SMEF0009
Written evidence submitted by Swishfund Ltd
Introduction
Swishfund Ltd is an alternative lender to SMEs in the United Kingdom. We have been operating since 2018. We are a subsidiary of Swishfund B.V. in the Netherlands. In the UK we provide short-term (up to 24 month) cashflow loans (up to £500k, secured and unsecured) to all SMEs for any purpose. From a risk/pricing perspective, we consider ourselves a Tier 2 / Tier 3 lender with an interest-rate around 21% per annum (our lowest interest-rate is 13.2% per annum).
This year, Swishfund Ltd won the “Responsible Lender of the Year 2022” award from Collections, Credit & Risk Magazine, due to our strong ESG values and innovative ESG projects. Our projects range from offsetting carbon for new customers (since 2021), to campaigning for cheaper finance for environmentally responsible SMEs, to creating neurodiverse legal documentation, and marketing campaigns for getting more finance to women-led businesses.
I am the managing director / country manager of Swishfund Ltd. For seven years before Swishfund I headed up a team of >50 FTEs as Head of Servicing, Collections, Recoveries & Litigation for Europe at Funding Circle plc. And before that I was an senior insolvency lawyer at CMS Cameron McKenna in London.
My reason for submitting this evidence is that I have been involved in UK finance for more than 20 years and, more particularly, SME lending and Fintech since 2013. I have strong evidence-based views on what works and does not, unfairness in the system, the importance of improving customer choice, and how finance can be more of a force for good in the UK.
Short Summary of Answers
The aim of any market should be for the widest range of suppliers to provide the biggest variety of services to every type of customer, without any discrimination or bias.
In the past six years, new regulation of finance in the UK has had the habit of creating adverse unintended consequences, for example: (i) the over-regulation of Peer-2-Peer closed many P2P lenders resulting in retail investors pursuing more risky investments in crypto and speculative property funds; and (ii) the over-regulation of pay-day lending pushed many consumers to seek finance from door-step lenders (loan sharks) on much worse terms than they had previously through regulated online consumer lenders.
Future regulation of finance in the UK should aim to reduce the over-dominance of too few large entities, who are able to undercut the market and prevent smaller and more innovative lenders from gaining a foothold. The SME lending industry should largely self-regulate; market forces (and government support) should drive a fairer and more competitive market, and greater customer choice.
WRITTEN EVIDENCE: SPECIFIC QUESTIONS
INDUSTRY ISSUES
There is finance available for almost every SME that has been trading for a minimum 6-12 months. Whether that finance is fair (i.e. based on affordability), or unfair (i.e. based on an expectation of default fees and recovery action) is a decision that responsible directors need to make when choosing the finance provider.
Whilst there are comparison websites for finance, the top recommendations of such websites are usually the lenders who pay the most to be higher up the list. Also, products change so rapidly that it is difficult for comparison website to keep up to date with the latest changes, resulting in sub-optimal recommendations to customers.
This is where intermediaries/brokers can help SME customers. Intermediaries/brokers should be obliged to ensure that they recommend the best deal for their clients, taking into account a range of considerations (i.e. not just pricing, but also term, security, corporate culture etc). To ensure some fairness in the “best deal”, intermediaries/brokers should be obliged to approach at least 3-5 similar lenders to obtain the best indicative offer for their client.
There are two channels: direct or indirect. Direct is traditional marketing, such as through GoogleAds, Email campaigns, TV campaigns, billboards, magazines, comparison websites, and word-of-mouth. Indirect is the use of brokers or introducers, such as accountants, lawyers, and business advisors.
It is a myth that the direct channel is cheaper for customers. The lender will want to claw back its Cost of Acquisition for all its sunk marketing spend. Further, a lender may take advantage of the lack of experience/knowledge of the applicant regarding pricing and fees. That said, a lender that relies on the direct channel will have higher operational costs, as it must filter through a much larger volume of direct (and fraudulent) applications; and these costs need to be passed on to the direct customers who accept an offer.
The Indirect route is not perfect, as brokers are either good or bad. The good brokers are great value as they know the market and get the cheapest/best deal for their customer; a deal that meets all the customer’s needs. A bad broker may: (i) offer the most expensive loan to the customer with the aim of refinancing it several times over a relatively short period (gaining a fee each time); or (ii) charge high onboarding costs; or (iii) credit stack by obtaining funding from several lenders at the same time (in conflict with each of their affordability assessments).
