The story of alternative finance is now well-known across the small business (SMB) lending community: Heightened risk management and capital requirements imposed on traditional lenders by regulators, following the 2008 global financial crisis, left a gap in the market that FinTech companies quickly sprang up to fill.
A decade later, and that gap remains for small businesses considered too small to be profitable for large financial institutions (FIs). One U.K. alternative finance player, CODE Investing, estimates the nation's small business funding gap at $60 billion, its CEO, Ayan Mitra, recently told PYMNTS.
One thing has changed for sure. Though the market climate of small business finance entered a world of banks-versus-FinTech, that climate has shifted into banks collaborating with FinTech firms today. Particularly in the U.K., where Open Banking rules are now in play, data sharing and partnerships between the one-time rivals are quickly becoming commonplace.
That market shift introduces new questions, especially for the FinTech companies adjusting to this evolution. Questions now swirl around data privacy as information is shared between banks and alternative finance players, and there are the matters of who owns the customer relationship and how compliance can remain top-of-mind with new systems and products in development. However, as small business operating expenses climb, fewer U.K. entrepreneurs report access to affordable credit and new loan approvals drop, according to the Federation of Small Businesses data, the opportunities for banks and FinTech firms to collaborate and increase access to SMB finance still remain strong.
According to Mitra, the alternative finance industry has come a long way to address the SMB funding gap. Today, these players have mostly been able to provide specified, lower-value loan products to small firms. SMBs seeking half-a-million GBP and up, meanwhile, are still stuck in the reverse-Goldilocks conundrum: too large for alternative finance, but too small for traditional institutional investors.
That's where companies like CODE see an opportunity, Mitra said, to work with those traditional FIs that have the balance sheet capital to lend out, but cannot efficiently access SMB borrowers — at least, not on their own. This shift is a recent one, and a dramatic departure from the competitive environment that Mitra said was prominent only four years ago. Encouraging large banks to innovate, he said, was "like pushing a tanker to change direction."
"They were unable to service customers efficiently, and there were high costs to serve, and high operating costs," he said.
Combining these FIs' balance sheet capital with FinTech's agile technologies and heightened customer service capabilities is playing out to be a winning combination for the industry.
Research last year from Reuters found small businesses in the U.K. propelled the nation's alternative finance market to grow 43 percent in 2016, according to the Cambridge Centre for Alternative Finance (CCAF). PwC research published, also from last year, found 82 percent of banks, insurers and investment managers plan to increase their FinTech partnerships in the coming three to five years. Mitra pointed to big banks' inability to quickly innovate and deploy capital, thanks to their size as a key driver behind FinTech firm's attractiveness to these players.
With alternative finance players now adjusting to this new market environment, their focus on which technologies could disrupt the space is shifting, too. Open Banking, PSD2 and blockchain are trendy topics in the AltFin community today, with regards to technology adoption, but Mitra said he is particularly interested in standardizing small business underwriting in the way the FICO score standardized underwriting for consumers in the U.S.
"There are products and scores out there for businesses, but they're not as accurate as customer scores," he said, citing a lack of data and more complex factors that go into rating the creditworthiness of a corporate borrower. Big Data and artificial intelligence (AI) could play key roles in this arena, as well as in other use cases of small businesses funding, he said.
Though CODE is working on such a tool, he said the solution has to be tested for several years to prove to partners, like institutional investors, that the rating solution is accurate and reliable. The company is also planning to distribute software to the SMB borrowers directly, which would automate visibility into loan values and rates for borrowers the instant they seek financing, an initiative that Mitra said aims to turn access to capital for small businesses into a proactive process, rather than a reactive one.
Alternative finance's ability to experiment with and explore emerging technologies makes these players even more attractive to large lenders that are less able to affordably do the same with agility. At the same time, alternative finance companies have to take advantage of their market position, act quickly to innovate and show FIs that partnerships are worth the effort.
"We keep a constant eye on technologies and proofs of concepts to be ready for the technology to be robust enough to deploy into the market," said Mitra. "The cost of ownership of the technology is probably 50 to 60 percent cheaper than the enterprise software that big banks run, so that gives us an added advantage."