4Choice and competition
51.The Government has tried to reduce the barriers to new banks entering the market, with the aim of improving the range of funding options available and reduce the high concentration of lending in the main banks. There is broad agreement that increasing the number of lenders will increase the diversity of choice and offer innovative products.128 As part of this, the British Business Bank runs programmes to support the growth of challenger banks and non-bank lenders, and directs 90% of its funds through a wide range of banks, asset finance providers, equity and venture capital investors, to try and increase diversity of choice and competition.129 It will take time for the new entrants and their products to become known among SMEs.
Challenger banks
52.In 2010, Metro Bank became the first institution in over a century to gain a full banking licence. A further six new banks have been authorised to operate in the UK since April 2013. Since then, the challenger banks have nearly doubled their share of the retail lending market,130 including mortgages and unsecured loans, from 4 per cent in 2010 to 7 per cent in 2013.131 In 2015–16, challenger banks increased their lending by 32 per cent, while lending from the big five banks fell by 5 per cent.132 We heard different views on the extent to which the dominance of four main banks led to gaps in finance for businesses. There is a perception among some that the high street banks have become more formulaic in assessing finance applications and are not proactive in seeking to understand their business customers’ needs.133 Rishi Khosla, Co-founder and Chief Executive of OakNorth, one of the challenger banks, said a lot of high street banks have gone to automated decision making, that businesses get excluded for not fitting narrow criteria.134 Gareth Oakley, Managing Director, SME Banking at Lloyds, said that Lloyds Bank does not operate a one-size-fits-all approach, and any perception that they did was anecdotal rather than borne out by the statistics. He said Lloyds enabled their local managers to have discretion to lend up to £1 million, and that Lloyds had increased its net lending by 25% over the last five years at the same time as the market has decreased by 13%.135
53.The new challenger banks appeared to be more willing than the high street banks to build a relationship with potential clients, and to understand their needs, before coming to a decision.136 Jimmy McLoughlin, Head of Entrepreneurship Policy, Institute of Directors, said their members felt the challenger banks offered a more personalised service:
When you go to the big high street banks it is that tick-box, “No”, and very formulaic response. The challenger banks at least are seen to see people and go through the issues in that more traditional model that we have perhaps romanticised a little bit about from previous years gone by. It feels much more as though they are at least getting a hearing, even if the answer they get is not what they want to hear.137
54.Gareth Oakley, from Lloyds Bank, recognised that the new banks might have a different risk appetite which enabled them to offer a slightly different approach, and that they were driving competition.138 The challenger banks were seen as providing a different service, with a focus on supporting business, emphasising customer service and longer opening hours.139 Some witnesses suggested the new entrants to the market were complementary rather than in direct competition with the traditional high street banks.140 Mr Khosla said that in the deals OakNorth had been involved in they had found it more likely to be in competition with private equity funds rather than other banks.141
55.The British Chamber of Commerce wanted the Government to reduce further the barriers for new banks entering the market.142 Regulation is necessary to provide investors with confidence that their money is safe because there is robust protection.143 We heard concerns that the requirement, since the financial crisis, for banks to retain a higher proportion of their capital in reserve can disproportionately impact upon new entrants,144 not least because they had not had years to accumulate assets.145
56.Bank lending remains the main source of finance for SMEs in the UK. Too many SMEs think that means the only source of lending is one of the established High Street banks. That is not the case. The new challenger banks have gained a reputation for being innovative, attentive to customer service, and proactive in reaching out to potential customers. We welcome the establishment of challenger banks and the fact they have started to increase their market share. The Government should set out how it plans to support the challenger banks that have entered the market for lending to SMEs, and what steps it is taking to further increase competition in the market place for SME finance. This includes consideration of how the regulatory regime, such as the rules on capital requirements held in reserve, can disproportionately affect the ability of new entrants to compete on a level playing field with the larger, more established banks.
The importance of data
Sharing credit information
57.The Small Business, Enterprise and Employment Act 2015 (SBEE Act) includes measures to ‘encourage’ the banks to share credit information on their customers with credit agencies and other finance providers and to improve the quality of credit decisions across the market. The models that alternative finance sector use to assess credit is improved by having access to data, so more data leads to better decisions.146 James Meekings of Funding Circle explained it as
The better data we have, the better we can assess risk. [ … ] We believe that by opening up more data, more of them [SMEs] will be able to pass our credit models. We will be able to get a better understanding of them. This will ultimately increase lending to small businesses.147
He also gave an example of where the banks fulfilled their obligations in sharing data with new entrants to the finance market, but they did so more slowly than they were required to.148
58.The Government has stated that it wants to increase diversity and competition in the market for finance. The new banks are disadvantaged by asymmetry in access to customer data held by businesses they would like to work with. We recommend the Government sets out in its response to this Report how they intend to monitor the implementation of the Small Business, Enterprise and Employment Act 2015 and, if need be, review the Act to ensure the banks are fulfilling their obligations to provide data when they are required to.
