Emergency loan scheme reversed alternative lending growth

7th September 2021

Analysis by Innovate Finance has found that the pandemic had reversed years of growth among alternative lenders and resulted in large banks significantly increasing their market share.

The fintech industry body said the emergency Bounce Back Loan Scheme saw £47.3 billion worth of state-backed credit channelled to more than 1.5 million companies. However, because non-bank lenders and small banks do not have access to cheap wholesale capital they struggled to access the scheme. Innovate Finance has now called for a new wholesale finance scheme and for reduced capital requirements for small and medium-sized banks, saying rules designed to tackle risk-taking by large banks were hurting smaller lenders.

The research by the industry body representing the UK fintech industry has revealed the share split in the SME lending market between the big banks and alternative lenders during the pandemic.

The alternative lenders and challenger banks led an increase in lending to small and medium-sized enterprises (SMEs) from 2014 to 2019 (from £69 billion to £83 billion), increasing their contribution to this total SME lending from 50% in 2014 to 65% in 2019 This was reversed in 2020 in the face of the Covid pandemic. During 2020, Innovate Finance estimates the large banks grew their market share from 35% to 56%, off the back of government guarantees such as Bounce Back Loans together with access to very low-cost term funding from the Bank of England (TFSME).

Despite initial obstacles and delays to obtaining accreditation for the Coronavirus Business Interruption Loan Scheme (CBILS), Innovate Finance estimates alternative lenders and smaller banks provided around 30% of all CBILS Loans to businesses in 2020. Peer-to-peer (P2P) and other FinTech lenders punched above their weight with over 20% of all CBILS loans from when they joined the scheme, considerably above their overall market share of SME loans.

Government and regulatory policies, including the British Business Bank and Open Banking, helped support the growth in new finance for the UK’s small firms from 2014-19. By the start of the pandemic, alternative lenders and challenger banks were providing around 65% of SME debt finance in the UK. Innovative new lenders grew the total finance available to Britain’s small firms and displaced the large banks as the dominant players in the market.

SME lending in 2020 was largely driven by the Government’s lending guarantees: bounce back loans and CBILS. Most alternative lenders were unable to provide bounce back loans as the Government scheme required interest to be pegged at 2.5% – a rate lower than the rate at which they were able to obtain wholesale capital to lend on to SMEs.

In contrast, the banks were able to obtain very low-cost term funding via the Bank of England TFSME scheme, at a rate significantly below 2.5% (TFSME – the Term Funding Scheme with additional incentives for SMEs – offered banks 4-year funding at or very near to Bank Rate).

Initially, alternative lenders were not eligible for the CBILs scheme. Advocacy by Innovate Finance and others helped make the case for them to be included and, despite a delayed start, alternative lenders made up for lost time and delivered around 30% of CBILs during 2020 – demonstrating the ability of the alternative finance sector to provide finance to Britain’s small firms.

Since April 2021, CBILS has been replaced by the Recovery Loan Scheme (RLS).  Again, the alternative lenders have suffered delays in being authorised as lenders – with the large banks securing approval at the outset. Many alternative lenders are still in the application queue. The scheme has been live since 6 April, with almost 4 months of further market share erosion towards the banks, of which c.30 have been accredited

Innovate Finance understands that during the pandemic it was essential to prioritise the routes to market used by the British Business Bank and Bank of England to pump finance into the economy.  Alternative lenders nonetheless demonstrated their capacity to do this and despite additional barriers have still punched above their weight in funding SMEs during the Covid crisis.

Alternative lenders and challenger banks are committed to turbo charging growth through  our small firms. Innovate Finance is calling for three measures in three areas:

  1. Reduce capital requirements for small and medium sized UK banks: The Bank of England should raise the threshold for MREL, a scheme designed to prevent the ‘too big to fail’ approach but applied to many banks that are not big and where any corporate failures would be absorbed by the wider market. Recent analysis by EY shows that MREL will reduce overall lending by mid-tier challenger banks by £42bn over five years (20% of lending).  The Bank should also disapply Basel III requirements for banks serving purely domestic customers,  as allowed under the rules (Basel III requirements apply to internationally active banks).  Basel III capital rules unfairly penalize smaller banks – large banks are allowed to use a ‘modeling approach’ which enables more efficient capital provisions, but this is not available to smaller banks. At present these capital requirements suck up capital that challenger banks could otherwise put to productive use by lending to small firms.
  2. Provide term loans for alternative lenders and challenger banks: The big banks have access to cheaper wholesale capital that the alternative lenders are denied. The Bank of England or British Business Bank should introduce a new facility to end this disparity.
  3. Ensure that alternative lenders are not penalised: It needs to be ensured that eligibility or delays in applications to be British Business Bank approved lenders for any lending schemes such as RLS or future lending guarantees to support long term growth. The Recovery Loans Scheme is currently  due to end on 31 December 2021, and alternative lenders and their customers must be given fair and equal access to this and any future guarantee scheme.

Adam Jackson, Director of Policy at Innovate Finance said “Alternative lending and challenger banks have been a great British success story, providing more finance to British businesses over the last decade. Now is the time to unleash their potential and give them a fair chance to power SME growth and create jobs. Alternative Lenders significantly outperformed on the delivery of CBILS and this demonstrates that Alternative Lenders will deliver loans to SMEs rapidly and in size and can do even more if they have equal opportunities”