Fintech – Evolution or Revolution
The banking crisis must not be repeated and governments, particularly in the UK, are setting out to seek to make sure it does not, at least not in the same way. To that end, various initiatives have been put in place to enable Fintech businesses to grow in order that the reliance of small businesses on bank finance alone is reduced.
What constitutes a Fintech business is not entirely clear and definitions vary by organisation, however definitions commonly feature reference to the use of a technology platform to drive innovation or efficiency in processes, applications or products deployed usually in respect of financial services.
The rather broad and general definition belies the breadth of activities now regarded as Fintech, which while by no means exhausting the activities that may be included is now recognised as including peer to peer lending, data collection, crowdfunding, invoice trading, asset management, credit scoring, automotive investment, digital currency, supply chain finance, foreign exchange, short term lending, revolving credit and trade finance.
The size of the market is also reported to be increasing rapidly. The National Association of Commercial Finance Brokers (NACFB) reported its members had made funds available to May 2014 of £12.7 billion but that this was anticipated to have grown to approximately £15 billion by May 2015. The University of Cambridge estimated that by the end of 2015 that £4.4 billion of funds would be deployed by Fintech's in Europe.
The playing field in which the Fintech's, or 'alternative financiers' and the banks operate is by no means level. Bank's throughout Europe have been subject to liquidity constraints and tightening of lending regulations. Their processes have been scrutinised and their market dominance has been questioned. While that has been in process, the banks have become more reluctant to lend to SME's preferring to lend to better capitalised larger businesses where competition to lend between banks still exists, however the banks have been more reluctant to lend to small businesses where either the capital base is lower, the track record is shorter or there is some uncertainty over the cash flows of its operation. As a result SME's have struggled to obtain either the amount or type of finance that they require.
Meanwhile, the British Business Bank set up in 2012, a development bank wholly owned by Her Majesty's Government, has provided a vehicle for the UK Government to provide direct and indirect lending support to small businesses, with a proportion being provided to alternative financiers such as Ratesetter and MarketInvoice among others. Presently it has provided £2.3 billion of direct funding and £2.9 billion of indirect funding (www.british-business-bank.co.uk).
By Section 5 of the Small Business, Enterprise and Employment Act 2015, the treasury has the power to require banks to share information on unsuccessful SME loan applicants with select alternative financiers. In these ways, the government is clearly giving favourable opportunities to such alternative financiers.
At the same time, the 2015 Summer Budget announced initiatives to allow tax relief for individuals in respect of bad debts incurred on peer to peer loans. In addition, peer to peer loans could be included in a new Innovative Finance ISA and consultation commenced on whether debt securities and equity offered via crowdfunding platforms should be eligible for inclusion in an ISA also.
The Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) make investing in qualifying small companies very attractive by providing a tax incentive of between 30% and 50% for such investments should the company invested in fail, thus reducing considerably the risk in making such an investment to a peer to pee5r lender, crowdfunder or other alternative financier as the investment is to that extent underwritten by a tax rebate.
As such, it is little wonder that both corporate borrowers and individual investors have been interested in embracing alternative financiers and no doubt that has contributed to their rapidly swelling numbers and loan books. Either way, it is clear that the government does not want SME's to remain reliant on bank lending but to embrace other channels of finance and it has been incentivising both borrowers and lenders to that end.
But enough of the 'Fin', what of the 'Tech'?
Incentives alone will not attract corporate borrowers whose natural and traditional tendencies would be to turn to their bank for financial support. Fortunately there are other attractions that in particular the current generation of younger business owners finds both natural and enticing.
The alternative finance lenders are not burdened with the baggage that increases structural cost to the banks; they have no branch networks, they do not have legacy technology that will take time and great cost to replace or improve but they do have access to capital as we have seen. They embrace modern technology with sophisticated algorithms scanning an ever growing pool of data using modern technology to facilitate scalable growth and using that technology to make quick underwriting decisions as well as provide risk management and corporate governance (in terms of avoiding conflicts of interest for example). Unlike traditional lending their decisions are based on available data, not on the experience of the managers or owners of a business, that in the modern world they may never meet.
Yet at the same time, the products they offer do not need to be bound by product lines and made identical by inflexible terms. Corporate borrowers are attracted to alternative finance because of its flexibility, they are finding they can hold a debt for longer, they can have less frequent interest payment schedules that fit their business cycle and often with lower interest rates all of which can give better certainty to them in terms of cash flow.
As a result the best of the Fintechs are seeing substantial growth. Indeed a new industry is beginning to appear to cater to the requirements of the Fintech's themselves as the demand for their services creates increasing demand from the Fintechs to deliver the finance they provide by buying in the support from the suppliers of the services on which they rely.
There is increasing competition for the banks that traditionally have supplied financial services to SME's and the lending to those customers is further squeezing those banks as the delivery of finance in the SME sector becomes more customer centric. Customer expectation, particularly among the younger generation of owners and managers is changing rapidly. This is a generation that do not feel the need for the constraints of the past nor the need to do something simply because of tradition. They expect a different level of service, they are used to things being immediately accesible with fast speeds of delivery and with little loyalty or thought for who is providing what they want, rather they are focussed on who is able to provide it where multiple suppliers are not an issue for them. Increasingly they expect flexibility in the channels of delivery which in their modern world means delivered right to their hands by a small number of touches on a mobile device.
This 'democratisation' where the customer chooses not only who they do business with but how, is the likely future for alternative finance and the Fintechs are already working on delivering that.
Of course, what will happen in the future can never be completely and accurately predicted and there are factors which could impact on this development. Not least will be the access the Fintech's will have to capital themselves, at what cost and of course the general health of the world economy may have an impact on that. Equally, how will banks respond, will they adapt to compete or will they continue to look further away from the SME market in favour of better blue chip customers? How technology evolves may have a dramatic impact on how financial services are delivered in the future and there may well be consolidation in the marketplace or indeed strategic alliances or acquisitions of alternative financiers, either by banks or others, in order to compete or simply share in the spoils of a market segment that the banks cannot otherwise easily access or effectively compete in.
What seams fairly clear on current trends, aided by government incentives, is that there is likely to be a greater choice for borrowers and that customers will have more say in dictating the terms and how they access finance from multiple sources.
The alternative finance market remains immature but it is growing up quickly. There remain questions over whether investors in crowdfunding or peer to peer loans really understand the risks they are taking. For example, who is responsible for the information provided to potential investors upon which they may choose to invest, is any representation given by the financier and if so what verification of the information have they undertaken before releasing it to investors? Does the fact that the alternative financier has been involved in or is promoting the raising of funds for a borrower lend credibility to the information such that they may be taken to assume any responsibility? Is it right that 'let the buyer (investor) beware' is appropriate, that any investor is considered 'sophisticated' or should there be some regulation of this market or investment process? Who is to be responsible for monitoring that funds raised by a borrower are applied for the purpose for which they were sought, who is responsible for monitoring the performance of loans and should a loan not perform to enforce its repayment?
The alternative financiers terms will often deal with each of these questions but in a largely unregulated market the question is whether the designation of risk and responsibility is wholly appropriate. One thing that is clear is that promotion of Fintech's and alternative finance is here to stay. Politically it may be considered preferable to break the monopoly of the banks and deal with the regulation or designation of risk in the alternative lending market afterwards. With the speed of evolution of the Fintech market that might be easier said than done as legislation might not be able to keep pace.
If you would like more information in relation to any of the issues discussed in this article, please contact Karen Williams.