The reform of the global banking system with its new regulatory requirements has created incentives for a raft of bankers and City-types to divest themselves of the demands and risks of running traditional financial institutions.
Many of these executives have been drawn towards new pastures where the traditional banks no longer wish to be, i.e. in the area of so-called alternative finance and shadow banking. Thanks to a combination of low interest rates creating yield-starved investors, and a lack of funding, particularly among small and medium enterprises (SMEs), a market has opened up for new investment and funding model combinations – using investor’s money to lend to businesses. It now seems that hardly a month goes by without the launch of another alternative finance or shadow banking service.
Of course, in principle, there is nothing new that the alternative financiers are offering – bringing together investors and borrowers is a traditional banking model that is as old as the hills. But unlike the banks, these largely unregulated operators are nimble and tech savvy. They are targeting a niche (some would say chasm) created by the mainstream funders, who appear to have either distanced themselves from small, finance-hungry companies, or are out of touch with the delivery channels that today’s businesses expect.
Encouraged and even supported in some cases by the state-owned British Business Bank, in the past three or four years the UK has seen so called ‘crowd’ funding companies being established such as Zopa, Funding Circle, and more recently Money and Co. Invoice exchange platforms, such as Market Invoice, Platform Black and Aztec Exchange have also launched.
Joining these have been various shadow banking operators such as Handelsbanken, Aldermore and Metro. And this is only in the business-to-business (B2B) sector. In the business-to-consumer (B2C) sector there are even greater numbers flourishing. Nicola Horlick, founder of Money&Co, and a well-known figure in London’s City district, predicts that alternative finance companies like her own will eventually be providing 15% of all lending to SMEs. Currently this figure is surprisingly high, at around 8%, with the balance coming from banks, according to Ms Horlick.
A Strategic Response
However, the idea of creating alternative sources of funding is not purely a post-Lehman natural market development; it is also a global strategic response to the crisis. The governor of the Bank of England (BoE), Mark Carney recently said that: “The extension of credit from entities and activities outside the regular banking system has been a core part of the Group of 20’s agenda to overhaul the global financial system since the 2009 Pittsburgh summit” – which was when the UK’s Financial Stability Board (FSB) was created.
One can go back further than 2009 to demonstrate that alternative finance is not new in the UK; a major example is in independent factoring and asset-based lending, which has for decades been highly successful in offering invoice finance based funding to SMEs and more recently to larger businesses too.
The clear benefits of invoice finance have long been voiced by the vast majority of factoring clients as well as supported by bodies such as the BoE. However, there has been some ongoing confusion among and misunderstanding among SMEs about its labelling of services – factoring, invoice discounting, recourse, non-recourse, international, domestic, asset-based lending, cash flow finance, are just some of the terms in use – and also its pricing models. It’s something the industry body, the Asset Based Finance Association (ABFA), has been looking to address for some years.
Unfortunately, this looks like it might also become the case with the new variety of alternative financing options. This relatively sudden influx of new and little-known providers with the accompanying array of business models and methodologies is, by many accounts, proving quite difficult to keep up with for many SMEs and intermediaries. There is also an issue of perceived credibility for the new alternatives, in that not many people know who they are, many are very small, and have little or no history – people are naturally cautious about entering into financial arrangements with such entities.
There is no doubt that these alternative providers are filling a gap with much needed funding for SMEs. They can provide low cost, quick, and relatively easy arrangements. Most arrangements can be done on-line within a very short period of time and without the burden of significant due diligence or having to commit to highly onerous contracts.
Despite the UK being one of the biggest and most developed factoring markets in the world, there is still considerable underutilisation in the use of receivables for raising finance, perhaps by less than half its true potential. Overseas, growth prospects are thought to be much higher in many countries.
However, it seems there is a need for clarity, a better understanding of alternative services offered and a proper assessment of the market and its players in order for this industry to fully develop and flourish. This is particularly so for the UK, where initial expansion has been rapid. In the first instance, a coordinated approach and some agreement on terminology and labelling would be desirable. In the second, credibility concerns need to be addressed, perhaps by some form of official recognition through licensing or regulation. Failure to make a proper assessment may well result in these sectors not reaching their full potential.
* The above commentary was written for members of the UK’s Association of Chartered Certified Accountants (ACCA). The author will be speaking at the first Alternative and Receivables Finance Conference being held in London on 17 October.
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