Like all parts of financial services, the alternative finance sector is coming to terms with the post-referendum landscape and what the Brexit decision means for the future.
This comes on top of the ongoing issues at US marketplace lender Lending Club which have continued to attract negative headlines.
With the tectonic plates of alternative lending continuing to shift, the issue of consolidation is once again back on the agenda. Furthermore, with the race for scale gathering pace, many platforms are being forced to re-evaluate their business models and client propositions in a new climate of economic uncertainty, in order to secure their long-term sustainability.
Critics may argue that this was always going to be the case – that the traditional banks’ retrenchment after the financial crisis was always going to be temporary and that only a few large scale challengers would be able to assert themselves in the sector and survive long term.
But this shows a lack of understanding of the industry’s future and the rapidly evolving competitive landscape.
Specifically, different platforms have different operating models. On the one hand, there are those set up to provide SMEs with access to lower-margin vanilla products. On the other are those which have identified specialist niches in which they can provide products that SMEs find impossible to access from vanilla providers, whether traditional banks or alternative finance platforms. Moreover, although still too early to tell, Brexit could result in a further tightening of credit from the banks towards SMEs in the months and years ahead.
Scale vs Specialism
When the bottom fell out of the financial markets in 2008 and the world realised that the structure of the traditional banking system was fundamentally flawed, the issue of scale versus specialism became immediately apparent.
The alternative finance supernova took off and hundreds of platforms sought to seize the commercial opportunities that SME finance provided.
Since then, we’ve seen a clear divergence in the types of growth strategies employed, with two camps clearly emerging.
In the blue corner are platforms offering vanilla products which have, quite rightly, focused on driving scale and origination volumes. In doing so, they have attracted significant capital from institutional investors keen to generate returns in a low interest rate environment.
Across the ring, in the red shorts, we’ve seen the emergence of specialist players which have combined technology with deep credit underwriting expertise to offer products that are less reliant on simple volume in order to deliver higher margin, sustainable returns.
The squeezed middle
What is becoming increasingly apparent is that, for platforms offering vanilla products, the long-term winners will be those that can combine scale with brand credibility.
Only by delivering against both of these can they withstand rising regulatory pressure and the potential threat of traditional banks increasing access to finance for SMEs if credit conditions improve.
Businesses that fail to meet either of these criteria, especially in a post-Brexit world, will quickly find themselves running out of road with their assets, technology and talent becoming firmly “in-play”.
So-called challenger banks will also accelerate this trend, given their ability to integrate technology-led platforms more effectively and the absence of any inhibiting legacy systems.
Indeed, we’ve already seen instances of collaboration, where alternative finance platforms have found a way to align their proposition with those offered by traditional banks. This trend looks set to continue.
For specialist players, a different set of challenges lies ahead. While regulatory pressures will undoubtedly need to be managed, attracting the right kind of talent with deep credit writing expertise, and combining this with a technological solution that can take advantage of the mandatory referral scheme included within the Small Business Enterprise and Employment Act will be key issues to address.
In such a dog-eat-dog landscape, evolution is as inevitable as it is necessary and will ensure that only those platforms with the right management teams, the right risk management frameworks, and institutional backing will survive.
This process will help drive up standards and ensure that retail and institutional investors who are wary of what consequences Brexit may bring will remain confident about the sector, while helping to deliver cash-starved SMEs with the capital necessary to survive and grow.