The Competition and Markets Authority is putting its faith in a fintech solution to disrupt the big banks’ dominance of SME banking. While the implications for leasing may only be indirect, they could still be significant says Asset Finance Policy’s Julian Rose
At the end of its marathon two-year review of the banking market, the Competition and Markets Authority (CMA) has placed its money on a financial technology (fintech) solution for disrupting the big banks’ dominance of the SME banking market. The implications for leasing are only indirect, but could still be significant.
Having decided that older and larger banks do not have to compete hard enough for customers’ business, and smaller and newer banks find it difficult to grow, the CMA’s masterplan is focused on technological change.
Small businesses will be able to instruct their bank to share certain data about their banking activities with other banks and with third parties.
Through online tools or applications, the CMA expects this will help businesses to manage and compare different banking accounts.
The CMA’s requirement for data sharing could be seen as only a small step from an existing Small Business Act provision, now in the implementation phase, that requires banks that turn down loan applications from small businesses to offer an online ‘referral’ to a range of alternative finance providers.
The idea is that alternative finance providers armed with information about the small business’s banking records might be willing to provide the finance that the bank has declined.
It is easy enough to dismiss all of this. It relies on small businesses choosing to allow their data to be shared with other providers. Would businesses with anything other than a perfect record do so?
It also assumes that many of the businesses rejected by the banks are still realistic lending propositions for other finance companies.
Data sharing at the individual company level also does little to overcome two quite fundamental barriers to entry into the SME finance market identified by the CMA: the challenges of capital requirements regulation for a new entrant unable to use historical information to justify holding a lower amount of capital than otherwise required, and the costs of funds for lending being higher for non-banks.
On both counts, the CMA seemed content to leave the problems to other authorities to consider. It noted it lacked the powers to change the capital requirements regime, and that the regime as a whole is subject to a number of significant other developments.
Regarding the cost of funds, it (rather oddly) pinned this to the idea that some banks are ‘too big to fail’, and as such benefit from lower wholesale funding costs, rather than considering the cheap money available to banks through the Funding for Lending Scheme and its post-Brexit-vote successor, the Term Funding Scheme.
The CMA came in for some quite severe criticism from challenger banks for its weak remedies to the market issues it identified.
It may not be a coincidence that Virgin Money froze its plans to enter the SME banking market shortly before the CMA final report was published, even though the bank blamed Brexit uncertainty.
Yet the CMA may not have completely lost its marbles. Data sharing and fintech does matter, and it could make a difference to the SME finance market, not least for leasing.
With access to market-wide lending data, combined with a range of other data on businesses and individuals, fintech should be able to help banks and other finance companies predict future loan performance with greater precision than is possible today.
The credit reference agencies may argue they already provide all of this. Some valuable work is indeed being carried out in the sharing of payments information on firms’ credit agreements and utility and other bills.
Predicting loan performance is, however, only partly about looking at the data to find the differences between individual businesses: What makes one business a lower or higher risk than another?
It is necessary also to look at the data to find the similarities between businesses. What makes a particular business sector, geographical location, or type of investment a lower or higher risk than another?
Many individuals and firms in the leasing industry quite rightly pride themselves on their expertise in making lending decisions in particular sectors, regions or for particular types of assets. This is based on their deep experience. It has served the industry well up to now, but is it enough for the leasing industry of the future?
As economic conditions tighten following the referendum, the need for better data on loan performance will only increase. Without the data, lending is simply unnecessarily risky, as insights about sectors, regions and asset types are missed, no matter what expertise is available in-house and what insights the credit agencies can provide.
It is also difficult for lessors to attract external non-bank investment, as investors typically want to understand the risks of a particular lessor’s portfolio compared to the wider market.
The CMA’s emphasis on data sharing and fintech follows not only the Small Business Act provision for referrals, but also a Bank of England discussion paper on UK credit data in 2014.
In its feedback, the Bank said it believed greater availability of market-wide credit data on the SME asset class could support market-based financing for SMEs, including through a deeper securitisation market for SME loans. Such information sharing is already in place in the leasing markets of the US, Canada and Italy.
With the CMA report, the regulatory impetus is growing for further data sharing. The Small Business Act and CMA might have focused on ‘micro’ individual business-level data, with all its limitations, but the biggest potential remains at the ‘macro’ portfolio-level data to give banks and other lessors far more granular and reliable information on SME lending risks than is available today.
Increasingly it is not a question of whether, but rather of when SME loan and lease performance data sharing will happen.