Lending puzzle still has missing pieces

Aldermore’s float has been touted as a sign that challenger banks are coming into their own. But there is still a long way to go before SMEs are properly served

Are the complacent high-street banking giants finally facing a serious challenge? Do small firms which need loan finance now have a decent choice of banking providers? Does the branch computer, at long last, say “yes”?

The so-called challenger banks, which have been fed and watered by ministers and regulators in recent years, are certainly growing fast. That was underlined yesterday by Aldermore’s announcement that it plans to float, raising £75m from the stock market to support its expansion.

The private equity-owned lender, which launched in 2009, also reported yesterday that its outstanding stock of loans to small and medium- sized enterprises (SME) hit £2bn in the first half.

Aldermore’s net loans to customers (including mortgages) has grown by a remarkable 64 per cent a year since 2011. Another rapid expander in the SME market is Handelsbanken, which has £7bn of small business loans on its books, more than double the level in 2010. The suggestion of the former Bank of England Governor, Lord King, to a frustrated business owner in Worcestershire last year that he should try the Swedish lender probably didn’t do any harm.

Shawbrook Bank is another expanding lender. The company’s stock of SME loans had grown to £1.4bn by June.

Santander is a bit long in the tooth to be described as a challenger, but it has about £12bn in SME loans, up 9 per cent over the past 12 months.

But the rest of the challenger sector is still pretty small. Metro Bank has SME lending of about £600m. The recently floated OneSavings Bank’s stock of SME loans is £1.5bn, but that includes buy-to-let mortgages. Strip that out and the figure is closer to £400m.

Compare those figures with big players such as Lloyds, which had £29bn of SME loans at the end of last year, and Royal Bank of Scotland which had £43bn, according to Bank of England figures. This picture, taken from 2013’s numbers, may change somewhat when Williams & Glyn’s spin-off from RBS are included further down the line.

But even at this level of growth it will still be many years before one can realistically talk about the end of the dominance of the big players. And Jonathan Rose, a partner at Capco, the business and technology consultancy, is sceptical about the ability of these new firms to grow organically into serious players. He points to problems with the banking “ecosystem”, such as the fact that it is easier for established banks to get regulatory approval to run with less capital on their balance sheets, and that the payments infrastructure is owned and controlled by the big players.

“The incumbent banks hold all the cards” he said. “With those problems, growing beyond a billion or two billion is going to be tricky [for the challengers].”

Some of the vaunted new kids on the banking block aren’t even in the SME lending market. Virgin Money, the rebranded Northern Rock “good bank”, talked about lending to small firms a few years ago but has now apparently dropped the idea. Tesco Bank isn’t looking to lend to businesses either, preferring to go after current account customers and mortgage lending.

Given that the four biggest incumbents still account for about 77 per cent of current accounts, competition in this area is welcome. But it does nothing to address one of the central criticisms of the UK’s banking sector, which is that while it is historically very good at taking deposits and lending to mortgage borrowers, it is awful at channelling finance to small businesses that want to expand.

The Bank of England’s aggregate figures show that the total stock of SME lending across all banks is falling. The Bank started measuring the stock of lending to small firms directly in 2011, when it was at £197bn. Since then it has dropped 14 per cent to £170bn, as the second chart shows. In the summer of 2012 the Bank and the Treasury established the Funding for Lending Scheme (FLS), which offered participating banks cheap subsidised funding provided they passed on the money to mortgage borrowers and small businesses. Last year the scheme was refocused to subsidise only SME lending. Yet the FLS has not pushed net SME lending flows consistently positive.

Some now say the problem is a lack of demand, citing surveys suggesting the majority of SMEs are “content non-borrowers”. But this isn’t clear cut. Many small companies were treated so badly by banks in the global financial crisis (such as seeing overdraft facilities suddenly withdrawn) that many were put off the idea of financing their expansion through bank lending. And it is notable that challenger banks insist there is strong demand from SME customers, contradicting the picture painted by the big players.

So given that existing official incentive schemes do not seem to be delivering the hoped-for results, what else should policymakers be doing? Adam Posen, a former member of the Bank’s Monetary Policy Committee, has urged the creation of an SME investment bank with public backing, similar to Germany’s Kreditanstalt fuer Wiederafbau.

Others see part of the answer in another sector of the market: peer-to-peer lending platforms are growing fast, with outstanding loans doubling to £2bn since last December, according to AltFi Data. Advocates say these platforms encourage lenders to make decisions like long-term investors, rather than box-ticking bank managers.

Mr Rose of Capco also suggests that regulators and politicians should be encouraging the development of a low-cost “cloud network” of IT support services, something that already exists in the German and US markets. “If those sort of entities existed here in the UK you would see how much easier it would be for a challenger bank to stand up” he says.