks for lending volumes if their current growth rates are maintained".[490]

260. Crowdfunded finance is, however, still regarded as niche by many businesses. The Institute of Chartered Accountants of Scotland (ICAS) believed that "innovations such as the emergence of retail bonds and crowdfunding remain, as yet, of only marginal significance".[491] The British Chambers of Commerce (BCC) said that feedback from their members revealed a high degree of reliance on "traditional debt finance." In a poll of their members, 49 per cent used banks or building societies, 10 per cent used equity and 8 per cent used "grants, venture capital, private equity, peer-to-peer lending and angel finance combined". The BCC said that there "remains little understanding of alternative finance options."[492]

261. In March 2014, the Government consulted on whether and how it could "legislate to create a mandatory process, whereby Small and Medium Sized Enterprises (SMEs) that have been rejected for finance are linked up with other lending opportunities from challenger banks and alternative finance providers".[493] Awareness of alternative lenders was a particular problem cited by witnesses to the Committee.[494] Discussing the Government's consultation on this issue, Mr Stocker said to the Committee:

    There needs to be some way that we can either build awareness at the point of application, or build awareness alongside the banks and banking infrastructure. I think some things are already being debated and discussed around referrals and ways of signposting, just to build awareness, because I think that with awareness you are going to have a lot more businesses finding out about us, using us, and creating jobs.[495]

The Peer-to-Peer Finance Association wrote:

    The P2PFA considers that any mechanism which required banks to provide information to SME customers about alternate sources of finance a helpful step in the right direction.[496]

262. As a result of its consultation, the Government has proposed draft legislation on a requirement for banks to refer SMEs rejected for finance to alternative lenders in the Small Business, Enterprise and Employment Bill.[497] It has also published, in draft, a statutory instrument to illustrate its current intention as to the exercise of powers under clause 5 of Bill.[498]


263. Crowdfunding is currently regulated by the FCA.[499] A number of risks from crowdfunding have been identified by the regulator, including:

·  A lack of minimum standards of due diligence or disclosure. In particular, the reporting requirements on borrowing businesses may be lower than for listed companies;

·  Investor over-optimism, particularly if due diligence or disclosure has been poor;

·  Problems with technology, IT security or the internet; and

·  A potential lack of regulatory experience or, with regard to loan-based crowdfunding, lending experience in crowdfunding firms.[500]

264. Crowdfunding/peer-to-peer finance is in principle a welcome addition to the UK SME lending market. For some SME borrowers, it can offer a credible alternative to bank lending. It represents a step towards more effective competition in the market.

265. Crowdfunding/peer-to-peer finance's market share of SME lending remains relatively small. Borrower awareness and understanding remain the most significant barriers to wider adoption. The Government has set out plans to require banks to refer those rejected for bank finance to alternative lenders. These are welcome in principle.

266. Commercial risk should remain with the lender. Crowdfunding and peer-to-peer lending platforms have a duty to explain clearly and fully, to those who wish to lend or invest through them, the risks that they are taking.

470   Financial Conduct Authority, Policy Statement 14/4, March 2014 Back

471   Funding Circle, Understanding risk, 17 February 2015 Back

472   Financial Conduct Authority, Policy Statement 14/4, March 2014, p 10 Back

473   Financial Conduct Authority, Policy Statement 14/4, March 2014, p 11 Back

474   SME0154 Back

475   Nesta, The Rise of Future Finance: The UK Alternative Finance Benchmarking Report, December 2013, p 7 Back

476   Nesta, The Rise of Future Finance: The UK Alternative Finance Benchmarking Report, December 2013, p 10 Back

477   Liberum AltFi Volume Index AltFi, as at 19 January 2015 Back

478   Q 922 Back

479   Q 922 Back

480   Q 929 Back

481   Q 920 Back

482   SME0154 Back

483   SME0108 Back

484   SME0139 Back

485   Q 931 Back

486   SME0110 Back

487   SME0115 Back

488   SME0093 Back

489   SME0080 Back

490   SME0011 Back

491   SME0101 Back

492   SME0104 Back

493   HM Treasury and BIS consultation, Help to match SMEs rejected for finance with alternative lenders: summary of responses, August 2014, p 3 Back

494   Q 968; SME0108 Back

495   Q 968 Back

496   SME0068 Back

497   Small Business, Enterprise and Employment Bill, HL Bill 57 2014-15, 20 November 2014 Back

498   HM Treasury, The Small and Medium Sized Business (Finance Platforms) Regulations 2015 Regulations: draft regulations, 6 August 2014  Back

499   Financial Conduct Authority, The FCA's regulatory approach to crowdfunding over the internet, and the promotion of non-readily realisable securities by other media, March 2014 Back

500   Financial Conduct Authority, The FCA's regulatory approach to crowdfunding over the internet, and the promotion of non-readily realisable securities by other media, March 2014 Back

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Prepared 13 March 2015