FinTech and SME Finance: A UK Perspective
Late last year I moderated a private roundtable discussion at the Milken Institute London Summit on SME finance with a number of influential policymakers and industry stakeholders involved in financial technology (FinTech). What follows are some of the key insights into the driving forces behind the UK’s proactive efforts in developing responsive policy and regulatory frameworks in support of financial innovation.
Competition as the Driving Force
When the UK’s lending market is dominated by four banks (RBS, Lloyds, Barclays, and HSBC) representing 85 percent of current business accounts in the UK, a credit crisis, as that experienced in the wake of the Great Recession, can cut off SMEs from their primary source for credit. A consolidated marketplace dominated by large banking institutions can also inhibit innovation from flourishing.
What moved the needle forward and brought the UK government, policymakers, and regulators to the table to develop more forward-thinking, digital-centric approaches was the recognition that traditional ways previously relied upon to support the SME marketplace were not working, and the banking system itself was not working. By adopting policies and frameworks supportive of digital innovation, the UK has attempted to kill two birds with one stone: driving competitiveness into the marketplace and addressing barriers to SME financing.
Fostering a Competitive Marketplace
The Financial Conduct Authority (FCA), the Competition and Markets Authority, and the UK Treasury, play critical roles in developing forward-thinking approaches to foster digital competitiveness.
With a favorable policy and regulatory environment, it is of no surprise that the UK has seen the formation and proliferation of online platforms leveraging the internet of finance to fill in the gaps left by larger banks in the wake of the Great Recession. Of course, merely creating an ecosystem supportive of tech-driven platforms does not go far enough to address an uncompetitive lending marketplace.
More had to be done to develop specific solutions and the larger enabling environment.
Invest in an Enabling Environment
During our discussion, it was clear that information asymmetry exists in the SME lending marketplace. For instance, SMEs are often exposed to plain vanilla financing products offered by traditional banks that have the marketing budgets to communicate effectively with SMEs. The product, in the end, might be less suitable than financing products provided by specialty finance providers who oftentimes lack market clout. Small businesses often do not have the time to look around for financing and can be unaware of the various financing providers out there if declined from a traditional financial institution. This was made readily apparent after the financial crisis.
The lack of awareness can prove costly for economic growth—with the potential to create a £20 billion hole in the UK economy by 2020 according to a study from GLI Finance and the Cambridge University Center for Alternative Finance.
The issue is not whether small business owners need capital; the issue is where to find it after they have been declined from the traditional banks.
The remedy: building a bridge (and awareness) to connect SMEs declined from large financial institutions with available and willing finance providers; then, leveraging technology to do this efficiently.
Hence, the impetus for the UK referral scheme, which addresses the information asymmetry in the SME marketplace by requiring banks to refer borrowers at the point of decline to a neutral finance platform capable of matching small business borrowers with all sorts of lenders. The FCA has approved three funding portals (Funding Options, Bizfitech, and Funding Xchange), allowing each portal to receive referrals from banks. These portals open the door for more sophisticated and niche finance providers to connect with SMEs more suited to their products, SMEs to receive the right financing products at the right time, and a more diversified and competitive financial services sector.
Invest in the Players
The British Business Bank is directly investing in alternative finance platforms. Under the Business Finance Partnership scheme and Investment Program, the Bank has invested £135 million across 4 platforms (Funding Circle, RateSetter, Market Invoice, and Zopa). Commitments to these platforms achieve two policy goals: 1) getting money out the door to SMEs, and 2) diversifying the sources of finance for SMEs by catalyzing the alternative finance marketplace through early investment.
The efforts don’t stop there, however. Late last year, the Competition and Markets Authority released recommendations on how to increase competition in the retail banking space through, in part, requiring banks to open up their customer data through an Open Banking API interface. In February 2017, the CMA released a final order giving large UK banks a year to develop the API interface for customer data sharing.
UK policymakers and regulators continue to seek out ways to drive digital innovation into UK capital markets, promote competition, and develop a more responsive financial services system capable of meeting the needs of UK SMEs. Over the last few years, UK officials went beyond recognizing there was a problem to creating a policy and regulatory environment supportive of digital innovation, where FinTech is viewed as one tool under the government’s broader efforts to foster digital competition to unlock the capital spigots and promote a more diverse lending ecosystem.
A Message to Colonials from Across the Pond
Our conversation didn’t stop with the UK. At points, participants made reference to the U.S. regulatory system—one participant’s commentary painted a clear picture:
"There’s such a dissonance in the States between manifest destiny and the regulatory framework. Take me out to the frontier but make sure that when I go there that I’ve checked with all of the regulators that I’m going to be crossing."