Christoph Rieche, co-founder and chief executive of iwoca
The latest independent report into small and medium-sized enterprises (SME) finance conducted by BDRC for the big UK banks, HM Treasury and small business federations was published on Thursday.
It found that almost half of UK SMEs can now be classed as permanent non-borrowers. Demand for finance remains muted. In 2017, just 5% of SMEs reported having applied for new or renewed loan or overdraft facilities. And although this is half the level seen in 2012 (11%), the report classes most SMEs as happy non-seekers of external finance.
Tell that to iwoca.
Since founding in 2012, iwoca, the specialist provider of working capital to small and micro businesses, has grown fast in its core markets of the UK, Germany and Poland.
The company has developed credit underwriting algorithms that draw data on small businesses’ underlying cash flows from merchant platforms among other sources.
It makes decisions on whether to extend short-term loans – ranging from £1,000 to £150,000, charging interest only on drawn amounts, with no early repayment fees, and typically used by businesses with fewer than 10 employees to fund stock purchases and working capital – in hours, rather than after weeks of form filling required by banks.
Having established a lending capacity of £150 million after a $20 million series B funding round backed by CommerzVentures among others in 2015, iwoca had provided more than £350 million to 15,000 different companies through 45,000 separate transactions by the end of last year.
“We have been growing in triple-digit percentage points year on year,” Christoph Rieche, co-founder and chief executive of iwoca, tells Euromoney. And that growth looks set to continue. “When we update our numbers for the first quarter of 2018 that total lending figure will have risen sharply again,” he says.
He adds that the firm, which last raised capital in the summer of 2017 from, among others, Neva Finventures, the venture capital arm of Intesa Sanpaolo, might soon look to boost its lending capacity once again with new equity than it can then leverage up.
“We have grown faster than we expected over the last six months,” says Rieche. “Our credit underwriting process has grown more precise in its analysis of the riskiness of new and small businesses as we have gathered more data from customer transactions and grown better at understanding cash flow.
“And we are now very excited by what we can achieve through open banking. If customers give us consent to access their bank payments, rather than them having to download and send on months’ worth of bank statements, we could soon be in a state of almost continuous underwriting and be ready to finance opportunistic stock purchases and the like even quicker.”
He adds: “We already operate at break-even, but to maintain current growth rates we are likely to raise more equity.”
Iwoca is not yet a big beast in small business lending, but it is eager to do more and it needs feeding.
This is all intriguing, because it suggests a ravenous unfilled demand among small business for credit that is not evident in bank lending surveys.
These paint a rosy picture of high levels of approvals for loans and overdrafts to SMEs, but subdued credit demand.
So, for example, UK Finance compiled data for the final quarter of 2017 suggesting that banks approved eight in 10 small business loan and overdraft applications and nine out of 10 from medium-sized businesses. Yet SME loan volume was 11% down compared with a year earlier. This seems to suggest a reduced appetite to borrow.
We are rather surprised to find that, even after various government initiatives, rather than closing, the funding gap for small businesses has actually been widening for the past three years- Christoph Rieche, iwoca
It’s odd though that bank lending surveys show an increase in lending to retail customers and to large corporate customers, with only small businesses deciding to just make do from internal cash resources.
Is something else going on?
Drilling down into the UK Finance numbers reveals some worrying details. For example, in the north of England SME loans and overdrafts fell 14.3%.
Yet iwoca doesn’t see reduced appetite for credit in that region: quite the opposite. It has pledged to make £100 million available to micro and small businesses in the north of England from now to 2020, even while the banks seem to be in a long but quiet retreat.
“We are rather surprised to find that, even after various government initiatives, rather than closing, the funding gap for small businesses has actually been widening for the past three years,” Rieche says.
“The problem for small companies is worse than is widely realized. In part that may be because reporting of loan approval rates fails to capture the large numbers of small businesses that enquire in branch or online about credit, but never formally apply because they believe they will be rejected whether for lack of collateral or historic financials, or that are simply discouraged by the drawn-out and burdensome application process.”
