Think Tank: New banks' SME lending dilemma

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Author Rachel Bridge on why high-risk SMEs may be disappointed, even by the challenger banks.

When it emerged earlier this month that Bank of England Governor Sir Mervyn King had advised a disgruntled small business owner to seek a loan from a new bank such as Handelsbanken after he was turned down by his existing bank, Bank of Scotland, the phones at Handelsbanken started ringing off the hook.

Because the Swedish-owned bank has no call centre, all the phone calls went through to local branches, causing an unexpected frenzy of activity.

Sue Toolson, manager of the Handelsbanken branch in Ilkley, Yorkshire, said: “Over the last two or three weeks we have definitely seen an increase in the number of enquiries. There are a lot of disillusioned and frustrated businesses at the moment.”

Even without Sir Mervyn’s assistance, the new so-called challenger banks such as Handelsbanken, Aldermore, Shawbrook Bank and Metro (Other OTC: MTRAF - news) , are riding high at the moment, hailed as saviours of small and medium-sized businesses (SMEs) with their promise of better customer service, faster loan decisions, and none of the baggage of the incumbent banks.

Handelsbanken now has 152 branches in the UK and is adding a new one every eight working days, while Aldermore has 12,000 SME customers in the UK and last year lent them more than £1bn.

The Government has made clear its support for challenger banks, pledging to simplify their access to the payments infrastructure and make changes to capital and liquidity rules so they can compete on a level playing field with bigger banks.

At present, however, several big hurdles stand in the way of challenger banks becoming a significant presence in the sector and so having a real impact on the ability of SMEs to access funds.

The first is the difficulty of switching bank accounts. It may sound like a trivial thing, but the hassle of moving to a new bank is a significant deterrent for small business owners, many of whom will put up with years of poor service from their existing bank to avoid the pain of moving their account elsewhere.

The second is the fact that, at present, few SMEs are even aware that challenger banks exist. A straw poll of small business owners at a round-table event last week revealed that precisely none of them had even heard of the challenger banks, let alone felt confident enough to consider doing business with them.

The difficulty is compounded by the fact that the challenger banks have so far relied largely on word of mouth and that only some of them have a physical high street presence; Handelsbanken and Metro do, but Aldermore and Shawbrook don’t.

Although Mark Henry, Richard Evans and Antony Sidney-Woollett have heard of the challenger banks, they ultimately chose Barclays (LSE: BARC.L - news) as the bank for their new business, Ram Foreign Exchange, which starts trading next month.

They did this because they wanted a tried and tested option that offered all the services they needed, and because Evans has held a personal account there for many years. It also helped that there is a Barclays branch opposite their London offices.

Henry said: “For us it made sense to choose a bank we already knew, rather than starting cold. There is so much to consider when setting up a business and we didn’t want to spend hours shopping around.”

But easily the biggest hurdle is whether challenger banks will actually be able to make loans to the SMEs that want one. If a small firm has already had its loan application rejected by a big bank for being too risky, a challenger bank will only be able to provide the loan if they are prepared to take on a higher level of risk than incumbent banks, something they are likely to have limited appetite for. Ditto start-ups, an even higher-risk lending proposition, given so few survive to their third birthday.

Which inevitably means that, so far, a lot of the challenger banks’ growth has come and is likely to come in future from enticing the better-risk SMEs away from the big banks, something which does nothing to increase overall SME lending levels.

Kevin Burrowes, UK head of financial services at PWC, said: “The success of the challenger banks will be driven by their risk appetite for lending. If they apply the same criteria as the 'Big Five’ banks then there is not going to be a significant increase in lending.”

The arrival of the challenger banks is obviously good news on one level because they bring a breath of fresh air into the banking sector. Their superior levels of customer service might even inspire the incumbent banks to raise their game. But cash-starved SMEs hoping for a funding bonanza are likely to be disappointed.

Rachel Bridge is an author, public speaker and journalist specialising in entrepreneurship and SMEs