State of Small Business Lending: US and UK

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1 State of Small Business Lending: US and UK Karen Gordon Mills Senior Fellow, Harvard Business School & Harvard Kennedy School Former Administrator of the U.S. Small Business Administration and Member of President Barack Obama s Cabinet OOCTOBER 2015

School Former Administrator of the U.S. Small Business

2 WHY WORRY ABOUT ACCESS TO CREDIT FOR SMALL BUSINESSES? DRAFT US: small firms produce half of private jobs, two-thirds of net job creation UK: small firms account for half of private jobs, 65% of net job creation US Small Businesses UK Small Businesses ~28 Million ~5.2 Million Sole Proprietors (~22M) Employers* (5.7M) Sole Proprietors (~3.3M) Employers (~1.9M) High Growth (~200K) Supply Chain (~1M) Main Street (~4M) Note: Remaining 500,000 business are Non-Supplier Businesses in the Traded Sector P 2

private jobs, 65% of net job creation US Small Businesses UK Small Businesses ~28 Million ~5.

3 US: SMALL FIRMS HIT HARDEST IN CRISIS -- 60% OF JOB LOSSES Quarterly Net Job Change by Firm Size ( 000) DRAFT Small (<500 Employees) Medium ( Employees) Large (1000+ Employees) Source: Bureau of Labor Statistics, Business Dynamics Statistics (latest as of 4Q14). Chart shows the change in the number of charges by firm size, specifically small businesses (firms with fewer than 500 employees) and large businesses (firms with more than 500 employees). P 3

Employees) Source: Bureau of Labor Statistics, Business Dynamics Statistics (latest as of 4Q14).

4 UK: JOB CREATION AT SMALL FIRMS ALSO HIT HARD DURING CRISIS 10% Percentage of Small Businesses Reporting Net Change in Employment, Last 3 Months 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 Source: Federation of Small Businesses (October 2015) P 4

6% 4% 2% 0% -2% -4% -6% -8% -10% 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13

5 WORKED FOR PRESIDENT OBAMA AS HEAD OF SMALL BUSINESS ADMINISTRATION ( ) DRAFT P 5

6 RECORD SBA LOANS HAVE HELPED, BUT LIMITED MARKET REACH DRAFT SBA represents <10% of market, limiting broader market impact $35 SBA lending up two-thirds from the crisis, bringing back 1,000 lenders, helped by new legislation and an agency-wide initiative to cut paperwork $30 Loan Volume ($ billions) $25 $20 $25.0 $22.0 $30.5 $30.3 $30.1 $15 $18.0 FY08 FY09 FY10 FY11 FY12 FY13 Source: Small Business Administration. 7(a) and 504 loan volume since Fiscal Year As of May P 6

agency-wide initiative to cut paperwork $30 Loan Volume ($ billions) $25 $20 $25.0 $22.0 $30.5 $30.3 $30.1 $15 $18.

7 US: CREDIT FROZE DURING CRISIS, SLOW TO RECOVER FOR SMALL FIRMS 80% 70% Percentage of Bankers Reporting Net Tightening or Loosening of Loan Conditions Net Tightening 60% 50% 40% 30% 20% 10% Net Loosening 0% -10% -20% Tightening Standards (Large Businesses) Tightening Standards (Small Businesses) Source: Federal Reserve, Senior Loan Officer Survey as of July P 7

-10% -20% 2007 2008 2009 2010 2011 2012 2013 2014 2015 Tightening Standards (Large Businesses)

8 US: BANK LOANS TO SMALL BUSINESSES FELL DRAMATICALLY 800 Loans fell 18% during and after crisis, only recently began growing again Small Business Loan Assets on Balance Sheets ($ Billions) Source: Federal Deposit Insurance Corporation, Call Report Data. As of January 2015 P 8

Sheets ($ Billions) 700 600 500 400 300 200 100 0 02 03 04 05 06 07 08 09 10 11 12 13

9 UK: BANK LENDING TO SMALL FIRMS FROZE IN CRISIS, YET TO RECOVER 20 Percentage Changes in Small Business Lending on a Year Earlier Mar 08 Jun 08 Sep 08 Dec 08 Mar 09 Jun 09 Sep 09 Dec 09 Mar 10 Jun 10 Sep 10 Dec 10 Source BIS: Monthly BIS survey and Bank calculations. Lending by four UK lenders to enterprises with annual bank account debit turnover less than 25 million. Survey ended December Source BOE: Lending by UK monetary financial institutions to UK SMEs with annual debit account turnover on the main business account less than 25 million. Data is through February BBA Source: Lending by a BBA panel of lenders to SMEs in Great Britain. SMEs are defined as businesses with turnover up to 25 million. Data is through December 2013 Mar 11 Business, Innovation & Skills Dept Bank of England British Bankers' Assoc Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13 P 9

Survey ended December 2012. Source BOE: Lending by UK monetary financial institutions to UK SMEs with annual debit account turnover on the main business account less than 25 million.

10 US: STRUCTURAL PROBLEMS ALSO PLAGUE LOAN MARKET Small banks supply about 40% of SME loans, but being consolidated Number of Community Banks (Left Axis) vs. Average Bank Assets (Right Axis) 16 2,000 Number of Community Banks ,800 1,600 1,400 1,200 1, Average Bank Assets ($ billions) Number of Community Banks Average Bank Assets 0 Source: Federal Deposit Insurance Corporation, Call Report Data. As of January * Per reports from the FDIC Acting Chairman Martin Gruenberg and a December 2012 survey of small business finances conducted by the Federal Reserve Bank of Atlanta P 10

($ billions) 0 1985 1990 1995 2000 2005 2010 Number of Community Banks Average Bank Assets 0 Source: Federal Deposit Insurance Corporation, Call Report Data.

