SME Borrowers of Alternative Lenders in the UK


By Gabriele Sabato, Edward Altman and Galina Andreeva

Abstract

SMEs (Small and Medium Sized Enterprises) are fundamental to the economic development of any country, and access to credit is seen as an important condition of successful economic growth. However, many SMEs experience problems with getting credit and the UK Government is introducing numerous initiatives in order to close the so‐called SME funding gap. Lending to SMEs is no longer restricted to banks, there are many new players coming to SME credit markets. These new players (or alternative lenders) use innovative lending technologies and often can offer better loan terms and/or faster decisions as compared to traditional credit providers. Nevertheless, little is known as to what kind of small businesses are choosing alternative lenders –are they just a random sample from overall population of the UK SMEs or are they different in some specific aspects? Is their credit quality better or worse? This paper provides a general overview of the external funding landscape for SMEs and an exploratory analysis of the SME portfolio of one of the UK alternative lenders. The results indicate that clients of the alternative lender tend to be younger, with higher levels of debt, but also higher returns as compared to the a generic sample of UK SMEs. Besides, their probability of default is lower, as estimated by SME Z‐Score, which may be because they are better informed of the opportunities available to them.

Introduction

In the years following the last financial crisis, the credit transmission channel has been damaged as regards to the quantity, price, and distribution of credit. This is a major problem for the small and medium size firms’ in Europe, which has also suffered from bank regulatory concerns of capital adequacy, heightened emphasis on default risk of bank counterparties and the general malfunctioning of credit extension and private sector growth. New regulatory requirements have forced banks to offload inventories of corporate and mid‐market debt assets, and to scale back traditional lending for the foreseeable future. Banks are mandated to simplify their businesses and shrink balance sheets. In 2012, the International Monetary Fund estimated that European banks needed to reduce their asset base by $2.6 trillion. Being heavily reliant on traditional bank lending, small and medium‐sized enterprises (SMEs), are confronted with difficult financing constraints in a deleveraging environment.

A number of innovations have been introduced in the last five years to counter the devastating impact of credit rationing in Europe, particularly from traditional bank lending. Both, large corporates and SMEs have started to drastically reduce their reliance on bank lending supporting the development of new alternative sources of funding (see Figure 1). For larger enterprises, especially in Northern Europe and the U.K., the high‐yield, non‐ investment‐grade bond market has grown from about €100 billion in 2010 to almost €500 billion by the end of 2015, with almost 700 different corporate issuers, of late. But, this market is only available to relatively large corporates. For smaller entities, and retail credit in particular, the internet‐based “crowd‐funding” market has shown considerable growth and promise, but still lacks regulatory scrutiny, size and sustainability issues persist in anticipation of continued tepid macroeconomic growth and a possible new economic downturn. In addition, non‐bank market‐based lending, or shadow‐banking, from institutional lenders can improve the flow of credit to SMEs, but will not be sufficient, in our opinion, to provide wide participation to the varied types of SMEs across Europe.