Poor Competition In Personal and #SME Banking (and What the CMA Plans To Do About It)

The Competition and Markets Authority has been investigating the state of competition for personal and small business bank customers, and the results are pretty shocking. The full report is here, the summary of findings here and the possible remedies are here.

We have until 20 November to comment on the findings and remedies (email retailbanking@cma.gsi.gov.uk). The CMA's provisional decision on remedies is due in February 2016 and the final report in April 2016.

Most glaring is the fact that 99.9% of all UK businesses are small - over 5 million of them - and the vast majority of them are sole traders. Yet small businesses do not benefit from most of the customer protection and other measures aimed at improving services and increasing competition for personal customers.

You would also think banks would do more to look after small businesses, given they are responsible for at least 5 million self-employed roles, and most new jobs come from that sector. But only 60% of SMEs survive beyond three years and only 40% make it past the five year mark. It's true that no job is for life, anymore, but poor financial services must surely be a factor in such high business death rates.

More has to be done to help this sector thrive. Have your say! 

Role of The Entrepreneur

I recently made the point that, instead of looking to the state for our personal wellbeing, the buck stops with each of us personally - whether as voters, taxpayers or whatever - to ensure the wellbeing of others. Some basic, inevitable economic constraints mean the state simply can't do that job for us on any sustainable basis. This is also the difference between an entitlement culture in which we behave as passive victims of our institutions, and an empowerment culture, in which we seize control of those relationships. Ultimately, the state can only serve as a facilitator, enabling each of us to meet our fundamental personal obligation through private enterprise.

But how can we meet those obligations? Which business activities will be the winners of tomorrow? And how can the state help?

Peter Urwin's "Self-employment, Small Firms and Enterprise" very helpfully explains the role of self-employment, with and without employees, as our primary source of "genuine entrepreneurial insight". Big corporations are of little use here. Businesses don't start big. Entrepreneurs start out self-employed, either with or without staff. Yet, picking winning business ideas is impossible: while "entrepreneurship is crucial for economic growth... we have no idea where it will come from - not even in the most general terms." As a result, the best that we - and government - can do is to ensure "a climate in which enterpreneurship can thrive".

Peter lays out some interesting stat's for the UK:

• over half of all new businesses won't exist in 5 years time - yet this is no bad thing: serial entrepreneurship seems to have a greater influence on success than academic qualifications;

• you're more likely to be self-employed if you have dependents under the age of 16;

• about 20% of males who are active in the labour market are self-employed (42% of those aged 65+);

• there is no obvious impediment to being self-employed, and people who struggle for various reasons to fit the big firm mould tend to be self-employed or work for small firms;

• small firms are easy to start, but face impediments to growth through tax and regulation, such as taking on employees - in the UK, only 6% of new firms create over half of all new jobs.

• in particular, "the costs of compliance... are regressive, as there are economies of scale in tax compliance... product market regulation and employment protection legislation". These costs have remained constant despite efforts to eliminate red tape. However, these costs don't prevent people starting up or remaining self-employed with no employees, they inhibit expansion.

It's suggested that there's a distinction between being self-employed for tax planning purposes, and being self-employed for 'genuine' enterpreneurial reason. But if it's impossible to pick who among the self-employed will be successful, then I don't see how you can reliably make this distinction, except with hindsight. Step one to starting your own business is to become self-employed. Perhaps you take that initial step for cynical tax planning reasons, or maybe with a view to figuring out what sort of business you might start. In either case a bigger business could emerge, with lots of employees. Life's what happens to you while you're making plans. The motives are pretty meaningless.

However, Peter rightly points out that there's little room for entrepreneurial activity in large firms - even if self-employed people with the "skills of entrepreneurship" are involved. Those skills essentially being to provide "the central concept around which the firm is initially constituted" and "to unearth the unknown unknowns." I've worked in two start-ups, both of which are still running after 10 and 7 years respectively, and various large firms. Once a bunch of people unite around any business plan it becomes tough to change. Add more years and more people and the job gets harder.

So it's laughable to see big corporate executives and entrepreneurs lumped into the same category, as Luke Johnson recently explained, though the CEOs still at the helm of the companies they created are in a category of their own. This latter group also prove the case for a lack of demand for genuine entrepreneurial skill in big corporations. It's the original vision of the founder that rules, and competing strategic visions aren't welcome. In fact, it's not uncommon for a business to oust its founder only to welcome him back to rescue the ship from doom (e.g. Steve Jobs).

