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Information friction in finance is threatening the spirit of entrepreneurialism

Access to finance is consistently highlighted as a serious concern for small to medium businesses (SMEs), which is worrying considering they are the lifeblood of our economy. Their contribution to the British economy is set to exceed £241bn by 2025, up 19 per cent from last year’s figure of £202bn according to research from the Hampshire Trust Bank and the Centre for Economics and Business Research.

Many may argue that the recent Bank of England base rate hike will force some businesses under has been long overdue in tackling the issue of ‘zombie companies’, however, this is a classic case of throwing the baby out with the bath water.

The big picture we should really be concerned about is snuffing out businesses with high potential. Providing cash flow to these businesses is necessary to safeguard a fragile economy, particularly in such uncertain times. 

Rate hikes typically result in an increase in lending profitability and so stimulates the appetite to lend. An increased appetite to lend doesn’t follow an increased ability to price risks on all loan applicants, and herein lays the risk: lenders become creative with the ways in which they entice borrowers and mitigate their risks. Alarmingly we have already seen these enticing models on the market - in the form of “payday-style business loans”.

These loans from mainstream lenders look and feel like the payday loans that flooded the market in the height of the recession. They take minutes to apply for, turnaround within one day and command interest rates of up to 23 per cent APR – five times more than some personal loans. Most crucially, however, they require a directors’ personal guarantee, forcing entrepreneurs to risk their own personal finances for their business.

The existence and potential proliferation of this model threatens the spirit of entrepreneurialism and the concession of limited liability, on which many successful businesses around the world are founded upon. British entrepreneurism cannot be allowed to erode due to lack of funding, and to stifle innovation through inequitable lending terms.

It would be unfair to point the finger of blame at mainstream lenders, as in reality, it is not their fault; rather this is a problem caused by information friction. There is not enough information about the companies applying for their loan, to make a proper assessment and to price lending risk effectively.

Open, frictionless information is key to ensuring the future of our SMEs. More data means banks and alternative lenders can reimagine financing models and lend to support the business forming the backbone of the economy.

Although there is a lot of data already out there such as financial statements, ownership information, directorship information and corporate group structures, the inclusion of Open Banking data will be key. Open Banking (an initiative led by the CMA to stimulate competition in banking through the opening up of APIs containing information such as account and transactional data) allows lenders to extract previously unavailable insights and an up-to-date, holistic overview of a company’s financial health. This adds the much-needed context to enable better, faster, more confident and crucially fairer lending decisions.

At these times of uncertainty, an open information economy can bring together businesses and lenders through the common language of data, safeguarding the spirit of entrepreneurs and giving them the break they need to prosper. 

 

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