Transforming Lending in the UK – Part 1

In an article ‘How should we fund the UK’s growth agenda?’ earlier this month, the head of the Business Finance Task Force asked for ideas on ways to transform lending and fund UK growth.

As someone who spent much of the past two decades raising commercial and equity finance for banks, public sector entities and businesses and having devoted the past 12 months to devising ways of reshaping commercial finance distribution, I’m excited by the possibilities.

I extracted a few key points (in quotations) from the article and centred my thoughts around them in a series of blog posts.

“The primary purpose of banks is the supply of credit to the economy. They have the credit-scoring skills, business relationships and networks to reach down into the SME sector. Our work should not impinge on the banks’ lending role; on the contrary, it should complement it. “

I wholeheartedly agree. As I mentioned in an earlier blog post, while alternative distribution channels will have a measure of success and do offer respite to a percentage of borrowers, the main channel (i.e. banks) needs a helping hand first. Individual savings, corporate balances, government payment accounts and even pension fund savings flow through the banks. We need to make sure that business lending flows smoothly through these channels, first and foremost.

“But we should ask, as banks deleverage and balance sheets shrink, whether there is a bigger role for banks as arrangers of finance rather than as lenders themselves.”

Here, I think that we need to be careful in differentiating between banks acting as introducer/referrers, and banks acting as arrangers.

Banks already have investment banking businesses whose purpose is to intermediate. The 2008 meltdown was the result of banks packaging and parcelling off credit risks to institutional investors and other banks.  It may be that policy makers will force separation of retail, corporate and investment banking, ring-fencing some risks. However, enlarging the role of the investment banks to arrange more, while contracting the lending side will be tricky – from where are these arrangers going to source these loans?

For non-banks to do day to day lending, there will need to be an import of business credit skills (as opposed to skills needed to buy bonds and tradable assets), so all we would have done is transfer the risk and infrastructure from the banks to other entities taking on the role. Regulation, statutory reserves, risk and profitability determine bank’s willingness to lend. With less to lend, their selectivity and risk measures increase.

I don’t think we need any more finance arrangers. What we do need is better access to, and availability of finance.

Banks introducing or referring alternatives to their customers could work – they already sell third party insurance and other financial services to retail and business clients. If commercial bankers took the long view and started offering a customer a total financing package beyond its own balance sheet, it’s customers may end up shopping around less and remaining satisfied (maybe even happy), and loyal.

Today, when a business gets turned down by its bank (or maybe sees its request drastically slashed), it is offered little alternative. If it’s lucky, the bank calls up the invoice finance subsidiary and sets something up. Most likely, the conversation ends at the ‘sorry’ point. One customer of a public sector bank found that a 10 year relationship was terminated by a new relationship manager in 6 months, accelerating pressure on the business and perhaps even pushing it over the edge.

Imagine that this lender realises that the business now falls out of its target risk profile (for whatever reason – sector, size, performance) and knowing the market, arranges an introduction to a friendly competitor, or even a channel partner of some sort (working capital platform, independent asset financier, commercial debt fund etc.) and assisted the business in securing much needed working capital. What customer loyalty and retention would this command? Or for that matter, what would the effect be on the SMB commercial finance eco-system?

I think that banks can play a major role in expanding commercial finance distribution beyond themselves, without necessarily harming their own business.

Whether the bank gets recompensed in the form of an introductory commission, revenue share, or an increase in ‘float’ (customer deposit), and services would be shaped by competition and market force – all beneficial to the business and the economy as a whole.