11 UK: LENDING TO SMALL FIRMS REMAINS HIGHLY CONCENTRATED DRAFT About 90% of small firm loans are provided by largest banks in UK Volume Shares of Small Business Loans in England and Wales, 1999 vs Others 4% Santander 11% Lloyds 23% Santander 4% Others 7% Lloyds 26% HSBC 11% HSBC 18% Barclays 22% RBS 29% Barclays 19% RBS 26% Source: 1999 figures from CC, 2013 figures from Charterhouse release Q Percentages may not sum to 100 because of rounding. P 11

2013 Others 4% Santander 11% Lloyds 23% Santander 4% Others 7% Lloyds 26% HSBC 11% HSBC 18% Barclays 22% RBS 29%

12 US AND UK ONLINE LENDING GROWING RAPIDLY Lending to Small Businesses, 2014 vs Estimates, Billions Online lending estimated to be 16% of issuance by 2020 vs. 3% today US Marketplace $47bn % 20 annual 15 growth +55% 10 annual growth 5 UK Marketplace 9bn E E Source: Company data, Morgan Stanley research estimates. P

13 US: THREE INITIAL MODELS DEVELOPED BUT LINES ARE NOW BLURRING Institutional-Driven P2P Marketplaces Institutional marketplaces, sometimes referred to as peer to peer lenders, were initially consumer-focused. Now, greater emphasis on small businesses. Borrower-Driven Broker Marketplaces Connect small business borrowers to a series of lenders that are part of their online marketplaces; most work with conventional lenders like big and small banks, SBA lenders as well as alternative lenders. Balance Sheet Lenders Use balance sheet capital from institutional investors and decisions loans via proprietary risk scoring algorithms that rely largely on cash flow data. Source: Authors analysis P 13

Borrower-Driven Broker Marketplaces Connect small business borrowers to a series of lenders that are part of their online marketplaces; most work with conventional lenders

14 US ONLINE LENDING ECOSYSTEM P 14

15 UK: P2P MODEL DOMINATES SMALL BUSINESS LENDING 70% UK Peer to Peer Lending Market Share Business Focused Platforms 60% 50% 40% 30% 20% 10% 0% Funding Circle LendInvest MarketInvoice Thincats Landbay Outstanding Loans New Loans Source: Data includes only members of P2PFA Source: P2PFA, Morgan Stanley Research. P 15

Circle LendInvest MarketInvoice Thincats Landbay Outstanding Loans New Loans

16 UK: P2P PLATFORMS ALSO SEEN AS GOOD VALUE AND EASY TO USE VS. BANKS, BUT LESS SECURE AND HIGHER RISK DRAFT 35% 30% UK Public Perception of P2P Lenders vs. Traditional Banks 25% 20% 15% 10% 5% 0% Socially Responsible Flexibility Value for Money Easy to Use Sustainable Trust Security Least Risky P2P Banks Source: UK Alternative Finance Industry Report (Nesta2014), Morgan Stanley Research P 16

Traditional Banks 25% 20% 15% 10% 5% 0% Socially Responsible Flexibility Value for Money Easy to

17 US AND UK: ONLINE MARKETPLACE IS EVOLVING RAPIDLY Sources of Customers Product Sources of Capital Bank Partnerships Account Receivable / Gov t in UK via British Santander / RBS in UK Gov t mandate in UK? Consortiums BancAlliance in US Traditional Banks Loan Brokers Invoice Lending Term Loans Short-term Cash Advances Business Bank Retail Inst l / Hedge Fund Traditional Banks Warehouse Lines Syndication Markets Small business customer does not always know what product will best meet their needs P 17

Consortiums BancAlliance in US Traditional Banks Loan Brokers Invoice Lending Term Loans Short-term Cash Advances Business

18 WHAT IS THE APPROPRIATE LEVEL OF REGULATION IN US MARKET? Two views: NEED FOR REGULATION IMPROVE EXISTING REGULATION/ ENCOURAGE MARKET MECHANISMS No current designated federal regulator Should there be one? CFPB should implement Dodd Frank 1071 Lack of transparency on costs to small business owners Concern that this might be the next subprime market Emergence of loan brokers High costs Clarify and streamline existing state and SEC regulatory oversight Let nascent market develop Current industry move to improve transparency Borrowers Bill of Rights Consistent disclosure of cost metrics Internal industry oversight increasing on loan brokers P 18

CFPB should implement Dodd Frank 1071 Lack of transparency on costs to small business owners Concern that this might be the next subprime market Emergence of loan

19 UK APPROACH Supportive Government Environment Streamlined Regulatory Environment Providing funds through platforms Single regulator: Financial via British Business Bank Conduct Authority vs. overlapping Tax free allowances for ISA regulation in U.S. investments in P2P platforms Principles-based oversight Results of Competition and Markets Investor protections, including Authority 2016 study on small capital requirements business lending in UK Borrower protections: clear, fair Potential support for referrals of and not misleading declines to P2P lenders P 19

The Future of Small Business Lending: CREDIT ACCESS DURING THE RECOVERY AND HOW TECHNOLOGY IS CHANGING THE GAME

The Future of Small Business Lending: CREDIT ACCESS DURING THE RECOVERY AND HOW TECHNOLOGY IS CHANGING THE GAME LendIt USA Karen Gordon Mills Senior Fellow, Harvard Business School & Harvard Kennedy School