View from the UK: Why the Alternative Finance Industry Needs Greater Regulation
The global alternative finance industry has undergone staggering growth in recent years. In 2015 combined market activity in the UK grew 84% from £1.74bn the year before to £3.2bn. Around 20,000 SMEs raised approximately £2.2bn in funding through online channels, representing a year-on-year growth rate of 120%, and experts at the Centre for Economics and Business Research predicted that the market will be worth £12.3bn by 2020.
Since the financial crisis traditional banks have retrenched from lending to small and medium sized businesses leaving a huge funding gap in their wake. Such lenders have withdrawn SME overdrafts at a rate of over £5m a day since 2011 and the number of approved overdraft applications has fallen by 47% since 2012.
A survey by business lending platformFunding Options found that only 36% of small businesses that applied for a bank loan in the last two years received the full amount they requested, whilst 13% were completely turned down. In stark contrast, 82% of respondents who had applied for some form of alternative finance had secured the funding they needed.
The industry has played a vital role in plugging this gap where big banks cannot, or will not, provide. The SME sector employs approximately 25 million people across 5 million businesses, making the successful implementation of alternative finance vital to the UK’s economic development.
Against this backdrop, it is no surprise that experts are calling for more consistent regulation across the sector to guide it during its next phase of growth. In order to continue its growth trajectory, the sector must now focus on building trust and awareness through adherence to regulation in order to attract both greater levels of investment, as well as more businesses seeking funding.
At present, seven in ten SMEs that are refused a loan from a traditional bank do not go on to seek alternative finance according to the Department for Business, Innovation & Skills.
And, according to a report by the British Business Bank, only 40% of small businesses surveyed had heard of peer-to-peer lending and half of them were familiar with only one such platform. Following feedback from its members, the British Chambers of Commerce stated that there is ‘little understanding’ of alternative finance with a mere 8% of respondents using P2P lending, venture capital, angel finance or other similar platforms.
The industry has worked closely with the government in recent years to gain greater traction in the market by moving away from its ‘alternative’ tag and further into the mainstream.
Initiatives such as the British Business Bank’s latest move to recommend for designation by HM Treasury only three companies – including GLI Finance investee Funding Options – for the Bank Referral Scheme will help SMEs become more aware of the range of finance options available to them. The scheme will enable these platforms to match SMEs that have been refused loans by designated banks with alternatives thus facilitating access to the finance that they need to thrive.
Improvement of SME awareness and understanding of their finance options will also encourage them to seek out other forms of funding rather than giving up at the first refusal from a bank.
Other developments, such as the launch of the Innovative Finance ISA in April will also help propel peer-to-peer lending into the public domain as it competes against other popular saving products.
Against such positive developments it is critically important that the industry adheres to regulation to strengthen its reputation. We must strive to ensure transparency within the sector in order to avoid failures such those we saw at TrustBuddy (Sweden) and Ezubao (China).
We must not dismiss out of hand the warnings of naysayers such as Lord Turner, ex-chairman of former financial regulator the FSA, who stated earlier this year that “the losses which will emerge from peer-to-peer lending over the next five to ten years will make the bankers look like lending geniuses.” We must instead learn from such comments, and help people such as Lord Turner to understand alternative finance – after all, one only has to look at the reputational repercussions of the financial crisis on the banking industry to understand the necessity of appropriate regulation and standards within the sector.
The implementation of official guidelines will also attract further institutional capital which will spur on the growth of the market. The University of Cambridge’s latest alternative finance industry report estimated that only 26% of peer-to-peer business loans were funded by institutional investors, indicating substantial opportunity for expansion in this space.
A 2015 study on marketplace lending by RK&O and Wharton FinTech found that 85% of institutional investors are interested in allocating capital to alternative finance in the future. However, in order to secure this group of potential investors the industry must comply with their investment criteria and be able do so with transparency and confidence.
Attracting institutional investors is key to the market’s scalability and will be a fundamental factor in determining its ability to continue to attack the SME credit gap, which currently sits at $1.5 trillion globally.
The industry is at a crucial stage of development at this point in time. With the capacity to move into the mainstream and become a true champion for SMEs, it is essential that we take stock and implement a thorough set of guidelines in conjunction with other key players in the sector, industry bodies and regulators to support us on the next step of our journey.
Louise Beaumont is Head of Public Affairs and Marketing at GLI Finance. She has over twenty years’ experience in growing companies – from initial spark, to operationalisation, results delivered, and value created. Having previously worked for organisations such as Siemens, Hewlett Packard, Microsoft, and Capgemini, Louise has focused on the UK’s fast growing alternative finance sector since 2010, including co-founding one of GLI’s investees. Louise has advised key UK government departments and units on FinTech and AltFin including; HM Treasury, British Business Bank, Government Office for Science, Cabinet Office, UK Trade & Industry, Department for Business, Innovation & Skills, and Number 10 Downing Street’s Policy Unit.@LouiseHBeaumont