Alternative funding needed as SMEs struggle to access bank loans

SMEs often struggle to obtain bank loans as they often have fewer assets to offer as security for lending and cannot demonstrate their creditworthiness for loans through past performance because of their limited trading history.

This issue is bound to exacerbate the problems many small businesses will face in light of the current COVID-19 pandemic. 

Figures from the Scottish Government estimate that SMEs account for 99.3% of all private sector firms in Scotland and, with 1.2 million workers, provide well over half of all jobs in the private sector.

Against this worrying backdrop, alternative models of sustainable lending are needed to provide better access to external funding for SMEs in Scotland.

One such financing model, which would act as a solution to the problem,s is crowdfunding. 

Unlike banks, which receive money from depositors and lend that to consumers and businesses, the operators of crowdfunding platforms do not take deposits or lend themselves. They act as brokers or intermediaries, generating income from the fees and commission they charge the borrowers and lenders using their platform, The Scotsman reports. 

In the beginning, crowdfunding platforms were focused on enabling retail investors to connect directly with borrowers but, more recently, financial institutions have started using them to invest in bundles of loans.

This latest development goes by the moniker “marketplace lending”. There are also equity-based crowdfunding platforms that match investors to firms wishing to raise finance by issuing shares, rather than by borrowing money as a loan.

The first crowdfunding platform was launched in the UK in 2005 and, in the early years, there was very little regulatory protection for consumers and businesses using them.

From the perspective of investors making loans, unlike deposits at a bank, loans made through a crowdfunding platform are not protected by the Financial Services Compensation Scheme (FSCS).

Some crowdfunding platforms offer a contingency fund that can make discretionary payments to investors if a borrower defaults in repaying their loan, but the recent failure of some high-profile platform operators highlights that the protection afforded by such funds should not be equated with that overseen by the FSCS.

In December 2019, plans were unveiled for Europe-wide rules to provide a robust supervisory framework encouraging more confidence in crowdfunding platforms. Whether the UK will align itself to these post Brexit remains to be seen.

Crowdfunding still marks only a small segment of the market in Scotland in terms of lending when compared with the volume of bank lending across the country. However, a report released by the Financial Stability Board earlier this year, found that the lending method is rapidly growing.

As collaboration between financial institutions and crowdfunding platforms accelerates through marketplace lending, it is hoped that the swift growth in crowdfunding will help unlock the potential of Scotland’s underfunded SMEs.

Read all of our articles relating to COVID-19 here.