Open Banking is relied on heavily by the alternative lending industry, to assess the risk of SME applicants. Unfortunately, Open Banking data is still not ubiquitously available, or standardised in the sector. For example, Metro bank does not sync with Plaid, which is one of the most commonly used Open Banking providers. This creates difficulties for customers, and barriers for alternative lenders to offer finance. The workaround is that Swishfund requires customers to download CSVs to then be uploaded into our technology, but this is sub-optimal and labour intensive.
Further, where a bank, neo-bank or large SME lender (i.e. >£100m originations p.a.) declines an applicant, they should be required to recommend such applicant to a panel of alternative lenders. Whilst this is a requirement on banks, it is not monitored or reported on. Further, the panel list offered should be publicly available, and the tender-process for new lenders getting onto that panel should be public and decisions open to appeal.
There is a range of finance available for different sized SMEs. The key issues will be product, pricing and security. With the emergence of revenue-based lending challenging the traditional venture-capital source of funds, more products are coming to the market catering for a wider range of SME finance needs.
Small SMEs are more likely to find funding in the higher priced alternative lending market. Mid-sized SMEs may find funding through some of the larger funds, neo-banks and specialist alternative lenders. The biggest SMEs will most likely they will have a strong bank relationship. That said, size is not the only risk factor for SME business failure, and risk of default is more likely to determine where the SME will find funding.
The availability of venture-capital funding has receded in recent years. Several venture-capital funds have ventured into different types of revenue-based lending, with variable degrees of success. The big scandal in venture capital funding is how little of it is deployed to female-run businesses / women business-owners. Apparently less that 1p of every £1 spent by venture capital funds goes to female-run businesses. Further studies should be carried out / reporting required on the diversification of demographics of venture-capital fund managers, and the diversification of their investments to different demographics of business-owners.
We were unaware of the scheme until this consultation.
An essential role. They support the credit analysis and underwriting processes. They are huge part of the decision-making processes for sensible lending. All prudent lenders will rely on Credit Reference Agencies to give impartial third party understanding of a company’s position, including existing borrowing and any distress in existing borrowing, which may not be apparent from Open Banking data. Regular monthly reporting to Credit Reference Agencies should be obligatory for any lender that provides more than £15k to a customer.
It helped the bigger alternative finance providers become even bigger. Smaller alternative finance providers with more innovative / game-changing ideas did not win any of the grants.
The fact that so many of these large “winners” of grant funding had to pay their funds back to be reissued to other applicants, highlights how poorly the awards were allocated. Further, the application process was manifestly unfair, with larger alternative finance affording lawyers, marketing consultants, strategists and accountancy firms to assist them with their applications. In summary, the grants supported puff over proof, and have only managed to line the pockets of those co-founders who were already on track to being the owners of unicorns.
Yes. This is due to a mixture of unconscious bias and thin credit histories.
It is more difficult for a non-homeowner to get funding than for homeowners. This is because of the perceived high risk in the social class, where there is little recoverability. The anti-social impact of this is that it keeps less-wealthy people from being able to build their businesses as fast or as robustly as people who have property assets.
Swishfund is one of the few alternative lenders who are still lending to non-homeowners, up to a maximum of £50k. This is because our lending is based on cashflow affordability. However, the pricing tends to be at the higher end of our portfolio due to the lack of recoverability.
Larger lenders should be made to report on the ethnic make-up of their applications and their originations. They should be required to report on the steps they take to mitigate the risk of unconscious bias within their marketing and their underwriting systems, and/or in their algorithms in any automated decision-making.
A specialist team in the FCA should be dedicated to identifying and redressing unconscious bias within machine-learning/AI-driven decision-engines; and ensuring that larger lenders (i.e >£100m originations per annum) are complying with their own anti-discrimination/fairness policies. Further, this team may benefit from working closely with The Alan Turing Institute, to ensure that the representations made by lenders in this regard are fair and accurate.
REGULATORY ISSUES
Most (if not all) alternative larger lenders signpost their complaints procedures or include them on their websites. Many smaller alternative lenders apply this best practice, even though it is not a regulatory requirement.
Interesting guidance, but not relevant for many smaller or higher-risk alternative lenders.
Slow, but effective. It only applies to authorised firms. Where lenders are regulated but not authorised (i.e. they don’t lend to sole traders), this is not relevant.
It is appropriate, and should not change.