Ultimately, Peter is to be applauded for essentially recommending that small firms should be allowed to retain all their staff as self-employed individuals. This would allow for the rapid expansion of a business around an entrepreneurial concept as it emerges, rather than straining its resources and strangling it in red tape before it has a chance to discover whether the concept will 'fly'. Of course, firms could still choose to offer employment to staff where that is necessary in order to compete in the labour market. But given the healthy, inevitable failure of most small firms within 5 years, and the inability to predict the winners, it seems pointless to require all of them to grind through the cost and admin involved in creating and maintaining the employment relationship.

A Good Year For Innovation In SME Finance

Source: Bank of England

As the headwind for UK banks stiffened today, we have news from MarketInvoice, the UK-based online invoice discounting platform, that it has enabled SMEs to raise £2 million against their invoices since February 2011, with £500,000 raised through the platform in August alone.

"Buyers" of each firm's invoices are institutional investors (such as asset managers and private investment funds) - who we know have plenty of cash in search of a home. They bid against each other on the platform to ensure some competition to provide cheaper funding. The types of deals done to date, and how the process works, are described here. In effect, this puts the traditional invoice discounting, or 'factoring', process online.

Of course, MarketInvoice is not alone in providing small businesses with alternatives to bank finance. Funding Circle, the peer-to-peer platform for small business lending, has also reported healthy interest. And Crowdcube facilitates equity investments.

So far, each of these new entrants has chosen to innovate around a specific funding instrument or process. No doubt other alternative providers, and further innovation, will emerge while the banks remain in complete disarray. Necessity, as they say, is the mother of invention.

Of "Credit Easing" and P2P Finance

Source: Bank of England

The governments proposal to intervene directly in the corporate and small business funding markets shows how grave it is that lending to UK businesses is shrinking.

But it seems crazy for the taxpayer to prop up zombie banks - subsidising tax-free savings rates that allow banks an average margin of 11% - and then to use more public money to shunt aside nascent private competitors. Surely, the result will be a never-ending spiral of financial dependency on the public purse. 

As NESTA recently reported, there are more innovative ways to finance small business. But the current regulatory framework - ironically designed to protect us from the banks - makes it unduly painful in terms of time and money to start true competitors. Which is why the P2P Finance Association was formed to help inform the move to a new regulatory framework and pave the way for new entrants. Without any of the vast subsidies the banks receive, these new platforms will lend more than £100 million this year to individuals and small businesses - and they already account for over 2% of the UK personal loan market.

So why doesn't the government foster the growth and development of alternative means of finance, rather than use public money to put them at risk?

For instance, why not extend the ISA tax-free cash subsidy to lending via peer-to-peer platforms?

A Plan for Small Business Growth?

Hat-tip to @JamesGreenThing for the link to the last Business Insider list of up-and-coming entrepreneurs.

These lists are always much more interesting 6 months on. In this case, the bubble in online coupons is more obvious, as is the fact that the fashion market is getting the Web 2.0 treatment. Yet BankSimple still hasn't launched.

Online invoice discounting has been on my radar since early 2008. So it's heartening that The Receivables Exchange is highly rated in the US, and reassuring that MarketInvoice is gaining traction in the UK. Doubtless there'll be more on that front soon.

Partly for that reason, SecondMarket really caught my eye. It's a market for alternative investments, so incorporates a channel for equity in private companies (e.g. CrowdCube in the UK). But the emphasis on gathering "robust market data" signals a growth in the availability of richer information about private companies. Focus on this is timely, given the massive official paywall around corporate data. Recent commitments to 'Open Government' (follow the Open Knowledge Foundation) are promising. There's already a Government commitment to arm consumers with their own data. Perhaps enabling SMEs to use their own data for their own benefit could be added to The Plan for Growth?

Image from AppAssure.

Anyone For 8% Market Share?

Barclays' withdrawal from the asset-based small business lending market is a real shot in the arm for peer-to-peer finance.

The head of the Barclays Business unit is quoted as saying, “It’s the leasing and hire purchase side [where] we found our proposition was not that compelling, comprehensive and competitive. Our market share was small, about 8pc.”

