SMEF0057
Written evidence submitted by OakNorth
Introduction to oakNorth
OakNorth was launched in September 2015 with one fundamental purpose: to serve and empower established small-to-medium sized businesses (SMEs) that were seeking to scale but were routinely underserved or overlooked by traditional banks: what we call the ‘Missing Middle’. Our founders, Rishi Khosla and Joel Perlman, had experienced this first-hand while scaling their previous company - Copal. In 2015, three years after launching that business, they applied for a bank loan and the ‘computer said ‘no’’, despite their business being profitable. The products, services, and experience needed to make their lives as a scaling business easier, and enable them to reach their full potential, were ‘missing’ from banks’ offerings. As entrepreneurs, their response was to build what was missing: a neobank for entrepreneurs, by entrepreneurs.
Providing fast, flexible debt finance of £250k up to tens of millions of pounds to businesses across the UK and across a variety of sectors, we have lent c.£10B to date, directly helping with the creation of tens of thousands of new homes and jobs across the UK.
Reason for submitting evidence
It is appalling that the funding gap still exists for the Missing Middle, especially as the positive multiplier effect of these businesses is evident in productivity, job creation, innovation, and GDP growth. We know, for example, that the billions we’ve lent to the Missing Middle since our launch in 2015 have helped with the creation of tens of thousands of new homes and jobs.
We want to help these entrepreneurs achieve their goals and ambitions, and a key part of this is ensuring they have access to the right finance at the right point in their growth journey.
INDUSTRY ISSUES
Q1. What are the key challenges Small Medium-sized Enterprises (SMEs) face when seeking finance?
In our view, the funding gap and access to finance challenge is most acute when it comes to mid-sized businesses which typically have between £2m-£100m in turnover. This is why as a bank, we focus on supporting the Missing Middle.
Most new banks / neobanks tend to focus on retail customers and micro businesses. The often-complex legal entities, ownership structures, and diversified banking needs of the Missing Middle are perceived as too difficult to address through the automation and apps these companies built upon.
Meanwhile, in recent decades, traditional banks have moved away from Main Street banking based on building trust and value in the local community, to Wall Street banking with centralised decision-making. They’ve closed numerous branches and invested in their digital offerings, but have focused on designing them for the mass consumer and micro business market. They continue to see value in their lucrative corporate clients, deploying large teams to spend time getting to know the business so they can understand its unique pain points and future growth potential, but Missing Middle businesses are considered too small to qualify for this experience.
At the smaller end of the scale, businesses are generally unaware of where to go for finance and what finance is right for them (debt, equity, or a combination of both). They’re relationship with their finances is often limited to monthly or quarterly meetings with an accountant who they will be largely reliant upon for finance advice.
Larger SMEs will likely have more sophisticated finance departments with a finance director and potentially even a CFO. They may have taken out both debt and equity financing in the past, and may have even participated in initiatives such as crowdfunding in order to raise capital. However, most of these businesses still tend to go to their clearing bank as their first port of call when seeking a loan and if they get a rejection or aren’t offered the right structure for their needs, they often don’t look elsewhere. Many wrongly assume that if a bank they’ve had a relationship with for years or decades isn’t willing to lend to them, then no bank will. As entrepreneurs and business owners are very busy people, they have limited time and resource to shop around for alternative lenders.
Q2. Through which channels do SMEs find the most success when seeking funding and why?
It depends on the business and the growth stage it is at. We have customers which did crowdfunding during the earlier stages of their journey, then later got private equity funding, and once they’d been trading for longer and had reached profitability, came to us for a loan. A business’ success in securing the right finance it needs is often down to knowing where to go, how to apply, and what options are available for their business at this current point in its journey.
Q3. What role can financial innovation play in SME finance? Is there more the government and the regulators can do to improve access to finance through innovative firms?
In order to enhance SME’s access to finance, we need to make it easier for innovative firms such as OakNorth to lend to them.
This doesn’t require less regulation but better regulation - i.e. regulation that is agile, proportionate and focussed. In a post-Brexit environment, UK regulators must take advantage of the flexibility that comes from our exit from the EU. They need to regulate in a way that removes the barriers to growth and scaling, develops a more proportionate and risk-based regulatory framework, and allows innovation and competition to flourish. This will benefit consumers and business with lower costs and better services without sacrificing financial stability or consumer protection.
