Redesigning SME credit for the 21 st century

Why are we focused on small and medium enterprise (SME) credit at Growth Street? In short, for 5 reasons:

1. It’s a massive market 2. It’s poorly served3. Banks aren’t investing in SME banking 4. Worse still, the one credit product every business needs – an overdraft – is being taken away

by the banks5. We think there’s a better way to lend to businesses

o Use data to make better lending decisionso Put customers first and offer information that helps companies grow (which is good

for them, good for us, good for lenders and good for the economy as a whole)o Use a marketplace so that SMEs aren’t reliant on banks for funding

1. Massive market

There’s currently £140BN lent to SMEs in the UK alone (and the Breedon Report suggests that there’s a further funding gap of c. £30BN unmet demand).

The number of SMEs in the UK is now at a record high – there are 5.2M businesses in the UK, growing at c. 6% each year.

2. Poorly served

The FCA and the CMA recently conducted a joint report into banking services to small and medium sized enterprises, and found that:

Only 25% of SMEs consider that their bank supports their business Only 13% of SMEs trust their bank to act in their best interest The SME banking sector has a Net Promoter Score of negative 8%.

[Net Promoter Score is a customer satisfaction measure that calculated the number of people who would promote their bank to a friend, less the number of people who would warn them off. Hence a negative score means more businesses are detractors rather than promoters of the service they get from their bank.]

3. Banks aren’t investing in SME banking

Retail and Corporate banks are being split apart. SME banking typically sits in between the banking services provided to consumers and those provided to large corporates. In the process of separation, we believe SME banking is falling into the gap.

Post the global financial crisis, there has been a wave of new regulation to try and make banking safer. New rules and requirements are consuming significant resources within banks, which means there’s little money left over for investment in new projects.

The majority of technology spending by banks is on maintaining their existing systems. Banks have built their systems over several decades, seen new technologies come and go, and often grow by acquiring other businesses. This means they now have a legacy of old, complicated technology which is expensive and time consuming to maintain.

This means there’s very little money left for investing in new technology and ideas. What remaining discretionary spend that’s left is consumed by bigger opportunities, which means SME banking services aren’t getting the investment they need.

4. Businesses need overdrafts

The one banking product every business needs is an overdraft. It allows a business to cover temporary cash shortfalls during periods when expenditure outstrips income. Nearly every business goes through these peaks and troughs, because accurately predicting income and expenditure is hard, and payments are often outside a firm’s control.

If a business doesn’t have an overdraft available, it has to create a cash reserve, or buffer, so that when they enter a period when expenditure outstrips income, they don’t run out of cash to pay for essentials – for example paying their staff, making rent, or settling their tax bill.

The problem with this approach to cash management is that there’s a huge unseen cost to holding on to cash and not spending it. It means the investment the business can make is restricted – they aren’t able to hire an extra person, or buy an additional piece of equipment, which reduces their ability to increase revenues and grow.

Which is why the decrease in business overdraft lending by banks is a real concern. In the last three years (since the Bank of England and others starting tracking and reporting business overdrafts), the amount lent to businesses is down 40% in 3 years. This isn’t just businesses borrowing less, its because bank’s are approving fewer overdraft applications. The number of approved facilities for smaller businesses is down 45% over the same period according to the British Bankers’ Association.

5. There’s a better way to lend to businesses

“Banking is necessary. Banks are not.” The traditional way banks lend to SMEs is outdated.

Banks typically assess SME credit risk (the likelihood that a lender won’t repay) by looking at the business’ current account history, their credit score and annual accounts.

By using these simple data sources (that often lack detail and are months out of date) banks make automated decisions that are based on what they’ve learned across their portfolio. They rarely study the business itself, and don’t have the ability (or interest) to monitor it closely, and provide feedback to their customers to help them grow their business.

At Growth Street, we’re taking a new approach. We take into account data that can be readily shared by the business – in particular information taken from their accounting software that can be shared securely over the internet. This gives us a much fresher, and more granular understanding of the business’ financial health, which means we’re often able to lend when banks cannot, or on better terms.

Using this information, it also frees up time so that we can talk with potential and existing customers, and understand their business better. By both looking at the same information, at the same time, we’re able to discuss with the business the progress they are making, and can share our perspectives on how we assess the financial health of the business. This transparency is vital to striking up a meaningful relationship with the business and to establish trust.

The detail and freshness of the data the business shares also allows us to forecast forward and help predict what will happen in the future. This helps the business plan its development, and gives it a better chance of growing successfully.

The last piece of the puzzle is to make lending to business independent of banks. At Growth Street, we are creating a marketplace so that different parties can lend to businesses via the Growth Street platform – both individuals and institutions. The benefit of creating a marketplace for business lending means that we can attract a range of different funding sources in an efficient way, which helps keep the cost of borrowing low for businesses, but perhaps more importantly, it means that SMEs aren’t reliant on banks for lending, and for overdrafts in particular.