VAT register
59.The SBEE Act introduced measures regarding disclosure of non-financial VAT registration data to help qualifying parties improve their models for credit scoring. HSBC suggested that Credit Reference Agencies (CRAs) should have access to VAT Register data so the CRAs could generate more accurate credit scores for unincorporated businesses.149 Funding Circle also called for the release of VAT statements to CRAs—and then approved finance providers with the consent of the business—to improve the data they use in making credit assessments, particularly for sole traders.150
60.We recommend that the Government explore allowing the Credit Reference Agencies and authorised finance providers access to financial data in the VAT Register, subject to the appropriate safeguards.
Referral scheme
61.The Small Business, Enterprise and Employment Act 2015 included proposals for banks to refer a business whose application for finance they have rejected to a designated platform, which will then match the SME with an alternative finance provider. Finance providers, from peer to peer lenders and banks, said they would refer a business on to another provider if they were unable to help, and that this was conventional in the venture capital community.151 We heard widespread support for the Government’s proposals to mandate designated banks to refer unsuccessful applicants to designated platforms. The British Business Bank has proposed three platforms to be designated, which have been confirmed by HM Treasury. The system for how it will work is being put in place “over the course of this year”,152 and the details of how it works in practice will obviously be important.153 For example, the ICAEW believes that the referral scheme should come alongside access to information and advice, before and after an application. If an SME has an application refused then a subsequent application is unlikely to be more successful unless it is made to a funder with different credit scoring criteria or a different form of finance.154
62.We found broad support for the scheme, introduced in the Small Business, Enterprise and Employment Act 2015, for banks to refer unsuccessful applicants on to an online platform that will link the business with an alternative finance provider. We also heard criticism that the implementation of the scheme was slow and there needed to be more information on how the scheme will work in practice. We recommend that the Government set out, in its response to this Report, the timetable for implementation of the referral scheme and how it intends to assess its success.
Switching
63.The Competition and Markets Authority’s recent investigation into retail banking found that the established banks still dominated the market, they did not have to work hard to retain their customers; and that this made it difficult for new banks to attract customers. Their recommendations for small businesses related to:
- Competition to develop comparison tools
- Loan rate transparency
- Loan price and eligibility indicator
- Standard information requirements for Business Current Account opening
- Sharing of SME information
- ‘soft’ searches
- Role of professional advisers
Together, their aim is to give business customers more tools to exercise choice over their finances, and level the playing field for new banks to compete for customers.155
64.Central to this is improving the ability of business customers to switch banks. Half of start-up businesses open their business account at the same bank that the business owner has their personal account and only 4% of business customers switch to a different bank in any one year. Obviously, many business customers are satisfied with their bank and see no reason to switch. Some businesses will be aware that carrying out multiple searches for credit can negatively impact upon their credit score, which understandably discourages shopping around.156
65.SME customers find it difficult to find comparative information on what the alternative offer might be. Disengaging from a bank is difficult and opening a new business account can be time-consuming. Small business people are often short of time and require quicker processes. The net benefits of moving from one bank to another do not appear to be sufficient to make the effort worthwhile. Customers understandably fear putting at risk a multi-faceted relationship built up over time.157 From the banks’ perspective, the Current Account Switching Service (CASS), introduced in 2013, had made progress. Gareth Oakley from Lloyds said the system worked “extremely well” and that more than 5,000 businesses switch accounts to or from Lloyds in a year.158 FSB research suggests that loyalty to banks is diminishing, as new businesses created in 2010–15 are more likely to move their current accounts than those created pre-2000.159
66.The recent Competition and Markets Authority Report found that the traditional banks did not have to work hard to retain their customers. Several of their recommendations focussed on transparency and helping the customer compare products so they could switch bank accounts.
Comparison tool
67.The CMA Report supported the development of a one-stop-shop to provide customers with a way of easily comparing offers on lending criteria, quality of service and price, and backed the launch by NESTA of a ‘challenge prize’ for the development and delivery of comparison services.160 The development of a comparison tool chimed with our evidence on the need for SMEs to see clear information online.161 The BBB has tailored its Business Finance Guide to be accessible online.162 Another initiative is the Business Banking Insight project, a website provided by the British Chamber of Commerce and the Federation of Small Businesses, and sponsored by HM Treasury, which carries online reviews of finance providers, products and services, posted by business people.163 The number of bank branches where a customer could go in to talk to a business adviser has reduced since 2008,164 and the rise of the alternative finance sector in the UK is testament to the appetite from business for providing this sort of information online. Banks and finance providers are more likely to rely upon an online presence and customers are becoming more likely to seek information online. The CMA want to encourage banks to develop online tools to help the SME customer find out their eligibility for that bank’s lending products.
