By Emma Lovel, CEO of the Lending Standards Board
The pandemic has cemented the massive shift from traditional finance to alternative finance in the UK. A pandemic-induced cash flow crisis among corporations and the rise of fintech and challenger banks are driving the rise of alternative lending models – the market is now worth £6.26 billion.
Alternative loans – financing that makes it possible to provide funds to companies and individuals without having to go through a “traditional” bank – create opportunities, but with that, new risks. It has the potential to diversify funding, broaden economic inclusion and increase competition. Yet the current lack of regulation and universal standards in the alternative lending market creates potential challenges in ensuring successful outcomes for clients.
The voluntary standards of good practice provide the framework allowing alternative lenders to control the risks not taken into account by the legislation while taking advantage of the opportunities. Here, we look at three alternative lending trends that are gaining momentum, along with considerations on how their respective risks can be mitigated.
Are non-bank lenders up to the challenge of SMEs?
The digitization and democratization of finance has accelerated, with digital-native alternative lenders adapting their consumer products to the needs of SMEs.
It comes at a time when a quarter of UK SMEs say they are in the middle of a cash crisisthree quarters are unable to access traditional finance, and 50,000 businesses go insolvent each year due to cash flow problems. Onboarding commercial clients in difficult circumstances requires alternative lenders to have appropriate governance structures and processes in place to support turnaround opportunities.
Reviving businesses and reducing the risk of default depends in part on the ability of lenders to direct struggling SMEs to turnaround professionals before it is too late. Without proper governance, oversight and training, at-risk customers could go unnoticed or be reported inappropriately, increasing risk to the lender and business customers.
Alternative lenders should have a global role assurance and oversight framework, integrating a set of processes based on professional turnaround expertise to foster consistent best practices in rescuing distressed businesses.
Buy now, pay later and the question of vulnerable customers
Buy Now Pay Later (BNPL) is another alternative lending model that is enjoying a resurgence in popularity due to the pandemic and the associated e-commerce boom. The seller gets instant payment, increased cart value, higher conversion rates and more traffic; while the consumer gets more affordable solutions that increase their purchasing power.
However, with no way to know the level of borrowing under this type of product or affordability assessments, BNPL presents the risk that vulnerable clients will overcommit, experience financial hardship or worsen an existing problem.
Part of the problem is that warning signs in vulnerable customers may be hidden in seemingly innocuous consumer behavior, such as the use of BNPL for essential spending in supermarkets.
In the absence of regulation in this space, companies should consider working toward best practice standards that can help identify red flags in customer data. This could inform smart, data-driven customer service that anticipates, identifies and responds to financial hardship through preventative measures such as financial education and reactive measures such as payment plans or reporting to third parties for a specialized assistance.
Embedded finance and customer journey
The concept of integrated finance is also transforming the UK lending landscape.
This model gives businesses the ability to offer their customers a unique suite of financial products and services without the need for a banking license. Amid growing consumer appetite for instant, integrated finance, companies will need to work to similar timelines with their products. This is where monitoring the digital customer journey to ensure the right results don’t waver will be critical.
Without having methods in place to track the entire customer journey, such as customer journey reviews, how will these companies know how their customers are being treated and how will they identify steps to take to mitigate risk?
By identifying areas where journey policy, process, design, or delivery is not adequate, companies can better understand areas for improvement across a variety of channels – and thus achieve good results for customers.
Recent research reveals that 45% of SMEs with plans for growth over the next 12 months are concerned about the use of alternative finance providers, partly out of fear of a lack of regulation. There are growing calls for the FCA’s mandate to be broadened to encompass the alternative lending market.
All lenders should consider working towards best practice frameworks to keep pace with the latest trends and ensure the best outcome for their customers and should continue to be adopted alongside legal regulation, to raise the bar of basic standards.
Developing standards in this space would also encourage and inform collaboration through the sharing of knowledge, expertise and ideas between regulators, traditional and challenger banks, and alternative lenders. This would drive industry-wide progress while supporting better customer outcomes and building trust between customers and businesses, ensuring alternative finance delivers on its promise of democratizing finance for all.