What can we learn from the UK Parliamentary Inquiry into SME Lending?

In the UK, the Treasury Committee is currently holding an inquiry into SME Lending. The non-bank SME finance market in the UK is much more developed than Australia's. Government has been much more pro-active in encouraging the development of an SME eco-system.

Despite this, there is much more to do and the problems are very similar to ours. Australian policy-makers could fast-track much needed improvements in our SME finance market by studying closely the findings from this inquiry.

Recently, there was a 2 hour hearing involving Funding Circle, Business Growth Fund, Funding Xchange and CrowdCube which brought to life the challenges faced by SMEs across the full spectrum of size and type in obtaining finance.

We have distilled the hearing into a 15 minute highlight clip.


The Treasury Committee's inquiry will consider the extent of competition in the market, the various sources of funding available to small businesses, including crowdfunding and peer-to-peer lending, and whether the current regulatory framework provides appropriate protection to SMEs when they borrow money.

Here are some very relevant excerpts

Stephen Welton, Chief Executive of the Business Growth Fund

With £2.5bn in assets and investments in over 200 SMEs, BGF is the UK's most active investment company, providing patient capital for SMEs in the United Kingdom and Ireland.

Katrin Herrling, co-founder and CEO of Funding Xchange

Funding Xchange is a leading online broker that enables over 45 lenders to compete to fund SMEs

Luke Lang, co-founder of CrowdCube

CrowdCube is a leading UK crowd funding platform that has enabled over 600 SMEs raise over £400m

James Meekings, Co-founder and CEO UK, Funding Circle

Funding Circle has facilitated over £2.2 billion in loans to small and medium-sized firms. It is a leading peer-to-peer lending marketplace that allows investors to lend money directly to SMEs.

James Meekings, Funding Circle

I think about 20 to 30% of small businesses that borrow through our platform don't think they could get a bank loan and so I guess the large share of them say that they could. But the question is why they're not.

Banks don't really do cash flow lending to small businesses. They lend against security and that's challenging for small businesses because lots of small businesses don't have much security to lend against especially when you're in a service economy like ourselves.
When they do lend, the capital requirements that they have to hold make it less profitable for them to do so. So there's this natural position where they'd actually prefer to lend on mortgages and on other consumer products.

The speed and ease of getting financing to invest in their business, it just puts them off when they go through a bank. We continually hear stories that it takes months for them to get finance through a bank. Through us it takes ten minutes to apply online. They can they speak to well trained professionals in that process as well so it's not purely just online and then we get a decision to them within twenty four hours.

So the whole process takes away any of the uncertainty. They get to do it anytime they want.

Stephen Welton, Business Growth Fund

When we talk about the SME market that's an incredibly broad term. It’s 5.8 million companies out there - over 90% of those employe one person so the customer experience for the person running a sole trader are very different from a business that's employing 50, 100, 200 people.

In looking at the customer experience, you have to look at what's been the escalator. What is it that you need for somebody starting up a business tomorrow on their own that is going to be seed capital from friends and family and government tax policy in terms of the EIS scheme and the CDIS scheme is really working.

The birth rate of new businesses in Britain has never been higher and that's clearly a signal of success - we are creating small companies.

What is their funding after that - the banks have a role to play. The banks obviously lend money with the expectation of getting it back.

There is nothing wrong with debt - there is obviously something wrong with too much debt in a business which is why you need to have alternatives.

I think the system we've got now is a lot more positive than it was when we started in 2011.

Alternatives are increasing. What we need to do a better job of is increasing the understanding in the SME population as to where to go.
One of the frustrations is if you think the solution to your problem is an overdraft and you go and ask for an overdraft and you don't get it that doesn't mean you can't raise funding it means you've gone to the wrong place to get funding.

So there is a big educational piece that we need to do and from our standpoint the startup environment in the U.K. is very healthy. Where we have a significant challenge is in scaling up the startups that are successful.

There are approximately 30-40,000 out of 5.8 million that would be defined as scale ups. These are the businesses that have significant economic potential they are hiring people, they will do a lot of exports. We are not doing a good enough job scaling them up and there is a funding gap there in terms of the amount of risk capital and bank finance to get those businesses to be the global companies that we're all aspiring to.

Simon Clark, MP

I think there is something comes out of our brief is the lack of awareness which often characterizes the businesses understanding of the various options that are open to them. How do we counter that?

Does government have a role to play in helping to clarify what the sector can actually look for in terms of finance?

Katrin Herrling, Funding Xchange

I think what the government has done very very well is actually create the ecosystem that provides access to many different sources of support.

I think where government has actually done a great job is identifying friction in the market and actually say here is a way we can address the friction.

Now what this has created is that actually the transparency and the ability to access these measures is now almost holding back these measures from actually reaching the companies that could most benefit.

So I do think that as we move into the next phase of making these instruments available, one of the areas where there could be more focus is actually

How do we create transparent access for business that is not super sophisticated that will not have a PhD in finance to understand which of these measures is actually right for them?

Simon Clark, MP

Part of problem is awareness. Part of the problem is also confidence.

You are at the front line - how do you imbue that confidence that you are not just an available option but a safe option to come to?

 James Meekings, Funding Circle

I think you highlight a very good point which is around trust. Even now when we are regulated and we speak to businesses, they want to know more about us.
But I think actually the government's done a very good job of helping lay the foundations for us to succeed on this front.

