Bank referral scheme deserves a cautious welcome

From this week, banks are obliged to refer rejected loan applications to alternative lenders. Is it good news for businesses?

The long-awaited bank referral scheme has been widely welcomed this week for opening up a new route to finance for small businesses and encouraging the take up of alternative finance options.

However, despite its good intentions, some advisers are concerned that the scheme could lead to an advice gap for businesses and may increase their exposure to risk.

What is the bank referral scheme?

Launched on Tuesday 1 November, the bank referral scheme was first proposed by chancellor George Osborne in August 2014 as a means of supporting small businesses that have had an application for a corporate loan rejected by their bank.

Under the proposed scheme, the rejected applications will be forwarded to an online portal where alternative finance providers will be able to extend offers of finance based on certain criteria.

The Scheme is potentially helpful on a number of levels. The British Business Bank has estimated that about 100,000 small businesses in the UK are turned down for a loan by one of the leading banks every year.

Once turned down, these businesses rarely consider approaching an alternative lender either because they are unsure how to go about this or because it can be confusing to compare the different types of finance on offer.

Commenting on the launch of the scheme, chancellor Philip Hammond referred to small businesses as the ‘backbone of the British economy’, adding that they should have access to a ‘wide range sources of finance’.


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Three platforms currently feature on HM Treasury’s approved list – Funding Options, Funding Xchange and Business Finance Compared – and more may be added in the future.

Is there risk involved?

In theory, the idea of matching small businesses with alternative finance providers is a good one and should help to increase take-up of more flexible finance option such as invoice finance and peer-to-peer lending. However, there are potential risks attached, which require close consideration.

For example, will steps be taken to ensure that providers invited onto the portal are not going to exploit businesses by providing unfavourable repayment terms or making unfair demands by way of collateral? How will the businesses know if the terms of the finance on offer are competitive or not?

It is unlikely that the portal itself could provide such assurances and businesses may not realise they would be using the scheme at their own risk.

Furthermore, the proposed data-driven lending model will not be able to give small businesses access to the rounded, impartial business advice that many rely on to realise their potential.

Tech-led businesses in particular often start life with a low headcount and have restricted access to management know-how. Selecting the right funding partner and professional adviser to deliver market insights and non-exec-style support is often vital to their future success.

Potential problems for fast growth businesses

Passing these fast-developing businesses from a traditional lender to an alternative lender could be selling them short. For example, consider the scenario that a growing business is experiencing cash-flow difficulties and needs a loan to pay wages or meet the cost of other overheads.

Without professional advice, how does the business know whether this is the right course of action or whether other more drastic intervention is needed to set the business on a more sustainable trajectory? And if the business is heading for insolvency, putting off seeking advice could leave it in a much worse financial position when administrators are eventually appointed.

Instead of pushing small businesses in the direction of alternative lenders without an advisory safety net, government should focus on encouraging them to seek advice from professional advisors who can impartially discuss alternative finance options.

With the Autumn Statement fast-approaching, there is also an opportunity for government to deliver more fiscal incentives to support this vital sector of the economy.

What next?

As the bank referral scheme gets underway, it will be interesting to see how effective it is in helping businesses source the finance they need. If businesses are regarded as too risky for traditional lenders, it cannot be guaranteed that alternative lenders will think differently.

In the meantime, small businesses should use the scheme with caution and make sure that any funding decisions they take are based on well-considered strategic goals that are rooted in robust financial information.

Simon Underwood is a partner in the advisory team at accountancy firm, Menzies LLP.

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