Written evidence from OakNorth Bank Limited (ATF 09)

Introduction to OakNorth Bank Limited

1. OakNorth, the bank for entrepreneurs, is a new British bank that provides loans to small and mid-sized companies (“SMEs”) to fund their growth. It breaks from the UK banking norm of lending to SMEs only when they have property as collateral. OakNorth offers loans secured against a range of other assets including stock, debtor books, plants and machinery, as well as unsecured loans, which are better suited to many high-growth businesses. 

2. The bank was founded by Rishi Khosla and Joel Perlman, themselves entrepreneurs who were inspired to launch OakNorth by the challenges they faced when securing finance from high street banks. The Board is chaired by Cyrus Ardalan, former vice-Chairman of Barclays, and includes Lord (Adair) Turner, Senior Independent Director, and Robert Burgess, Non-Executive Director.

3. OakNorth gained a full banking licence in March 2015, exited mobilisation and began lending and taking deposits in September. Its capital base is circa £85 million, and it is focused on loans between £1 million and £15 million.

4. OakNorth’s founders recognise that growth companies play a pivotal role in the British economy and have created the bank to ensure these companies are better supported in the future.

Reason for submitting evidence

5. OakNorth Bank is submitting evidence because the market for business loans, particularly to SMEs, is uncompetitive to the detriment of new banks and SMEs that want to access finance.

Evidence on the specific points outlined by the Business, Innovation and Skills Committee

What have been the most successful Government policies to assist growing companies to access private finance and where is there room for improvement?

6. SMEs in the UK borrow about half as much as their counterparts in the US and Germany, where they are supported by competitive and diverse banking systems. In the US, there are approximately 7,000 banks; in Germany, there are approximately 2,000; but in the UK, there are only 350. Furthermore, four banks account for 90 per cent of SME business loans[1] in the UK, while in the US, the biggest four banks control only 39 per cent of the small business loans market and in Germany, the biggest four lenders control 20 per cent of the total banking market and we expect their share of the SME lending to be similar.

7. Over time, large UK banks have focused increasingly on large companies, while centralising and automating processes for SME loan applications in an attempt to cut costs. SMEs have generally found it increasingly difficult to access debt finance, particularly when they don’t have property to use as collateral, and the barriers to entry for new banks looking to serve this market were until recently too high.

8. The revised authorisation process, which involves initial authorisation with conditions before exiting mobilisation, has reduced these barriers to entry by making it easier for prospective banks to raise funds to launch their business. This has been instrumental in encouraging new banks to set up, thereby giving SMEs more choice of financing options, but a number of barriers remain towards achieving the Government’s stated ambition of a more competitive and diverse banking system.

9. The format of the newly extended Funding for Lending Scheme (FLS), while helpful, doesn’t achieve the full potential of supporting growth in SME lending supply. Although new banks can now benefit from cheaper funding, in its current format the scheme prevents OakNorth and other new banks from making full use of FLS due to limited eligible collateral in their loan book.

10. This collateral is also reduced by 50 per cent, further limiting access to FLS. Given that small banks are already subject to tighter capital and liquidity requirements than larger banks, we believe that current FLS requirements are too onerous for new banks which reduces competition in the banking sector and results in a worse deal for SMEs that are seeking debt finance.

11. Furthermore, replacing the Bank Levy which only applied to big banks with an 8 per cent Bank Corporation Tax surcharge, which applies to all banks, is a retrograde step in terms of stimulating more competition for the benefit of bank customers. Ramping up taxation on profits means that smaller banks will have less capital to reinvest in their businesses and less retained capital to lend to SMEs. It also sends a very negative signal to investors looking to put capital into the banking sector. It is the only industry singled out for an additional surcharge, making it a less attractive sector to invest in which holds back new banks in particular. This surcharge should be withdrawn or reduced for banks below a certain size in the interests of creating a more competitive and diverse banking system that better supports British business and the economy.

12. As the European Banking Authority noted in its paper Proportionality in Bank Regulation, regulation should be judged by five measures to ascertain whether it is proportionate. These include whether sufficient differentiation is made between different types of banks without compromising the objectives of regulation. The Bank Corporation Tax surcharge and the Funding for Lending Scheme both fail on this measure, for the reasons stated above. The Bank Corporation Tax surcharge also fails on the measure that regulation should be proportionate in relation to the objective sought i.e. that banks “should continue to make a fair contribution in respect of the potential risks they pose to the UK financial system and wider economy.” [2] Large banks pose a systemic risk to the UK economy, small banks do not.