So when I think of the bigger question about what is the role of government in this place I don't think the role of government is to be doing our marketing for us. But it is to set the right foundations in terms of regulation, making sure there's no friction. I think government has done a good job of that.

It's really important there is a level playing field between all the different forms of competition in the market. There’s probably still a bit more to be done on that front.

Regulation builds trust. We've always been pro-actively trying to get more regulation and to protect consumers but also to help us build trust.

Simon Clark, MP

What regulation to feel is missing at the moment which we don't currently have?

James Meekings, Funding Circle

I wouldn't say that there is regulation missing. Regulation is in a good place to protect consumers interest. When I said there's more to be done I was more referring to a level playing field between us and banks and specifically and what we can do and what we can't.

For example one of the things we would like to see and we’re working with the Bank of England on this is for investors to be able to sell their loans to the Bank of England to make those loans Central Bank eligible.

Luke Lang, CrowdCube

When the government started to invest matched funds alongside retail investors through Funding Circle, it had a big impact on their business.

It increased the liquidity to those companies and increased that certainty of funding.

James Meekings, Funding Circle

Every business of ours at Funding Circle gets a relationship manager and speaks to them on the phone and they always laugh as they say

I thought this was online but actually I've spoken to you more through this application than I’ve spoke to my bank manager in the last 10 years!

Alison McGovern MP

Thinking about the banks - what would you say that their competitive advantage is? Do you think they have any other advantages that they are exploiting?

James Meekings, Funding Circle

Everyone has a bank - every small business has their bank. The challenge you've got when it comes to competition is when I think about it is we have over 30,000 business customers in the U.K. They will have direct debits which pay back into it into a bank.

If we want to change our bank, we have to move each one of those direct debits. So if our bank says no to giving us finance then can you actually go to another bank is the question.

And you can't risk it because in the very need to go get yourself financed you put the greatest financial risk on your company by moving across. So actually competition within banking is actually really difficult but you have to swap all your banking just to get a loan from a different bank.

So what you actually need is non-bank solutions to complement banks and that's why we have partnerships with banks.

They want to keep that banking relationship - they want to sell insurance, they want to sell the foreign exchange and cross-sell everything. If they can't do the lending they don't want to lose the other stuff.

So I think the biggest advantage they have is the plumbing and how tied in SMEs are to them.
That's why I think the open banking initiatives the government are pushing a really exciting because it's going to unleash more innovation, more competition without business actually having to move bank.

Nicky Morgan MP

Do customers report that depending on the type of business they're running they're getting more or better offers of financing?

Stephen Welton, Business Growth Fund

The company that's doing really will always raise funding. So you need to focus on those that are struggling whether it's the state of the economy or the sector they're in.

There tends to be a very heavy focus on technology but every company is technology enabled. A business which isn’t technology enabled isn’t going to exist.

If you look at what venture capital community in large part is looking at in London, it's a very similar sort of thing they’re looking for - the next Facebook, Google and hopefully we'll find them.

But there are a lot of other businesses than that - if you’re in the glamorous sector then everybody's going to meet you. If you're in manufacturing or doing something more traditional then that's probably not so exciting.

I think attitude is important and it is harder but there are changes that are happening.

Businesses are created with less assets now. Banks do secured lending. If you don’t have security it's going to be harder to raise traditional secure financing which is why alternatives are so important.

Katrin Herrling, Funding Xchange

Thinking through the changing shape of the U.K. economy and how that is actually impacting needs for funding.

One of the key trends - there are more companies that are not asset rich and therefore will find it harder to work within existing risk models of banks for example.

There are other trends as well which I think of really important to recognize. One is the trend towards self employment. We will see more and more of the micro companies that I know are not the scale of companies that would attract equity investments but they're becoming more and more part of the real economy.

I think this is one of the constraints that I see as we move into a world where we have less competition in the alternative finance sector and I think we do see as a result of concentration where models are winning out that have the mass appeal but also are very well financed. Clearly yes there is a proposition that resonates with customers.

What it hopefully doesn't lead to is that the diversity of different lending solutions that are available are being crowded out of the market.

Stephen Welton, Business Growth Fund

If we are truly to create really big businesses we need to think in a totally different dimension and there are many reports saying the funding gap is anything from 3 to 6 billion a year or 10 to 20 billion.
What I think that is highlighting is that the major sources of capital in this country and it's not government which are the long term investors namely the pension funds are not putting enough capital into supporting small businesses.

And that is where I think there is a significant opportunity because the capital exists in the U.K. We need to address the question of risk because obviously it is risky supporting small businesses but it isn't a good enough answer to say it's too risky for us to do this.

If you look at the local authority pension funds, there are 89 of them. Collectively they have over 200 billion of assets. How much are they doing to support local businesses in their area?

Stephen Hammond MP

Can I stick on the point about the institutionalization of marketplace lending platforms. Is that a trend you recognize in your own business and is it a trend you would expect to continue?

James Meekings, Funding Circle

Clearly in our business, yes.

The British Business Bank started lending 100 million pounds through our platform. The purpose of that was to help catalyse institutional money coming in to support businesses.

What’s it's clear, whether it's retail or institutions, there is an appetite to help small businesses and to earn yield in doing that.

One of the challenges with the government's referral platform is when a small business goes into a branch they talk to that relationship manager about getting a loan. They don't enter it in a system anywhere.
So when you see bank adverts a few years ago that they approve 9 out of 10 business loans, it always winds businesses up because that doesn't reflect their experiences of going to a bank.