Those are my gob-smacked italics.

According to the same article, the Finance and Leasing Association "said asset finance represents the majority of debt-financed business, and that its members provided £1.7bn of funding to support business investment in December, 5pc higher than the same month in 2009."

Barclays says it can target this £21bn market segment with unsecured loans. But of course it's talking through its hat. The Basel III head-wind blows strongest in the unsecured lending space. So even if Barclays can magic the £1.7bn asset-based portfolio into unsecured loans, it doesn't seem a great alternative use of capital.

But it's an interesting strategy if you're lending some of your own cash on a peer-to-peer platform, instead of leaving it in a savings account.

Barclays stands to lose out on both fronts.

Image from Gogherty.com.

Swiss Tailwind For Personal & Small Business Social Finance

Banks will find it more costly and less profitable to offer short term unsecured personal and small business finance under Basel III rules, according to a recent McKinsey report.

To comply with the new rules, Banks face a long review of their businesses and products to reduce risk, use capital more efficiently and minimise the need for market funding by the end of 2012.

Which is more great news for participants in the 'capital light' social finance business models, like Zopa and Funding Circle in the UK.

As I mentioned in the context of the proposals to regulate vertical shadow banking functions, people using these 'horizontal intermediaries' benefit from:

1. Loan amounts being split into small one-to-one loans at inception, rather than having to wait for the slicing, re-packaging and grading involved in asset-backed securitisation;
2. A direct, one-to-one legal relationship between borrower and lender for the life of the loan, enabling better control over debt adjustment and collection, where that becomes necesary;
3. Lenders retaining day-to-day control of the management of their money and credit risk, minimising the capital required by the intemediary;
4. The intermediary not needing to slice and re-package debt to alter loan maturities, since lenders can manage this by assigning loans of unwanted duration to other lenders;
5. The intermediary having no balance sheet risk, and therefore no temptation to engage in expensive and complex regulatory, tax or other arbitrage;
6. Transparency in the original underwriting decision and loan performance against grade - making lenders' due diligence easy, and removing the moral hazard of the kind we see in vertical intermediation models, where the endless slicing and re-packaging makes due diligence hard.

For these reasons, one might expect banks to allow their depositors to lend directly to their personal loan and small business customers. But it seems unlikely the banks could feed themselves on the scale of fees their nimble competitors can afford to charge. And they would soon face calls to allow the peer-to-peer approach for mortgages and larger corporate loans - by which time other nimble providers may well beat them to those segments too...

Image from Gogherty.com.

Late Payments Directive And SME Trade Finance

The Late Payments Directive should produce a rush to implement reasonable supply chain finance arrangements for any private or public sector customers who want to try to insist that payment terms exceeding 60 calendar days are not "grossly unfair to the creditor".

That's all very well if the financing package is big enough to interest the usual suspects, but alternative models are needed to finance the early repayment of invoices on a smaller scale, and this bodes well for online social finance platforms.

SME's Shun Bank Finance Offerings

Interesting report today that "less than half SMEs have taken action [to address cashflow pressures] with 11pc hiring an in-house credit controller, 9pc using invoice discounting and 8pc factoring". There are over 4.7 million SMEs in the UK (see demographics below).

According to the Telegraph:

"Peter Ibbetson, chairman of NatWest and RBS small business operations, is concerned that so few SMEs are using banking services to alleviate the problem but small business organisations believe companies are reluctant to incur extra charges after their bank borrowing experiences."

In other words, it appears SMEs would rather leave debt on their books, taking any loss and resulting income tax deduction, than become hog-tied by a bank at rates of about 36%APR in consumer finance terms - at least that's the rate we estimated Zopa lenders would have to beat to offer attractive trade finance. That's because you should factor in (excuse the pun) the charges on any additional accounts you're required to hold as part of the finance deal, the holding cost of any deposit held as a guarantee, as well as fees and the interest rate on any overdraft, loans, letters of credit and/or factoring. SME owners are also increasingly required to take a commercial credit card, which doesn't benefit from protection from all the old dirty tricks that are gradually being weeded out under consumer banking and finance regulation.

Yet more evidence the time is ripe for an alternative source of SME trade finance?