13. Crowdfunding and P2P platforms are not subject to the Bank Corporation Tax Surcharge.  They are also not subject to nearly as onerous regulatory requirements regarding retained capital and liquidity which puts new banks at a further disadvantage.

Does the UK have globally competitive markets / suppliers for financing (and debt financing) at 1) seed 2) venture and 3) growth stages? What steps could Government take to strengthen these systems?

14. While the financial sector in the UK is among the most sophisticated globally, the domestic banking sector is not diversified and offers poor choice to SMEs. As mentioned earlier Bank of England statistics show there are only 350 banking institutions in the UK compared to 2,000 in Germany, and in the UK four banks control 90 per cent of the SME business loans market. Lack of choice has probably contributed to a) the apathy that exists among business customers in the UK, b) the lack of switching between banks and c) may indeed have choked off some of the demand for debt finance. In this sense, Government’s attempts to create a more diverse domestic banking eco-system are crucial for the financing of enterprise and growth.

15. 90 per cent of SMEs use their business current account provider for loans, according to the Competition and Market Authority. This strongly suggests SMEs are not used to approaching third parties for their lending requirements, often reconciling themselves to the fact that they cannot raise debt financing. There is also an information asymmetry as large banks have a detailed understanding of their business current account customers’ cash flows. It is now law for the large banks to share this data with credit bureaus, but this still has not converted into availability of this data to new entrants.

16. In terms of equity, financing options improve dramatically as companies progress to later stages in their development. At seed stage, the UK lacks a robust angel investing community. At venture stage, the picture is better. Most large VCs have UK operations and access to series B financing is often achievable – less so for series A because the UK VCs are more risk-averse than, say, their US counterparts.

17. At growth stage, the options for equity financing are better still, but there is a large gap in debt finance – particularly below £5 million EBITDA and a £10 million ticket size.

Are alternative methods of raising finance (such as crowd-funding and peer-to-peer) sufficiently well-regulated and monitored for companies to be confident in utilising them?

18. We have serious concerns about limitations in the regulation of crowdfunding / peer-to-peer debt financing. The most dangerous competitor is one with lax credit processes and our experience of peer-to-peer platforms demonstrates that they use much looser criteria than banks when considering loan applications. This applies to smaller and larger platforms alike, and it is of course concerning that the largest crowdlending platforms now have very substantial loan books. This can have the impact of distorting the market environment.

19. The crowdlending / P2P approach to credit underwriting is putting pressure on other market participants, increasing overall economic risk and jeopardising financial stability.

20. Many of the deals available on peer-to-peer lending platforms are so risky they are effectively equity investments masquerading as debt.

21. Many consumers are of the belief that peer to peer lending products are comparable to fixed term deposit savings accounts, when in fact the former carry much higher risks.

What are the main improvements or interventions, in terms of finance, that the Government should make to achieve the objective of increasing the number of successful and high-growth businesses in the private sector?

22. The Funding for Lending Scheme should require less collateral to be pledged as this, on top of capital and liquidity requirements, further disadvantages new banks which don’t pose a systemic risk to the UK economy, unlike their large counterparts. This change would increase competition in the banking sector and give SMEs that are seeking debt finance a better deal.

23. The Bank Levy was created as a financial stability contribution after the 2008 Financial Crisis and applied to large banks who were required to make an appropriate contribution which reflects the risks that they generated to the economy. Replacing this with a tax on all banks, including ones that cause no systemic risk to the economy, is a remarkably harsh and ill-conceived move against smaller banks and the businesses they lend to.

24. Ramping up taxation on profits means that smaller banks will have less capital to reinvest in their businesses and less retained capital to lend to SMEs. This surcharge should be withdrawn or reduced for banks below a certain size in the interests of creating a more competitive and diverse banking system that better supports British business and the economy.

25. The FCA noted in June last year that the Government’s target to create 15 new banks over five years will be exceeded. 14 banks had been authorised in the two years to June 2015, with a further 20 firms in the early stages of authorisation. It may create financial instability if all of these new entrants operate in the same space (e.g. SME loans), as we have seen with the bubble in buy-to-let property investing which was, in part, inflated by an oversupply of cheap finance from a large number of new banks. We could see other bubbles being created if there is an oversupply of cheap finance to particular sectors, and it would reduce the probability of success for all new market participants.

25. New regulation should also be introduced to require the peer-to-peer debt financing industry to tighten its credit processes and retail investors should be better apprised of the risks they are taking when they lend through any peer-to-peer platform.

8 February 2016