A UK Government report released in April 2013 revealed that SMEs have faced a more challenging environment for accessing credit since the financial crisis, with rejection rates for both overdrafts and term loans found to be significantly higher from 2008-9 onwards. This reflected the traditional banks’ attitudes towards risk, with increased regulation and higher capital requirements forcing many to deleverage and behave more cautiously.
Incoming Basel rules demanding that banks treble the amount of collateral required for a small company to borrow money could still further reduce the number of small firms that receive funding, despite the UK’s major banks setting high targets for the amount they intend to lend to SMEs this year. Lloyds, for one, has pledged to lend GBP12bn this year.
The Government has attempted to encourage lending via a number of means, and in 2014 it announced legislation to navigate banks’ reluctance to lend, forcing those that decline an SME’s application for credit to refer them to other sources of funding. This will, if implemented correctly, see a dramatic increase in the amount of money available to SMEs from non-banks.
Adam Tavener, chairman of Alternative Business Funding (ABF) finance partner pensionledfunding.com, and one of the chief proponents of the ABF collaboration, expects the legislation to translate into an additional £2bn in alternative funding, doubling the current market.
The rise of alternate lending is also being seen in the US, where Goldman Sachs’ specialty lending arm floated on Wall Street in May, offering loans to US businesses with no credit ratings and between $5m and $75m in annual earnings.
However, other regions have seen a slowdown in the use of shadow banking. The clearest example of this is China, where the boom in shadow banking, reaching 75% growth in 2010, has slowed down dramatically. The Chinese shadow banking industry has experienced a wave of regulations from Beijing, fearing the level of risk presented by the industry. This is despite it having provided an integral source of funding for the economy and the government previously actively encouraging shadow lenders to fill the funding gap left by overstretched traditional banks.
There are numerous advantages to non-bank financing for SMEs. For one, it encourages financial innovation in the market. It is also true that smaller alternative lenders are often in a better position from which to judge businesses based on their own individual merits and can thus provide bespoke funding structures. In terms of the wider economy, a collapse in the alternative lending market is unlikely to cause the kind of knock on effect that was seen in the banking industry during 2008.
Alternative lenders do, however, present their own set of risks. They are fairly opaque in how they operate, with little regulation. With the influx of risky lending that could come into the sector when the rules change, the lack of regulatory oversight could exacerbate the potential systemic risk. Introducing more stringent regulations, as has been the case in China, could cause a slowdown in the market and an important source of funds to be taken away from businesses that need the money.