The rise of the payday-style business loan

 
Damian Kimmelman
The Changing Face Of The UK High Street
Source: Getty

British banks have been mired in criticism for not lending as much as they could.

Many businesses have meanwhile found that alternative lenders lack the data to provide products that are tailored to their needs.

But there is a worrying trend in the lending landscape that is far more threatening to the spirit of entrepreneurship.

Some lenders are dishing out business loans with terms that are not only unfair, but which could have dangerous implications on the future of British companies.

Snuffing out the promising companies

Access to finance is consistently rated as a serious concern for small to medium enterprises, which is worrying considering these businesses are the lifeblood of our economy.

Their contribution to the British economy is set to exceed £241bn by 2025, up 19 per cent from last year’s figure of £202bn, according to research from the Hampshire Trust Bank and the Centre for Economics and Business Research.

For businesses already in a tough position, the Bank of England’s recent rate hike could force them under.

Many may argue that a rate hike forcing some businesses under has been long overdue in tackling the issue of “zombie companies”.

But this is a classic case of throwing the baby out with the bath water, and we should be concerned about the consequences of snuffing out those businesses with high potential.

Providing cash flow to these smaller businesses is necessary to safeguard a fragile economy, particularly in such uncertain times.

Creative credit

Rate hikes typically result in an increase in lending profitability, and so the increase often stimulates the appetite to lend.

But an increased appetite to lend doesn’t always follow an increased ability to price risks on all loan applicants, and herein lays the risk: lenders become creative with the ways in which they entice borrowers and mitigate their risks.

In fact, we have already seen these enticing models on the market; they come in the form of payday-style business loans.

These loans from mainstream lenders look like the payday loans that flooded the market in the height of the recession. They take minutes to apply for, turnaround is within one day, and command interest rates of up to 23 per cent APR – five times more than some personal loans.

Most crucially, however, they require a directors’ personal guarantee, forcing entrepreneurs to risk their own individual finances for their business.

Safeguarding the spirit of entrepreneurs

The existence and potential proliferation of this model fundamentally goes against the spirit of entrepreneurialism. It also goes against the concession of limited liability, on which many successful businesses around the world are founded upon.

We cannot afford for entrepreneurialism in the UK to erode due to lack of funding, and we must not stifle innovation through inequitable lending terms.

Information friction

It would be unfair to point the finger of blame at mainstream lenders, because in reality it is not their fault.

Rather, this is a problem ultimately caused by a lack of information.There is simply not enough information about the companies applying for loans to make a proper assessment, and to price lending risk effectively.

Open, frictionless information is key to ensuring the future of the SME community in the UK.

With more data, banks and alternative lenders can reimagine financing models and lend to support the business forming the backbone of the economy.

Opening the data floodgates

While there is a lot of data already out there, such as financial statements, ownership information, and corporate group structures, the inclusion of Open Banking data will be key.

Open Banking is an initiative led by the Competition and Markets Authority that aims to stimulate competition in banking.

As it stands, SMEs cannot share any account information held by their banks. But the scheme provides a mechanism for small businesses to give their permission for the banks to share their information with other lenders.

This ultimately allows lenders to extract previously unavailable insights, and get hold of an up-to-date, holistic overview of a company’s financial health.

This adds the much-needed context to enable better, faster, more confident and crucially fairer lending decisions.

One common language

During these times of uncertainty, an open information economy can bring together businesses and lenders through the common language of data.

This will safeguard the spirit of entrepreneurs and give them the break they need to prosper.

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