Ineffective. Few know it exists or what it does.
No. It would make funding SMEs more expensive, less competitive, and would create more and higher barriers to entry for new lenders. Further, the velocity of money in SME finance would slow down considerably; and many SMEs would struggle to fund any funding at all (which would lead to more business failure and unemployment).
When putting together any new regulations, the regulator must consider the impact on the WHOLE market, not just the banks, or neo-banks, or listed alternative lenders. Tier 2 / Tier 3 lenders support a large part of the UK SME community that cannot get funding from these larger institutions, and so they cannot be treated the same when it comes to regulation.
Over-regulation of commercial lending will create new barriers to entry, and reduce competition in the sector. Further, it will increase costs which will be passed on to the SMEs, making it more difficult for SMEs to obtain affordable funding and more likely to fail if they take funding that they cannot afford.
That said, affordability should be the dominant consideration in all lending decisions, rather than recoverability. Affordability may be measured on current cashflow or post-lending anticipated cashflow, but a responsible lender should only lend where the repayment schedule is carefully analysed to be affordable. There are some alternative lenders at the top end of (i.e. >50% APR) that lend on the basis of recoverability only (and have large teams of collections agents), which is immoral in Swishfund’s view.
As a non-bank, this will not directly impact Swishfund. However, if the banks and neo-banks find it harder/more expensive to lend to SMEs then this will support the alternative lending industry. Ultimately the outcome is that SMEs that could once find cheaper lending for working capital and growth will have to find such funding from more expensive providers, and this will slow growth in the economy.
GOVERNMENT POLICY ISSUES
Yes.
The Government should offer partial guarantees to lending to newer SMEs, or SMEs that are improving society through having strong Environmental, Social, Governance (ESG) purposes or values.
The Government should fund research into whether SMEs that have strong ESG purposes are more credit worthy, as this could create a virtuous circle where SMEs with stronger ESG purposes and values are able to obtain cheaper credit. This will also lead to more venture capital investment into this sector.
Thinking laterally is also important. The Kickstarter scheme was a great scheme, and Swishfund hired one of our trainees through that scheme. She made a great contribution, and we became her work-family, supporting her inside and outside of her work-life.
Also, the UK Infrastructure Bank should be much more involved with SMEs. Arguably, all SMEs are part of the UK economic infrastructure. The UKIB have a massive pool of money and many ESG purposes. Many SMEs would support the objectives of the UKIB directly, rather than the UK Government relying on lending it in huge chunks to big business in the hope it will “trickle down”. Why not set the criteria and let lenders do the administration and lend directly?
Finally, as cost of capital is an important factor in the success or failure of SME lenders, the government could support SME lenders who cannot benefit from low inter-bank lending rates, or large volume institutional trades or public listings. Match-funding is a great way to achieve this, to ensure that the whole SME community is served, and not just the most conservative and established businesses.
The impact of BBLS (and CBILS) and the RLS has been to:
(i) artificially create a zombie culture of SME businesses. These zombies looked good on paper as they had apparently survived through Covid. Many were then able to borrower commercially in 2022. Many quickly failed, causing a spike in defaulted debt and an increase in pricing for all other SME borrowers;
(ii) artificially change SME borrowers’ expectations of the price of commercial debt given the risk of their business failing; and
(iii) undermine the financial services industry with the embarrassingly amateur way in which these schemes were rolled out. For example, approved lenders were using a shared Googlesheet in the cloud to record who they provided funding for under the BBLS and CBILS schemes, so other lenders could check that the customers were not making multiple applications at the same time, i.e. “CBILS stacking”.
Yes, but why not tie it to ESG-related purposes, or businesses with strong ESG policies and values?
Once the regulator has assessed any demographic inequalities in SME borrowing, such a fund should be used to redress the balance. In so doing, the fund may need to consider different and more innovative risk assessment processes, to avoid the same traps that the traditional and larger lenders have fallen into.
Even as a relatively small lender in the market, the British Business Bank have always been very helpful and supportive. They are limited by resource; but make an excellent effort to be inclusive. However, the match-funding programmes were limited to larger lenders, which gave those larger lenders an unfair advantage in their cost of capital.
The British Business Bank should take over much of the responsibility for SME lending from the FCA, and be supported by the government to develop innovative new lending models, and create more diversification in the lending market. The British Business Bank could also have a greater involvement in promoting alternative lenders and fair competition in the SME lending industry.
END
August 2023