The British Business Bank reported in February that SME loan application rates showed a continuing decline last year, with just 1.7% of smaller businesses seeking new loans, the lowest figure since it began monitoring this data in 2011.
In addition, there has been a decline in SMEs confidence that they will get a loan when they apply, down to 43% in the three months to November 2017, compared to 58% in the previous three months.
The worry is that banks’ general unwillingness to lend to small businesses is being hidden behind high approvals for a select few.
There is a danger in reduced growth and investment in productivity in a key segment: small businesses account for one in three private-sector jobs and 20% of GDP. Of course, banks must be wary of selling inappropriate credit that these small companies cannot service.
However, if the financial system as a whole cannot make funding available for small business owners to improve and grow their companies, then that starts to look like systemic failure.
Justin Protts, economist at independent think-tank Civitas, sees a state-owned investment bank as one way to close the funding gap for small businesses.
|Business lending by UK banks is in long-term decline|
Distribution of net lending by sector
|Source: Civitas – calculated from Bank of England data|
|Business loans are a smaller percentage of UK bank balance sheets than their|
Loan types as a proportion of 2016 banking assets
|Source: Civitas – calculated from ECB MFI Balance Sheets Online 2017|
“There is no doubt that low investment, particularly in enterprise, is a cause of the UK’s current economic woes and a significant part of that problem is the failure of the banks to lend to SMEs, which make up 99% of businesses in the UK.
“The experiences of institutions elsewhere, particularly of Germany’s KfW and the US’s Small Business Administration, show that government-owned investment institutions can play an important role in providing the sort of business investment the UK is lacking and at no ongoing cost to the taxpayer.”
However, the worry extends beyond lack of patient capital supporting long-term investment by small businesses. Managing working capital just to keep the lights on is difficult for a quarter of such business due to continuing late payment by bigger corporate customers. That is the finding of recent research by Close Brothers.
David Thomson, chief executive of Close Brothers Invoice Finance, says: “Our research suggests that despite a series of efforts to combat the matter led by government and other organizations, too many SMEs still aren’t being paid on time.
“This is an issue causing real hardship for many firms and has negative implications for the performance of the economy as a whole.”
Iwoca’s Rieche is hopeful that the government might take other steps to encourage non-bank lenders to fill the gap.
In September, with RBS unable to divest Williams & Glyn in accordance with undertakings after its government bailout, it agreed with the UK government and received EU approval for a package of alternative remedies to encourage competition in SME lending. This includes a more than £400 million capability and innovation fund and more than £300 million in account switching incentives to new lenders taking on customers moving away from RBS.
“That £700 million package seems to be geared to the number six, seven, eight, nine and 10 bank lenders,” says Rieche. “But they are no better equipped to serve small and micro businesses than the big five high-street banks.
“And non-bank lenders only have the chance to apply for a total of £65 million of grants from the capability and innovation fund.”
He suggests it might be better to make more resources available to alternative providers of credit that are actually focused on serving small and micro businesses.
For a company part-owned by the venture capital arms of two large European banks, it once seemed logical to assume that iwoca, as a technology company with a new approach to credit underwriting but few customers of its own, might distribute its product through banks with plenty of customers but poor ability to serve them.
It has not turned out like this.
“We’d be absolutely delighted to service small business credit underwriting for banks on a white-label basis,” says Rieche. “It would be a win-win. But integration with any bank is much harder than you might first think. It has to be fully in the core of their systems and the bank must then work to extend it to their own customers.”
For now, he says: “You can either build a software as a service business or a lending business. I am not sure you can do both. We are building a lending business. Let’s see how that question looks when we have reached a million customers.”
The one partner into which iwoca has fully integrated its credit API is Tide, a start-up digital business bank set up last year that provides current accounts to small businesses.
Rieche says: “We launched at the very end of last year and we were delighted by the high level of interest shown by Tide customers that had an appetite for credit. We will wait to see if the take-up is equally as impressive.”
If established banks are reluctant or incapable of integrating iwoca’s offering, they might foster a serious competitor. Having focused on provision of flexible working capital and overdrafts to begin with – facilities that don’t suit banks – an obvious next step for iwoca will be to extend term loans, which are banks’ bread and butter.