The ability for new banks and existing mid-tier and specialist firms to scale, grow and deliver genuine competition for the incumbent, high-street banks, is being hampered by barriers to growth, particularly the MREL regime and capital requirements as explained elsewhere in this submission.
Q4. How accessible is finance for SMEs of different sizes?
In terms of equity, there are numerous options as businesses grow from a micro, to a small, to a mid-sized business – crowdfunding, schemes such as EIS/SEIS, angel investing, venture capital, private equity, etc. but the issues as previously notes are that many businesses don’t know where to go at different points in their journey.
When it comes to micro and small businesses seeking loans below £250k, there are a number of fintechs and neobanks available that provide funding of this size quickly and easily. However, once businesses reach a certain size (typically revenues of £2m-£100m), there options become much more limited as detailed in our response to Q1.
Q5. Is finance available to allow SMEs to scale up from venture capital funding?
Yes, but it goes back to whether they feel they can access it and whether they’re aware of where to go for it. In the current economic environment, it is harder to raise equity, while debt is more expensive given higher interest rates, and is not typically available to earlier stage companies with less than three years of trading history.
Q6. How successful has the Bank of England’s Term Funding Scheme with additional incentives for SMEs (TFSME) been at encouraging banks to lend to SMEs?
We are very supportive of the Scheme but in our experience as a smaller, newer lender, certain processes within the Scheme could be simplified to make it more effective. It would also perhaps be worth exploring whether the Bank of England’s risk could be shared with other entities such as the British Business Bank in order to make the scheme more effective and to diversify risk. Finally, in a rising interest rate environment, we are yet to determine how impactful the Scheme can be given the need to balance cheaper funding for SMEs against monetary policy tools used to dampen inflation.
Q7. What role do credit reference agencies play in supporting SME finance?
They play more of a role when it comes to micro and small business’ access to finance. Once businesses reach a size where they’re seeking loans of millions of pounds, the role credit reference agencies play tends to be limited to the checks carried out on the ultimate business owner/s for anti-money laundering purproses. At OakNorth for example, we don’t make credit-score based decisions on our lending as our loans are of a size that requires robust and in-depth credit analysis.
Q8. What impact has the RBS bailout state aid Alternative Remedies Package and its various funds for SMEs (implemented by Banking Competition Remedies Ltd) had on SME access to finance?
Given that Covid delayed / impacted the plans of most of the recipients of the grants, and several of the recipients returned all or a portion of the grant they received, it is too soon to determine the macro-impact.
Q9. Is securing access to SME finance particularly challenging for women, people from ethnic minorities, people from certain social classes, or any other group? Is so, what should be done about it?
We cannot speak on behalf of other organisations but at OakNorth, we don’t discriminate based on gender, race, religion, sexual orientation, or social circumstance. This is evidenced in both our incredibly diverse workforce and leadership, as well as our loan book. Our focus is purely on the business performance, its creditworthiness, and future growth potential.
REGULATORY ISSUES
Q10. Do SMEs have adequate and appropriate access to a complaints procedure when in dispute with their bank or lender?
We cannot speak on behalf of other organisations but at OakNorth, if a customer has a complaint, we have well-regulated procedures enabling them to submit and escalate it as needed.
Q11. How effective has the Lending Standards Board’s Standards of Lending Practice been?
We don’t believe it has had an impact on SMEs’ access to finance as this was not the primary reason it was created, but it does provide an effective benchmark for banks to compare themselves against their peers and the LSB’s standards.
Q12. How well does the Financial Ombudsman Service (FOS) work for small business complaints?
Businesses that borrow from OakNorth tend to be above the turnover threshold to use it, so we don’t have any interaction with the FOS when it comes to our lending. However, we believe it is effective for the micro and small businesses that fall within its current threshold.
Q13. Is the FOS’s existing role in SME finance appropriate? If not, how should it change?
The FCA has launched a call for input earlier this year, looking at increasing the turnover threshold to £6.5m, which would mean more businesses of the size we lend to could use it should they have a complaint. We’re therefore supportive of raising the threshold, but as a business focused on customer delight (80% of our new loan origination comes via referral and 40% of borrowers are repeat customers), our hope is that our customers wouldn’t feel the need to use it.
Q14. How effective has the Business Banking Resolution Service been, and what lessons can be learnt from it?
We haven’t had any interaction with it, so don’t feel we can provide an informed view.
