The chatter surrounding the rise of alternative lenders hasn’t come close to quieting down. Viewed by many as the chance for small businesses to gain access to capital from somewhere other than the Big Bad Banks, alternative financing has built a reputation as the new support for the underdog following the financial crisis and subsequent heightening of lending restrictions among traditional lenders.
The alternative finance hype is only expanding. Massive IPOs and venture capitalist attraction have experts positioning the alt-lending market to reach a $1 trillion valuation. Recent research by the University of Cambridge and Ernst & Young revealed that not only is alternative lending particularly strong in Europe, but the U.K.’s own market accounts for nearly 75 percent of the EU industry, eclipsing any other member state.
But a new report by the U.K. Treasury Committee published this week appears to be quelling the excitement surrounding alternative lending.
The report, “Conduct and competition in SME lending,” takes an extensive look at the issues surrounding small businesses’ access to financing and the health of small business lending competition in the U.K. While the Treasury acknowledges the validity of the alternative lending buzz, the report highlights why businesses may need to step back from the view that alt-lenders are the superheroes saving SMEs from the Big Bank villains.
Praise for Alternative Lending
At a time when small businesses seem to struggle with accessing capital from mainstream banks, the U.K. Treasury’s report notes the soaring growth of the alternative finance market. Citing the January 2015 Librium AltFi Index, the Treasury highlights estimates that alternative lending has accounted for more than £2.7 billion in financing, with peer-to-peer business lending itself experiencing about a 200 percent growth rate.
The report includes insight on the state of P2P lending from several high-profile industry players that echo the Librium AltFi report. CEO and co-founder of alternative lender MarketInvoice Anil Stocker, for example, told the Treasury Committee that not only his company, but the alternative lending market as a whole “could become a serious force in SME lending” if their growth rates continue on their current path (Stocker told the Committee that MarketInvoice has grown 465 percent in the last year). “We will not be called alternative anymore,” he said. “We will be more called mainstream.”
Similarly, the Association of Chartered Certified Accountants told officials 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.” The report aligns itself with commentary submitted by banking giants RBS and HSBC that crowdfunding and P2P lending are posing as stronger competitors to traditional banks. “These new entrants,” the report agrees, “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.”
The Treasury’s report detailing the impact of P2P lending on SMEs’ access to capital does not ignore the validity of the market. But borrowers must consider the reality of the alternative finance industry, which, the report warns, is not all positive.
The overall newness of the market inevitably raises concerns about its ability to pose as significant competition to mainstream lenders. The Treasury notes that the volume of peer-to-peer lending in 2013 was “very small.” In the first half of 2014, P2P lending accounted for only about 1 percent of the £24.8 billion worth of bank loans to SMEs in the same period, the report says. “Challenger banks and alternative lenders are therefore not yet at a scale sufficient to challenge incumbents,” the report finds. “There is currently little evidence to suggest that new entrants in the SME finance market and existing measures to improve competition will deliver the transformation in competition that the industry needs.”
Its comparatively small size, the report finds, makes alternative lending a niche industry. The Institute of Chartered Accountants of Scotland, for example, told officials that “innovations such as the emergence of retail bonds and crowdfunding remain, as yet, of only marginal significance.” The British Chambers of Commerce found that among its members, only 8 percent users “grants, venture capital, private equity, peer-to-peer lending and angel finance combined.” The group similarly resolved that there “remains little understanding of alternative finance options.”
Together, the data suggest that “alternative lenders…appear to have made only a limited impact on the overall shape of the SME finance market,” the report concludes.
In considering these caveats, the Committee found four main concerns of which businesses should be aware when considering P2P financing:
• “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.”
A Path To Improvement
These warnings do not mean, however, that SMEs should entirely dismiss alternative lending options, the report said. Part of what makes P2P lending so potentially risky is the lack of available data from the space. “The amount of lending from alternative sources is not yet well documented,” the Treasury writes. “Official sources barely record it at all.”
Increasing data collection within the SME lending space as a whole – which did not become commonplace, the Treasury noted, until after the financial crisis – as well as increasing visibility of all lending options for small businesses can help to mitigate SMEs’ risks when seeking out loans. The Peer-to-Peer Finance Association agreed, telling the Treasury that any mechanism that increases awareness of alternative financing options is a “step in the right direction.”
An initiative to boost visibility of SME lending options has already begun, the Treasury report said. In March 2014, federal officials began exploring legislation that would require small businesses rejected by banks for a loan to receive information regarding lending opportunities from rival banks and alternative lenders. The government has now released draft legislation on the matter, titled the Small Business, Enterprise and Employment Bill.
While the Treasury Committee declared that alternative lenders’ contribution to the SME lending sector must be recognized, the potential risks of these financing options like P2P lending must be understood, and SMEs should not necessarily dismiss mainstream lenders altogether. “SMEs’ negative perceptions of banks’ willingness to lend appear to have resulted in an increased reluctance of SMEs to apply for credit,” the report said. “However, these perceptions may also be too pessimistic – SMEs may be more likely to have their applications for credit accepted than they perceive.”