Alternative Lenders delivered for Small Businesses during Covid
Alternative Lenders delivered for Small Businesses during Covid
by Mike Carter, Head of Lending and Investment, Innovate Finance
30 May 2022
In this blog post we assess the contribution that Alternative Lenders (non-bank lenders using digital lending platforms) made to small business (SME) SME lending during the Covid crisis, including Innovate Finance members’ part in that lending, and the challenges for SME lending looking forward and how our members can help.
- Alternative Lenders were largely borne out of the Financial Crisis and had successfully built a market share close to 10% of the SME lending market prior to the onset of the Covid crisis.
- The Covid crisis was both a resilience test for Alternative Lenders and an opportunity to show whether the sector could help in delivering the solutions to the crisis
- Alternative Lenders delivered c.22% of Coronavirus Business Interruption Loans Scheme (CBILS) loans, more than double their pre-crisis market share - demonstrating their ability to deliver funding where it’s needed.
- In doing so they overcame a number of disadvantages compared to the big banks: a pricing disadvantage versus the banks (who had access to cheaper wholesale funding including the Bank of England’s Term Funding Scheme) and delayed accreditation to the CBILS scheme (where big banks had a head start in offering CBILs whilst Alternative Lenders had to wait in queue for British Business Bank approval to participate in the scheme).
- Alternative lenders have also led the way in lending to SMEs outside London and are playing a significant part in financing house building across the UK by small builders.
- Looking forward, there are several significant challenges ahead for SMEs which will require increased levels of funding: higher energy costs and inflation, rising interest rates and the cost of reaching Net Zero. The Government also has ambitions for Levelling Up, which requires focused lending to under-represented SME Founders in every part of the UK. Where will this additional funding for SMEs come from?
- Alternative Lenders have been funding the growth in SME lending since the Financial Crisis. They continued to increase lending in 2021, at a time when gross lending by banks fell to the lowest since 2013, and they have shown they can deliver additional funding to SMEs where it’s needed. However, they themselves can be funding-constrained. The key policy Ask to help meet the upcoming financing needs of SMEs is an expansion of British Business Bank (BBB) wholesale funding and guarantee schemes for SME lenders.
The British Business Bank (BBB) published their excellent annual Small Business Finance Markets 2022 report in March which provides a comprehensive review of financing for SMEs in 2021 – you can read it here. We drill down further on the Alternative Lenders and in particular their performance distributing CBILS loans during the crisis. Innovate Finance’s data is derived from public sources such as the BBB and HM Treasury, some private data from our members, together with some estimates of our own to join the dots.
Nomenclature and scope
A quick word on terminology and scope before we start: in this blogpost we split the market into our definitions of Large Banks and Other SME Lenders, illustrated in the chart below. We define Other SME Lenders as Alternative Lenders (these are SME lenders with no bank license), Challenger/ Smaller Banks and Asset Finance companies. Our focus for this post is the Alternative Lenders, and we include Alternative Property Lenders within this category
Secondly, our analysis focuses on gross lending made during each year by £amount of loans written. We don’t look at year end stock of loans and we don’t look at net lending (which is gross lending in the year less repayments made in the year). This is because gross lending is the measure of demand for credit from SMEs at any point in time.
The background – Other SME Lenders were funding the growth in SME lending before Covid
It is well documented that SMEs in the UK account for c.50% of jobs and private sector turnover. SMEs are no different to large companies in requiring debt funding in order to invest, grow and finance working capital. At the time of the Financial Crisis in 2008 the SME lending sector was dominated by the large banks and the majority of the Alternative Lending sector as we know it today had not been created. However, the large banks started to reallocate capital away from SME lending following the Financial Crisis and this was the catalyst for the establishment of Alternative Lenders and Challenger Banks to fill the gap. By 2014 the market share was roughly even as between the Large Banks and the Other SME Lenders, and from 2015 to 2019 it was the Other SME Lenders who funded the growth in SME Lending, as shown in the chart below:
Drilling down further, in the lead up to the Covid crisis, Alternative Lenders had grown rapidly, reaching £7 billion of annual lending or a 9% market share from almost a standing start a decade earlier. Innovate Finance members accounted for c.50% of this loan volume, deploying their innovative tech-led, data-intensive, capital-light business models across a wide range of products and throughout the UK.
The Covid crisis impact on SME lending
When the Covid crisis hit, the Government stepped up very quickly to provide loan guarantee support schemes to lenders to enable them to re-start lending and provide SMEs with vital funding. This support enabled lenders to take the credit risk of a borrower whose immediate credit outlook was difficult to assess due to the prevailing economic uncertainty. Alternative Lenders participated in the Coronavirus Business Interruption Loan Scheme (CBILS) scheme. but they tended not to participate in the Bounce Back Loan Scheme (BBLS) scheme, largely due to the 2.5% p.a. interest rate stipulated by the Government on BBLS loans. Alternative Lenders cannot fund a loan at this rate of interest (as their own wholesale funding is more expensive than this) whereas the banks had access to the Term Funding for SMEs scheme (TFSME) from the Bank of England (not available to Alternative Lenders) ,under which they could repo their SME loans at close to Zero percent financing cost.