Q15. Should SMEs have the same level of consumer protection and deposit insurance limits as retail consumers?
We are supportive of an increased FSCS limit to £150-200k and a widening of eligibility to include businesses. This would have several benefits:
Q16. Should commercial lending to SMEs be brought into the regulatory perimeter?
In our view, this would create more friction and cost for banks and lenders, so would likely have the opposite effect in terms of improving access to finance for SMEs, with not much perceivable benefit.
Q17. What impact will the PRA’s proposed Basel 3.1 capital requirements framework, and in particular the proposed removal of the SME support factor, have on SMEs in the context of the PRA’s objectives?
If they are implemented in line with the PRA’s recent consultation paper, we believe that the proposals will have a negative impact on SME funding in the UK. This is because by the PRA is proposing to increase the amount of capital that banks and mutuals need to hold against each SME loan and therefore potentially increasing the cost of lending to SMEs. This is because of the proposed changes to the SME support factor and other changes proposed in the paper. This will likely have a negative impact on the cost of credit to SMEs and given their importance in the UK economy, a resulting negative impact on UK growth.
We and many other banks have fed our concerns back to the PRA both directly and in collaboration with our trade bodies. We have also raised the issue with colleagues at HMT.
If implemented, these changes will mean the UK would be an outlier in comparison to peer jurisdictions such as the European Union, and on average, the cost of funding for UK SMEs would likely be higher than the cost of SME funding in the EU.
Whilst we support strong risk based and proportionate regulation, we are unclear why the PRA is proposing this path, given that UK capital requirements are already some of the highest in the world. For example, peer banks in the US are usually subject to less intensive capital requirements, than those in the UK.
The PRA’s proposal on Basel 3.1 together with the Bank of England's implementation of MREL requirements make it more difficult for smaller and mid-tier banks to compete and grow their lending to SMEs. These requirements also make the UK an outlier vs. the regulatory requirements in the EU and US.
GOVERNMENT POLICY ISSUES
Q18. Should the Government do more to enhance SME access to finance? And, if so, what?
As noted in our response to Q3, in order to enhance SME’s access to finance, we need to make it easier for innovative firms such as OakNorth to lend to them.
This doesn’t require less regulation but better regulation - i.e. regulation that is agile, proportionate and focussed. In a post-Brexit environment, UK regulators must take advantage of the flexibility that comes from our exit from the EU. They need to regulate in a way that removes the barriers to growth and scaling, develops a more proportionate and risk-based regulatory framework, and allows innovation and competition to flourish. This will benefit consumers and business with lower costs and better services without sacrificing financial stability or consumer protection.
The ability for new banks and existing mid-tier and specialist firms to scale, grow and deliver genuine competition for the incumbent, high-street banks, is being hampered by barriers to growth, particularly the MREL regime and capital requirements as explained elsewhere in this submission.
Q19. What has the impact of the Covid Bounceback Loan Scheme (BBLS) which was followed by the Recovery Loan Scheme, been on SME finance?
We didn’t participate in the BBLS as it was aimed at smaller businesses than those we serve in our normal course of business. Our view is that it played an important role in helping smaller businesses through the pandemic, but that in some cases, it simply delayed their closure, rather than preventing it. According to research by Fundsquire, 20% of small businesses in the UK fail in their first year, and around 60% fail within the first three years. The BBLS will have therefore inevitably enabled a proportion of small businesses to continue trading which otherwise would have (and some could argue, should have), failed sooner.
Q20. In the US the Treasury approved a fund, (State Small Business Credit Initiative (SSBCI)) for incentivising and supporting underserved businesses. Does the UK need similar provisions?
Initiatives like this can be beneficial as long as they don’t crowd out the private sector or take market share from them. In our view, a more effective approach is to cooperate with banks and lenders, removing barriers to their lending capabilities (through areas such as capital requirements, MREL, etc. as detailed in this submission) vs trying to compete with them.
Q21. How useful is the British Business Bank? Does its finance hub improve SME access to finance?
We believe the British Business Bank has an important role to play which was clearly demonstrated during the pandemic for example. However, we do believe it would benefit from more independence as recommended in Lord Jim O’Neill’s “Start-up, scale-up” review published in 2022. This would enable more lending to invest in their growth – in particular, plans to examine the securitisation of ENABLE programmes to facilitate greater scale.
September 2023