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The changing world of SME lending
“Get the banks lending again!”
That was the desperate cry in the wake of the financial crisis.
The big high street banks needed to shore up their capital and had to block-off some of their lending pipes. They needed to get their risk levels down. Fast.
But politicians knew that the credit crunch could choke-off the small and medium sized businesses (SMEs) that were powering the recovery.
For almost a decade, banks have been given the ultimate mixed-message: “lend” and “don’t lend”.
Regulators want them to be less risky, but politicians don’t want to see small businesses starved of funding.
In July the Government announced a new plan to encourage banks to lend to SMEs, so they can more easily export their goods and services post-Brexit.
But, with all this focus on the banks, some have missed significant wider changes in the world of SME lending, driven by technology, which might make 2018 the year that the small business lending taps are turned on in full.
Deciding whether to approve an SME loan was previously a job for a bank manager or committee. They would meet the owners. Comb the business plans. Kick the tyres.
This was a hugely time and labour-intensive process that made borrowing expensive.
But technology and hard data are starting to rewire the model.
For now, banks retain a significant advantage in the SME lending market. The data banks hold on their customers’ financials enables better credit risk modelling than the competition – which is reliant on filings at Companies House and bank statement printouts.
This advantage is about to be removed.
The 2018 game-changer
Open banking regulations brought in by the Competition and Markets Authority next year will force banks to share this data with any third party authorised by an account holder.
All of a sudden, non-bank lenders will be able to combine their own data sets with those held by the bank. Not only will this help lenders decide if a business is credit worthy, but it will also help lenders monitor the ongoing affordability of repayments through the life of the loan, meaning the lender can step-in before problems become too serious.
Collections and recoveries in small business lending will change, giving lenders more confidence to make positive decisions in the first place.
But just as the banks will lose a competitive advantage in one area, they might level the playing field in another. The General Data Protection Regulation will come into force just a few months after open banking, and will require companies to make certain data points ‘portable’. This means enabling authorised third parties to access the data.
A bank could ask an eCommerce company for data on a small business that uses its marketplace. Assuming the business is happy to share the data with the bank in the hope of securing a better deal on credit, this extra information could help banks improve their own credit modelling.
2018 will bring about dramatic changes in small business lending. The transfer of data control from institutions to small businesses will mean more lenders, better credit decisions, and fewer bad loans. A boom in competition will emerge.
Small businesses, and the broader economy, stand to benefit from the boom.