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Spot early signs of business distress with Open Banking

The Financial Conduct Authority (FCA) is pushing lenders towards higher levels of SME lending. For some, this could feel like a push closer to the edge. Beyond that lies uncertainty. In 2020, then interim-CEO Christopher Woolard stated that one of the FCA’s objectives was to “ensure that there is not a repeat of the well documented historic issues in the treatment of SMEs.

But asking for more significant SME lending volumes is asking lenders to expose themselves to inherently more risk. SMEs experience high rates of failure in their early years and are more likely to have limited financial records to judge affordability securely.

Services that utilise Open Banking can give lenders the up-to-date insights they need to lend to more SMEs with confidence.

Why SME lending is a challenge for lenders

Serving the SME market fairly and affordably carries several challenges:

  1. Inherently unstable: Historically, small businesses are risky lending prospects. Around one-fifth of small businesses go bust in their first year. That figure rises to 60% over the first three years.

  2. Tough times: Instability is intensified in a turbulent financial environment. The double-whammy of Brexit and COVID-19 may mean that some SMEs which were financially secure 18 months ago are now in dire straits.

  3. Already overburdened: SMEs supported by the Bounce Back Loan Scheme (BBLS) in the first lockdown are now making repayments. Now, lenders must get the most up-to-date view of affordability to understand their capacity for further credit.

Why do SME affordability checks need to change?

Lenders must look to new technologies to meet the FCA’s expectations and extend more lending opportunities to SMEs without taking on a greater degree of risk. Traditional models have two distinct shortcomings for serving an SME audience:

  • Lacking up-to-date information

In a turbulent economic environment, the winds can change fast for fledgling businesses. The traditional approach, judging affordability from information in company accounts, could mean using data up to 20 months out of date.

Lenders need a comprehensive snapshot of income and expenditure at the time of application to get the most up-to-date information for judging viability.

  • No red flags for incoming defaults

Another problem for lenders is not getting a heads-up when things are trending in the wrong direction. Typically, lenders will only learn of defaults after a business has fallen behind, limiting their recovery options and potentially leading to a cascade of non-payments.

Lenders need access to new metrics for judging credit risk and affordability that offer early warning signs for businesses going bad.

Experian’s Commercial Acumen can help

Commercial Acumen is a new Open Banking service from Experian designed to help lenders quickly understand SME credit risk and spot signs of distress early. The FCA's push for increased lending to SMEs should not leave lenders feeling cornered. There is an opportunity to support more UK small businesses in a stable and sustainable way, through the power of Commercial Acumen.

Click here to read the full article by Experian.

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