Incumbent banks' tendency to prioritise larger clients has created a gap in the market during Covid-19 crisis.
In September, Allica Bank secured £26m ($33m) in funding from investors and launched a £100m funding round. The bank, which only received authorisation in late 2019, claims it has had more than £1bn of enquiries from businesses in the aftermath of the Covid-19 pandemic.
The surge in demand has been driven by small and medium-sized enterprises (SMEs), particularly outside London, that have found it difficult to secure funding during the crisis, says Richard Davies, chief executive, Allica Bank. “SMEs' supply of finance has been very badly damaged by Covid-19 outside of the government schemes,” he says.
[Covid-19] has created an opportunity for digital banks that can access real-time data to support their credit scoring models and better understand the risks facing their clients
UK government-backed initiatives, such as the Coronavirus Business Interruption Loan Scheme, have made billions of pounds in loans available to SMEs but the supply of finance to many smaller firms has nonetheless been badly disrupted by the crisis. Traditional lenders have tended to prioritise loans with a government guarantee and stayed clear of SME lending, according to Mr Davies, which has created a gap in the market for digital challenger banks.
“Many SMEs have seen a big drop in demand or suffered late payments, putting them at risk. Others have seen demand rise for their services during the pandemic. But the risk-averse incumbent banks have been very careful about who they lend to, preferring larger companies,” says Aurelie L'Hostis, a senior analyst at research group Forrester.
“Traditional banks historically lack commitment to the SME segment because the return on equity can often be quite low. The SME market can be a costly to serve, when compared with corporate customers.”
Fintech advantage
Ms L'Hostis says the onset of the Covid-19 crisis has made credit scoring models used by incumbent banks look outdated as they do not provide sufficient up-to-date data to make an informed decision about lending criteria. As a result, many SMEs are still struggling to get access to funding despite the government support programmes, she says.
“It has created an opportunity for digital banks and fintechs that can access real-time data to support their credit scoring models and better understand the risks facing their clients.”
So far this year, UK SME lender OakNorth Bank has approved £1.4bn in new loans to businesses. The bank, which launched five years ago, relies on a machine learning platform and uses expansive data sets to speed up the process of lending to SMEs. “OakNorth have developed an innovative model that has allowed them to better understand the issues facing a portfolio during the crisis,” Ms L'Hostis says.
Another UK challenger, Metro Bank, has sought to reboot its business after a difficult 2019 by acquiring peer-to-peer lender RateSetter in August as it seek to expand into other areas.
“Metro Bank is trying to find a way to serve the SME market and the fact that it acquired RateSetter shows that this is an area it wants to push into,” Ms L'Hostis says, adding that the £12m acquisition provides it with more sophisticated credit-scoring models.
“In order to lend to a small business in the current climate you need to know what their liquidity levels are and whether they are going to be profitable in six or 12 months. A lot of the fintechs harvest data in real time and have much better models in place,” she adds.
“The incumbent banks have been very risk averse in lending to SMEs at a time when there is lots of demand so you are seeing these smaller lenders gain ground, because they have a capability that the incumbents do not have.”