68.We agree with the CMA that access to finance for SMEs would be improved by the banks providing comparable information, easily accessible online, in areas of interest to current and potential SME customers, such as lending criteria. We support the CMA’s backing of the NESTA challenge prize to develop a comparison tool to provide this information for SMEs, and its requirement that the banks provide financial backing and technical support to the NESTA project. We will monitor its progress.
Alternative Finance
69.Technology has developed to enable businesses or individuals to come into contact with organisations which might wish to invest or lend to their business. Since the first online platform, Zopa in 2007, the alternative finance industry has continued to innovate and develop alternative ways of how to provide funding.165 In 2014, the online alternative finance industry facilitated loans, investments and donations totalling £1.74 billion. In 2015, this had grown to £3.2 billion, a growth rate of 83 per cent in one year.166 The sector is continuing to evolve. Local authorities use alternative finance to fund community projects and universities use alternative finance models to raise funds from their alumnae.167 High Street banks are forming bilateral arrangements with online providers.168 Institutional investors and high net worth individuals are increasing becoming involved in alternative finance.169
70.Two types of alternative finance, in particular, are growing in popularity. Peer-to-peer business lending involves investors lending money to businesses through an online platform. This has shown signs of growing strongly and accounted for £1.3 billion of lending in 2015—3 per cent of gross lending. Equity based crowdfunding enables individuals to contribute funds to a specific company or project via an online platform. The investor purchases a debt security or equity share in exchange for a product or reward. (It can also be a donation.)
71.Banks are seen as good providers of standardised loans but not so good at providing other, more bespoke products.170 Where they have shown an unwillingness or inability to provide a service, others such as alternative finance have filled the gap.171 A recent report from Deloitte said that alternative finance will not present an “existential threat to banks”, and they should be considered complementary not as competitors.172 The Institute of Directors did not see crowdfunding and challenger banks as replacing the traditional high street banks but rather were opening up entirely new avenues.173 The alternative finance providers do not see the banks and investment funds as a high risk to alternative finance.174
72.Alternative finance has enabled SMEs to raise finance in a relatively simple way without going to the high street bank.175 James Meekings, from Funding Circle, which started in 2010, said they specialised in helping the S in SMEs—the average number of employees of an SME borrowing from them is eight and the average loan is £50,000. It has since grown to be one of the top five lenders to SMEs in the UK.176 He said Funding Circle was seen as easier and quicker than the bank, and attracted businesses that were struggling to get a meeting with their bank or do not approach their bank because they do not think they would get a loan.177 It is noticeable that new business start-ups show average or lower awareness of traditional forms of debt finance compared to SMEs as a whole, but show higher than average awareness of new forms of finance such as peer-to-peer lending.178
73.The main barrier to the growth of alternative finance appears to be awareness among potential customers of what it is and how it might meet their business needs. An internal poll of British Chamber of Commerce members found “little understanding” of alternative finance options.179 Surveys of Institute of Directors’ members found 7% saw non-bank options like peer-to-peer platforms as important to financing their business, and only 2% for equity crowdfunding.180 The SME Finance Monitor found only about 1% of SMEs used crowdfunding in 2015.181 However, there are signs that this is changing—the Institute of Directors survey also found the number who thought equity crowd funding would be ‘important’ or ‘very important’ in the next ten years rose from 8% five years ago to 38%.182
74.The direction of travel is clearly towards finance being provided online, either through an alternative finance provider or an established bank, or a hybrid of both. The alternative finance sector in Britain is seen as user friendly, at the forefront of innovation, and filling a gap in SME finance for a raft of start-ups and entrepreneurs. The main barrier to growth of alternative finance appears to be a lack of awareness of their existence among SMEs, and a lack of understanding of how they might meet the needs of a new or growing business. The barrier of access to information and advice, rather than access to finance, appears to be magnified with alternative finance. We recommend that the British Business Bank’s collection of feedback regarding the Business Finance Guide specifically seeks views on the range of alternative finance providers and the products available. We further recommend that they set out how that will inform their strategy for increasing awareness of understanding finance options, and how the alternative finance sector can be promoted among those in the accountancy, legal and banking sector involved in giving face to face advice to SMEs.
