For a service sector dealing almost solely with numbers and structured data, the world of small business lending could not be better suited to disruption by digital machines.
But recently, Bank of England governor Mark Carney rightly pointed out that, despite small and medium sized enterprises (SMEs) facing a £22bn funding gap, almost half don’t plan to use external finance, citing the hassle or time associated with applying.
The governor announced that the Bank would therefore champion a data platform to help SMEs have an easier time when applying for credit. The vision builds on Open Banking, bringing together data from a wide range of sources including Companies House, HMRC, utility companies, and telecommunications firms.
With a single “data passport”, SMEs could easily apply for finance at dozens of providers with the click of a button.
So how has it come to the humiliating point that the industry’s own regulator is proposing innovations that could accelerate growth and improve customer service? What are the banks’ armies of IT and product development staff doing?
The governor’s comments underscore a failure by banks to embrace the digital economy and invest to keep pace with the changes happening to their customers.
SME owners don’t just expect their bank’s lending process to be as seamless as their personal loan applications – they also expect banks to recognise how the financial makeup of firms has changed thanks to the digital revolution. Most SME financing from banks is centred around equipment or property assets, but digital services firms have neither.
Innovative finance providers, including my own company, have already embraced the data sources that the Bank of England will promote to open up access to finance.
Powered by new data connectors like DueDil, TrueLayer, and Codat, we automate the analysis of public data, bank transactions, and accounting records to make it faster and easier to provide credit to small businesses. Since launching, we have facilitated over £100m of lending to growing SMEs, and are rapidly expanding our operations to help more businesses across the country.
So why haven’t traditional banks made similar investments in order to price loans in the digital age? In my view, the reason is simple: it is not profitable for them to do so.
Under Basel III – the global rules governing how banks are regulated – banks are directed to hold almost double the amount of capital against an SME loan compared to a buy-to-let mortgage, for example. Holding more capital means making less profit, so all else being equal, banks naturally double down on loans that require lower amounts, such as mortgages.
And so we have seen banks close branches, sack business lending sales teams, and fail to innovate, while instead channeling more lending into the unproductive housing market, rather than the productive SME economy.
While challengers and fintechs are happy to lead the innovation in business lending, without structural reform of banking capital rules, we are unlikely to see strong competition from banks.
This is a challenge that Carney’s successor must tackle if the UK is to unleash the full potential of its SMEs.