UK SMEs embracing peer-to-peer lending
- Published on Tuesday, 07 May 2013 10:22
- Written by Liam Collins
Liam Collins, policy advisor at Nesta, the UK's innovation foundation, explains how innovative finance models are stepping into the void left by shrinking bank lending
Small and medium sized enterprises (SMEs) are vital to both growth and employment in the UK. In 2012 3 in 5 private sector employees worked for SMEs which had a combined turnover of £1,500 billion. Yet in the wake of the 2008 financial crisis it is these vital businesses that have suffered most. While larger businesses had access to alternative finance such as bond markets, SMEs were left stranded once the high street banks decreased their lending. Recent research by the National Institute of Economic and Social Research showed that it was the most creditworthy SMEs - those most deserving of credit, that were disproportionately affected by the crisis.
The recently commissioned Breedon Review on access to finance predicts the business finance gap could be between c£84bn and c£191bn over the next five years. One significant driver of this is the pressure banks are currently under as regulation, both domestic and international, has led them to restrict the flow of lending as they attempt to meet higher capital ratios. But aside from this, the crisis has highlighted the concentration in the SME lending market with just 5 lenders having a share of over 90%.
The Government for their part has created a number of initiatives to attempt to get credit flowing to business again. Billions of pounds are being put through The Funding for Lending Scheme, The National Loan Guarantee Scheme, The Business Bank and the Business Finance Partnership. While Government support has gone some way to addressing the finance gap, some businesses that received backing through this last scheme are showing how the SME sector can reduce their reliance on the high street banks.
Online peer-to-peer lending is an exciting new model for delivering finance to UK SMEs. A relatively recent phenomenon with the first sites facilitating the practice less than a decade old, the amounts being lent through peer-to-peer have increased significantly since the financial crisis. The model, which allows groups of individuals to pool small amounts to fill a loan request was initially used to serve the personal lending market but has been expanded further to serve the business community in recent years. Funding Circle, the leading facilitator of peer-to-peer lending in the UK has facilitated over £100m in lending to SMEs to date. Others such as ThinCats and Zopa (who are planning on expanding from doing personal loans to sole-trader loans) are also helping fill the void created by the high street banks.
Nesta research, Banking on Each Other, published in April and based on a survey of Funding Circle lenders and borrowers, indicates that borrowers are not just approaching peer-to-peer as a last resort but also value the speed at which loans are delivered. Loans get funded on the site in an average of 12 days compared to bank processes which can take 6 to 12 weeks. The businesses themselves came from a wide variety of sectors; almost half were exporters and were looking for around £35,000 to fund working capital or expansion.
On the lender side, those that participated tended to be wealthy individuals that used this wealth to build a diversified portfolio on the site to protect themselves against any defaults. Typically lenders had lent to almost 70 companies through the site and had earned interest of over 6% after fees and bad debt. The 'Autobid' tool, which was widely used by lenders, assisted them in easily apportioning their funds widely across businesses matching certain criteria in relation to risk rating and interest offered.
Looking forward, there is potential for significant growth within peer-to-peer lending; Nesta's research shows that indications are good for peer-to-peer lending. . Seventy seven per cent of the businesses surveyed predicted they would turn to peer-to-peer first when seeking external finance. The majority of lenders also predicted they would be increasing their allocation to the model in the coming year.
Currently P2P business lending is a small market – accounting for £120m annually. But, based on lenders' predictions of future activity, Nesta predicts that peer-to-peer has potential to deliver as much as £12bn in business lending annually.
While this is not the sort of amount that will replace the need for banks, it could make it a significant part of the funding ecosystem.