The regulation of alternative finance
75.Surveys of alternative providers put the risk of an online lending platform failing as the biggest risk to the sector—57 per cent said the potential collapse of a well-known platforms due to malpractice was a “high, or very high” risk, followed by cyber security breach (51 per cent) and changes to tax incentives for investors, such as SEIS (37 per cent).183 The FCA requires every authorised firm to have in place arrangements for what would happen if it were to collapse.184 Mr Woolard saw the possibility of investments within a portfolio failing as a larger risk than failure of the platform.185 The British Business Bank conducted detailed due diligence on the underwriting of the finance platforms when considering where it chooses to invest.186
76.The FCA has three operational objectives: to secure an appropriate degree of protection for consumers, to protect and enhance the integrity of the UK financial system, and to promote effective competition in the interests of consumers. The FCA regulates two types of crowdfunding: investment-based crowdfunding, involving the purchase of unlisted equities and debt securities in start-up and young businesses; and peer-to-peer lending, which involves lending to individuals, businesses and projects.187 The UK is the only country with a dedicated regulatory regime for peer-to-peer lending.188
77.In 2014, new rules came into force for the regulation of crowdfunding platforms operated by firms authorised by the FCA, with a commitment that the FCA to monitor and review in future the crowdfunding regulatory framework—an approach broadly supported by the alternative finance providers.189 In July 2016, the FCA issued a Call for Input, inviting views on the review should cover,190 with the intention of ensuring that the balance is right between supporting this evolving market and ensuring consumers are adequately protected.191
78.Evidence from the alternative finance sector supported the regulation of their industry, and supported the Government’s current approach—90 per cent of online platforms in the 2015 UK Alternative Finance Industry Report thought current regulation was “adequate and appropriate” for their activities.192 One Peer to Peer platform, Funding Knight, said that the regulatory framework in the UK had “created an investment climate which is the envy of the European Union and beyond”.193 The Institute of Directors said light touch regulation had contributed to the growth in the industry and put the UK at the forefront of the global alternative finance sector. Mr Woolard said the FCA placed the same requirements on both the existing crowd-funders as they stand today and banks are exactly the same.194
79.The current regulatory framework was praised by those in the industry for being clear and relatively easy to understand, and seen as a standard for other countries to follow. We conclude that it has struck the right balance between safeguards and allowing space for the sector to innovate and expand. The sector is expanding and evolving. It is important that the regulatory framework is flexible, and if need be is revisited, to address the changing landscape. As such, we welcome the Financial Conduct Authority’s willingness to engage with the alternative finance sector before making any change in the regulations. We urge that this approach is repeated in the future.
129 Q165, Q168
130 ‘Challenger banks’ describes new, smaller banks, that are not the traditional High Street retail banks
131 Financial Times, Challenger banks try to shake up the big four, 4 January 2015
132 KPMG, A new landscape, challenger banks annual results, May 2016
133 Q5, Q11, Q16
134 Q82
135 Q95, Q79
136 Q16
137 Q11
138 Q101
140 Q42
141 Q98
142 Q47
143 Q114. Q156
145 Competition and Markets Authority, Making banks work harder for you, 9 Aug 2016. Q117
146 Q145
147 Q146
148 Qq132–137
151 Q158. Q159
152 Q171
155 Competition and Markets Authority, Making banks work harder for you, 9 August 2016
156 Competition and Markets Authority, Making banks work harder for you, 9 August 2016. HSBC ATF039
157 Q10
158 Q96
163 Business Banking Insight , HSBC ATF039
164 Banks close more than 600 branches over the past year, BBC Online, 13 May 2016
165 Q191, Q194
166 NESTA, Pushing boundaries: the 2015 UK Alternative finance industry report, 2016. See also NESTA, Business Insights, 2016
167 NESTA, Pushing boundaries: the 2015 UK Alternative finance industry report, 2016. The Royal Society ATF041
169 NESTA, Pushing boundaries: the 2015 UK Alternative finance industry report, 2016,
170 Q147
172 Deloitte, 2016 Marketplace lending: A temporary phenomenon?
173 Q42
174 NESTA, Pushing boundaries: the 2015 UK Alternative finance industry report, 2015
175 Q65
176 Qq121–123
177 Qq122–123
178 British Business Bank, Small Business Finance Markets 2015–16, February 2016
181 Q181
182 Q3
183 NESTA, Pushing boundaries: the 2015 UK Alternative finance industry report, 2016
184 The Financial Conduct Association (FCA) was set up in April 2013 to act as the conduct regulator and prudential regulator for those financial firms in the UK not regulated by the Prudential Regulation Authority (PRA). The PRA is the prudential regulator and supervisor for around 1,700 banks, building societies, credit unions, insurers and major investment firms. The conduct of these firms is also regulated by the FCA
185 Q195
186 Q195
187 More information on the types of product used in alternative finance, and which ones are regulated and unregulated are given in the FCA evidence ATF063 para 16
188 Q150
189 Q151
190 FCA launches call for input on crowdfunding rules, 8 July 2016
192 NESTA, Pushing boundaries: the 2015 UK Alternative finance industry report, 2016
194 Q184
28 October 2016