The most recent UK government statistics (published Oct '09) show that, at the start of 2008, there were 4.8 million UK private sector enterprises of which 99.3 per cent had 0 to 49 employees. Only 27,000 (0.6 per cent) had 50 to 249 employees and 6,000 (0.1 per cent) employed 250 people or more.

B2B Lending

Gartner has recently warned banks that consumer peer-to-peer lending platforms are a force to be reckoned with. Any business with a UK consumer credit licence can lend directly to consumers at Zopa, but the timing also looks good for SME's to get into their own peer-to-peer market without the aid of the banks.

A recent survey commissioned by Belgian bank KBC amongst businesses with turnover of £10m to £1bn suggests that UK businesses are continuing to borrow, even at higher rates.

“The people in the real economy, not the financial economy, are saying: ‘We’re still going, but financial fuel is going to get a lot more expensive for us,’” said Cameron Marr, general manager of the London branch of KBC Bank.

At the same time, however, 70 per cent of respondents expect credit to become less easily available. They foresee the cost of borrowing rising and loan covenants becoming tighter. The number of corporate defaults is expected to increase."

Necessity, as they say, is the mother of invention...

Join the Quest for the Source of EU Legislation

This is the Last Straw. I've just seen "micro-enterprise" defined in a document called "2005/0245 (COD) LEX 797" as:

"an enterprise, which at the time of conclusion of the payment service contract, is an enterprise as defined in Article 1 and Article 2(1) and (3) [oh, don't forget 2(3)!!] of the Annex to Recommendation 2003/361/EC".

I'm thinking of launching a Quest to find those responsible for this latest gobbledigook and demand to know in plain English what "micro-enterprise" was intended to mean, without referring me anywhere else.

But where to start?

In 2005, the UK's Better Regulation Commission produced a fascinating, literal "map" of what we might really loosely describe as the 'European Union legislative process'. See especially page 14.

I'm not being sarcastic here. The report is a veritable base camp from which to begin the quest for the source and true meaning of EU legislation. It provides a guide, pack animals, tents, rope, torches and other basic tools. The rest of the specific search is down to good eyesight, a laptop or PC, broadband, physical fitness, strength, caffeine, food, and several towels that can be soaked in ice cold mountain springs and wrapped tightly around one's head. Oh, and a journey to Brussels. With a lobbyist.

Are you in?

It will be very crowded, but ours will be lonely work. Listening amidst the din of countless institutions and committees for the mystical whisper known as the "Social Dialogue". For it is only in that stream of semi-consciousness that we may dare to even hope to find the truth of the coded messages embedded in the "stakeholder input", "advice", "green papers", "proposals", "adoptions of proposals", "opinions", "consultations", "co-decisions", "common positions" and, ultimately the Regulations and Directives that emerge six or seven years later to drive us to distraction.

No?

Yeah, sod it. I'm staying in London to earn a crust.

Predictions for 2008 - Financial Services 2.0

The SCL's annual predictions are among the most visited pages of its web site, and it's time to get them in again. Here's mine, for what it's worth:

"Economic conditions will deteriorate further in the financial services industry. Downward pressure on revenue and the cost of funding, marketing and distributing financial services to consumers and small businesses will force institutions to compete on innovation and service quality. But not being organised to provide either, these incumbents will fail to resist the entry of facilitators that have built trust and loyalty by empowering consumers to get the product that is right for them personally in other retail markets. Banks will be the back office service providers, not the front, for Financial Services 2.0."

Stephen Green, Chairman of HSBC, seemed to acknowledge yesterday that this ball is already rolling.

Should be fun... apart from the bit about deteriorating economic conditions.

Online, business is personal

References to “business” (and "SME's") are actually references to individual people, so business is highly personalised.

Taking the UK as an example, in 2005 the Small Business Service found there were 4.3 million businesses in the UK, 3.2 million (74%) of which were owner operated, employed no staff and generated an estimated annual turnover of about £190 billion. Only 6000 UK businesses, or 0.1%, had more than 250 employees.

By March 2006, Ofcom reported that 15.36 million UK households (60%) had Internet access; over 11 m UK homes and small businesses had broadband; 40% of adults, and 70% of 16-24 yr olds, with internet access had used social networking sites (defined as any site that enables entry of personal online profiles).

Government statistics put the UK’s population was estimated at 60.2 million people in mid-2005, approximately 80% of whom were over the age of 16.