The CBILS scheme launched on 23rd March 2020, initially distributed by the large 5 banks. Over the course of the summer of 2020 many more lenders were accredited to the scheme, encompassing Alternative Lenders, Challenger Banks, CDFIs and Asset Finance companies. Initially there was skepticism in some quarters as to whether Alternative Lenders were really needed to distribute these loans, and there was some frustration on the part of Alternative Lenders as to the time taken to obtain accreditation from the BBB. However, the Covid crisis was not only the first major financial test for the sector but also the opportunity to show how Alternative Lenders could contribute to the solutions in times of crisis. So how did they do?
As a result of the CBILS scheme, the second half of 2020 saw a strong recovery in SME lending, and our members contributed to the delivery of much needed CBILS loans to SMEs around the country. This continued into 2021. The chart below shows our estimates of market shares in CBILS by type of lender for the duration of the scheme (which closed on 31st March 2021) compared to their pre Covid market shares.
Based on Innovate Finance estimates:
- Alternative Lenders outperformed their pre-covid market share by some distance, delivering c. 22% of total CBILS compared to their pre-covid market share of c.9%. Innovate Finance estimates that the majority of these CBILS loans were provided by Innovate Finance members, including Assetz Capital, Funding Circle, Iwoca, LendInvest and Nucleus Commercial Finance.
- Bear in mind that many Alternative Lenders were only accredited to the scheme some months after it started and missed out on the initial demand (we estimate that c.23% of loans were written in the first 7 weeks, before Alternative Lenders were accredited.) Innovate Finance estimates that Alternative Lenders provided c.29% of CBILS loans from the point at which they were accredited to the scheme
- Innovate Finance members were also active within the Challenger Banks segment, with Atom Bank, OakNorth Bank and Starling Bank providing over 25% of the volume written by this segment
Overall, aggregating CBILS loans written by our Alternative Lender members and our Challenger Bank members, we estimate Innovate Finance members together wrote c.20% of the total CBILS loans. Not bad for a sector that didn’t exist a decade ago, and a testament to the focus and investment that has been placed on FinTech by policymakers and VC investors during the last 10 years.
Emerging from the Covid crisis stronger
In 2021 lending volumes across the market returned to normal levels (effectively, where lending would have been expected to reach in 2021 based on normal growth from the 2019 pre-covid volume), with some contribution from the tail end of CBILS and from the CBILS replacement, the Recovery Loan Scheme. However, we estimate that despite the unavoidable fall in lending in 2020 versus 2019, Alternative Lenders increased their lending in 2021 by an impressive 19% compared to pre-covid lending in 2019, demonstrating that they have emerged from the Covid crisis with the wind in their sails. In contrast, the BBB noted in their Small Business Finance Markets report: “2021 gross bank lending was the lowest in real terms since 2013 when lending was still recovering from the Global Financial Crisis”
Looking forward – strong headwinds for SMEs will need additional funding
Looking forward, SME’s face considerable shorter-term headwinds such as the cost-of-living crisis, and longer-term challenges including the path to Net Zero and rising interest rates. Compared to the outlook pre-Covid, these are new and significant business issues which ceteris paribus means SME funding needs will be higher than pre-Covid.
Additionally, the Government has a stated Levelling Up strategy which is looking for funding to be made available to under-served parts of the SME market, both geographically and socially. Where will this incremental funding come from?
The evidence pre-Covid was that Alternative Lenders were delivering the marginal growth in SME lending, and they already provide funding to many underserved segments of the market
We also know from the CBILS experience that Alternative Lenders have shown they can deliver significantly more than their historical market share. So what’s holding them back?
The Access to Funding problem
For now, it’s mainly Access to Funding that restricts SME lending, both the amount of funding and the economic price of funding available to Alternative Lenders. They stand at a significant disadvantage to the banks. Additionally, those lenders that are also P2P platforms are experiencing a continued regulatory squeeze on the volume of funding they can access (the latest being FCA proposals on financial promotions in CP 22/2).
Accordingly there are calls for the Government to assist in providing funding for Alternative Lenders as well as a longer term loan guarantee scheme to replace RLS. If this Gordian knot can be solved by policymakers then Alternative Lenders can help many more SMEs to invest in people and equipment to accelerate their growth; to smooth their path to Net Zero and manage through the cost of living crisis; and to play a crucial role reaching SMEs in underserved segments as part of the levelling up agenda. Over time the SME lending market should become large enough to attract sufficient private funding to ensure there are adequate volumes at competitive risk adjusted prices without Government assistance, but we’re not there yet.
What else? Longer term, the SME lending market will also benefit from better data sharing in the form of enhanced Open Banking and the more powerful Open Finance. This will enable better credit decisioning, providing SMEs with easier access to a wider range of finance providers and finance products, and it will help to reach thin file borrowers. In the meantime, here at Innovate Finance we’re proud to continue to be a partner for members who have played a vital role in the economy in good times and in bad. The best is yet to come…!
For more information, please visit Innovate Finance Website here
Innovate Finance members providing lending to SMEs and smaller property developers include: AskIf, Assetz Capital, Atom Bank, Blend Networks, Capitalise, CrossLend, CrowdProperty, Funding Circle, Funding Options, Iwoca, Just Loans Group, LendInvest, Liberis, Nucleus Commercial Finance, OakNorth Bank, Oxbury Bank, Satago, Starling Bank, Swoop Funding, Tide, Trade Ledger