Please note, this information is for general guidance only and should not be taken as financial advice. Always seek professional advice before making any financial decisions. Your capital is at risk.
The financial crisis of 2007/08 led to many changes in the business funding landscape, and this period essentially marked the genesis of the alternative lending market.
In the UK, corporate debt markets were once dominated by the four biggest high-street banking groups—global names with broad product offerings. During the crisis, as these banks withdrew from lending markets, many SMEs found themselves unable to access capital. This lack of business funding hindered growth and, in many cases, survival, causing significant ripples throughout the economy.
To prevent these issues from reoccurring, the UK Government opened up the banking market by making banking licenses more widely available. Before this, there hadn’t been a new bank in the UK since the early 1900s. While not all new banks have been successful, there are now well over 100 licensed banks incorporated in the UK, with many more based overseas but operating within the UK.
Often, these new banks are backed by equity investors as they grow and acquire customers. Their goal is to become self-sufficient and funded by customer deposits and money markets (similar to high-street banks) as quickly as possible.
Names like Monzo, Starling, and Revolut may be familiar due to their online personal banking services. However, many other new banks focus on specialist corporate lending products and support for SMEs. As regulated entities with a range of corporate products, these institutions compete head-to-head with high street banks, usually offering points of differentiation that can be hugely beneficial to borrowers.
Why Choose a Challenger Bank for Business Funding?
There are two key reasons why a Challenger bank would be attractive—expertise and appetite.
In what is becoming a competitive market, Challenger banks know that to take market share, they need a point of differentiation. They recognise that most customers rely on certain key services, and this is where they focus. These banks offer working capital products with greater flexibility or better pricing, fund MBO and MBI transactions, support businesses prioritising ESG, provide fast and clear decisions, and offer dedicated relationship managers. They also cater to pre-profit businesses investing in growth, those refused simple bank accounts elsewhere, and a host of other specialisms.
The appetite point naturally follows this. These banks are growing, with many estimates suggesting their market presence will grow by 40%-50% CAGR over the next 4-6 years. Much of this growth will be in the SME market, given how underserved this market is by traditional banks.
For many borrowers, a Challenger bank represents an opportunity to work with a dedicated specialist lender who can provide solutions tailored to their market segment. While high-street banks focus on ever-larger clients, the void they leave is being filled by Challengers.
What Are the Risks of Business Funding with Challenger Banks?
There have been issues with lenders in the Challenger bank market. Bank North, SVB, and more recently, Metro Bank are examples of what happens when things don’t go as planned. These issues arise for various reasons, and it’s not unusual for an industry experiencing high growth to encounter troubled waters.
Notably, HSBC quickly acquired SVB, continuing to support their strategy. In the tech market, SVB stood out as a key supporter of new and growing businesses, using their expertise to support businesses that mainstream banks couldn’t serve. Often, high-street banks don’t serve certain sectors or businesses because they lack the in-house ability to understand them. The fact that HSBC chose to acquire a bank that supported clients it couldn’t support itself helps validate the strategy of SVB and Challengers more generally.
The banking market isn’t without its issues, and the financial crisis showed that even high-street banks aren’t immune. As with any significant stakeholder in business funding, doing your due diligence remains critical. Understanding who your lender is, how they approach the market, and where their funding comes from is essential. Approaching the funding process in good time opens up a wider market and allows a greater number of options to be properly investigated.
Conclusion
While Challenger banks are less well known, the Bank of England regulatory framework ensures they are held to account, providing a level of comfort for those who don’t just take no for an answer. The alternative debt market, and Challenger banks in particular, ensure banks operate in a competitive market. To make the most of this and remove any uncertainty, borrowers need to be aware of the options available to them and look beyond the high street.
In today’s market, Challenger banks aren’t just a backup option when the high street bank says no. They are a credible alternative that can often provide a better overall solution, particularly in the SME market.
