Business lenders need greater regulation and transparency for SMEs to thrive
The number of business lenders in the UK have exploded since 2008, but business lenders are not regulated and there is a lack of transparency about their offers, says Jennifer Tankard, Chief Executive, Responsible Finance.
There are reasons to be cheerful about the UK’s small business sector. Small business confidence has hit a one year high, despite slow economic growth in quarter 1 of 2018 and small business profits are also up, according to the latest FSB Voice of Small Business Index. This is in spite of the fact that access to finance remains a challenge. The Index reports that the proportion of small businesses successful in their credit applications was down.
The issue of access to finance for small businesses remains a perennial problem. Is it that small businesses are reluctant to borrow, given current economic turbulence? That some may lack ambition to grow beyond their current size and market? Or is there insufficient supply of appropriate products on affordable terms?
One thing that we cannot dispute is the growing number of organisations providing small business finance and the range of products on offer. The number of business lenders in the UK have exploded since 2008, many of which are highly innovative and specialise in specific types of financing, such as working capital, asset finance, invoice finance, trade finance, property finance and merchant finance. Trying to navigate through this choice to reach the right product on the right terms is time consuming and difficult for business owners who are more likely to be run by creative entrepreneurs rather than finance experts.
Too much choice is not often seen as a problem in a capitalist economy. But business lenders are not regulated and there is a lack of transparency about their offers. This means that businesses may end up with finance products that they don’t understand, are more expensive than they thought and have conditions attached which may turn a minor cash flow problem into a full scale viability crisis.
Businesses don’t develop sophisticated in-house finance functions until they are into million pound turnovers. For the vast majority of SMEs and micro-enterprises it’s the owner and directors dealing with funding, not a qualified finance director. This means the people reviewing and agreeing loans are actually consumers not finance professionals. But these consumers are offered no protection at all.
Lending to SMEs often requires personal guarantees so the business owner is personally liable as much as they are with a consumer loan. Because of this, inappropriate lending to small businesses can prove catastrophic. Not only can it result in the loss of a business and jobs but the consumer (director or owner) is personally liable and affected too. In extreme cases business loss can also result in the loss of the family home, marital breakdown and suicide.
Because the market is unregulated, lenders do not have to show the cost of borrowing in any particular way, such as a clear up front statement of the APR and additional fees. This means the borrower is unable to determine the total cost of the loan and compare it with alternatives.
Lenders do not have to undertake an assessment of affordability resulting in small business owners, many of whom are optimists, taking on more finance than they can manage and afford to repay.
And there is no transparency of when fees and charges will apply. For example, one alternative business lender has charged 15% of monthly repayments as a “missed payment fee” and others charge “default interest rates” of 300%. Clearly there is no shared understanding of what is reasonable when businesses do run into difficulties.
So how do we maintain a competitive business lending sector while ensuring small businesses, critical players in economic growth, job creation and employment, get the finance they need? We believe that all business lenders should undertake proper affordability checks around income and expenditure, based on both the strength of the business and the circumstances of the owner / director, if the lender is seeking personal guarantees.
Lenders should clearly display the cost of credit by reporting the total cost of borrowing on representative examples of APR, charges on arrears and missed payments in a prescribed manner that allows borrowers to more easily compare across lenders. Loan contracts and information explaining the detail of these should mirror consumer lending contracts. And small business owners / directors should get similar support to consumers in building financial capability skills as they have similar needs.
The responsible finance business lending sector knows that it is feasible for business lenders to introduce these steps, because responsible finance providers already do so. We believe these measures are the key to business success and sustainability as well as to local economic growth, which in many parts of the UK is dependent on the stability of the small business community.
Creating a level playing field for business lending with more transparency and a focus on supporting borrower choice rather than maximising the number of lenders in the sector is good for productivity and good for the economy. It is now time for the business tail to start wagging the finance dog.
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