Alternative business finance is any type of finance that doesn't come from a major bank, and these days businesses can get it from challenger banks, specialist independent lenders, and of course the much-heralded crowdfunding and peer-to-peer lending platforms.
The current breadth of alternative lenders in the market is one result of the recession: banks became highly restricted in their lending criteria, scores of businesses couldn't satisfy those criteria, and alternative providers cropped up to serve the ones left behind (or at least to go some of the way).
While the banks had a decreased appetite for lending for a long time, this situation is slowly improving, but small businesses, hit hardest by the banks' sudden unwillingness to lend post-recession, make up a third in turnover of the UK's economy — and 25 per cent of them still don't feel their bank meets their needs.
Meanwhile, 'alternative' finance is looking more mainstream by the minute, with alternative business finance providers originating over £76 billion of funding in 2014 — an impressive 45 per cent of the mainstream banks' total. It's clear that alternative finance, previously the 'plucky underdog' of business finance, is catching up.
Where is alternative finance winning?
Lack of SME funding from banks has resulted in £2.9bn of unrealised revenue over the last 5 years, and alternative finance is now doing much more than just plugging the gaps — in some areas it's leaping ahead. But where does alternative finance do a better job than the high-street banks?
Flexibility is one key advantage. Alternative providers don't have a 'tick-box' approach to lending — they can look at the full set of circumstances before making a decision, and are much more likely to lend to higher-risk or more unusual propositions.
Alternative finance is also winning when it comes to variety: there's a whole world of things that can be used as security for business lending, and alternative providers are willing to take them. For example, merchant cash advances are based on card terminal sales, and have been a boon for retail and hospitality businesses — a difficult sector for the banks to lend to.
While 'alternative finance' and 'FinTech' might seem like almost interchangeable terms, it's still worth pointing out that technological innovation is another ingredient of alternative finance's success, with new products emerging all the time to serve specific needs and situations. Take Kabbage as just one example — e-commerce firms can now access a line of credit in hours, where before they would have stood little chance with the banks.
Finally, agility is arguably the most important reason for alternative finance's success — no legacy systems, no complex internal hierarchy, just empowered teams who can make quick judgement calls and turn applications around in a day rather than a month.
Where are the banks winning?
There are still some areas where the banks have the upper hand. The most obvious is infrastructure, namely the multiple and diverse revenue streams that mean banks can afford to have lower rates on many products. For the lucky SME whose application is accepted by both the bank and an alternative lender, the bank is often cheaper like-for-like — but many other SMEs still don't get to make that choice.
The banks are also heavily regulated and monitored by the Financial Conduct Authority (FCA), so their loan book has a lower chance of defaults than the alternative lenders who choose to lend to higher-risk businesses — although steps are being taken, regulation remains one space where alternative finance lags behind the big institutions.
Ironically, trust is another area where the banks are still ahead. Even in the wake of the credit crunch, many small business owners make their bank their first port of call, and there's still a sense that the big banks are more reputable and alternative finance providers are a somewhat unknown quantity. It's an unfounded assumption in the majority of cases, but alternative finance still has some work to do in terms of confidence and public awareness.
Where can alternative finance help the banks?
Partnerships between alternative and mainstream finance could be the key to filling the funding gap — for example, Funding Circle's involvement in the British Business Bank's Funding For Lending Scheme is just one example of a positive collaboration between two big organisations on either side of the fence.
Last year in the USA — arguably the most advanced and diverse alternative finance market in the world — Lending Club (an alternative lending platform) and Union Bank formed an alliance under which the bank could purchase personal loans through Lending Club's platform. There are also plans for the partnership to create new credit products in collaboration.
One reason alternative finance exists in the first place is because banks have been lacking innovation and flexibility — something alternative finance firms have in abundance — and more knowledge sharing could help big banks apply learnings gained by alternative finance in the last few years.
Lastly, customer sharing is an obvious but important step in collaboration between mainstream and alternative finance. The upcoming government referral scheme will require banks to refer customers they turn down to alternative providers, which should go some way in helping businesses who struggle to access finance.
Alternative finance and FinTech aren't here to beat the banks — they exist to address serious problems in an antiquated industry that's failing to keep up with the times.
Effective collaboration and partnership is the key to closing the funding gap for SMEs, and if we can find a way to combine the innovative and tailored approach of alternative finance with the regulated and robust approach of the banks, we might realise that situation.
With alternative providers already lending 45 per cent of what the banks are, the message from SMEs is loud and clear — they need business finance, wherever it comes from.