Beat the banks with alternative finance

The government should focus on alternative forms of finance, outside the conventional banking system.

This is according to a new report from the Federation of Small Businesses (FSB), which is calling on the coalition to look to continental Europe for new ways of ensuring that SMEs get the funding they need.

The FSB’s report focuses on the potential benefits of alternative finance, such as so-called peer-to-peer lending. But what are these alternatives, and how can your business benefit?

What has the FSB said?

In response to the banks’ continued failure to extend credit to small businesses, the FSB is encouraging the government to focus more strongly on alternative sources of finance. It says that businesses in Germany and the United States have been better able to get the credit they need, because there is a broader diversity of funding sources in these countries.

The business group has called on the government, businesses, and financial institutions to consider different ways to ensure that businesses get the money they need – without relying entirely on the ailing banking system.

What's wrong with bank lending?

The bank has long been the first port of call for businesses in need of finance. But events since 2008 have led many to suggest that the days of the bank manager’s pre-eminence will soon be over.

Perhaps the primary problem with bank lending is that there simply isn’t enough of it. Businesses of every size are finding that it is no longer possible to secure credit with the big financial institutions. The majority of first-time overdraft applications are now rejected. Other firms are finding their credit lines cut with little or no warning.

Bank lending is also expensive. Base rates remain at historic lows – but the cost of borrowing on the High Street keeps on rising. The terms on which businesses can secure credit are becoming gradually less favourable.

What are the alternatives?

Although the bank remains the most popular source of funding for most businesses, it is not the only option on the table.

The FSB has singled out so-called peer-to-peer lending as a potential growth alternative. This new type of finance has enjoyed a rise to popularity in the last two years – thanks in part to the continued paucity of bank lending.

Peer-to-peer (or P2P) lending is intended to work without the need for an intermediary financial institution like a bank. Instead, ‘peers’ transact directly. In practice, this tends to involve online marketplaces through which lenders and borrowers can find each other. Loans made under these systems will generally consist of several chunks of cash, each from a different lender. The model is becoming increasingly popular in the consumer sector thanks to Zopa, but firms like CrowdCube are bringing P2P to businesses.

P2P lending has three major advantages: you don’t have to deal with a bank, the loans tend to be cheaper, and your creditors tend to be more sympathetic. For many, the idea of P2P is to foster better links between borrowers and creditors – thereby creating more sustainable, more mutually beneficial long-term arrangements.

The FSB has called on the government to throw its weight behind P2P lending, and there are indications that there may be some support for the burgeoning new area in the Budget.

In the meantime, if you are considering making use of P2P lending you should ensure that you seek independent advice.

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