What alternative finance is, the factors behind its rise, who uses it and why

The headline figure is that the global alternative financing market was estimated to have grown to over $100 trillion by 2012, according to academic reports. While authoritative research using defined methodology to accurately estimate the value of this still fractured market is hard to come by, empirical evidence suggests the true value of the alternative finance market has now, in 2016, well surpassed that level. Regional benchmarking surveys are now being initiated by partnerships such as that recently announced between the Cambridge Centre for Alternative Finance at Cambridge Judge Business School and Polsky Center for Entrepreneurship and Innovation at Chicago Booth School of Business. Supported by research partners such as IDB, BDC and KPMG these benchmarking surveys should begin to provide real insight into what is widely considered as the fastest growing financing sector in the world today.

Alternative Finance: A Definition

So what exactly is alternative finance? Broadly defined, alternative finance can be categorized as any kind of business finance which does not originate from a mainstream ‘traditional’ lender such as a high street or commercial bank. Alternative finance encompasses private equity, asset finance, equity leasing, peer-to-peer lending, crowdfunding, different kinds of corporate bonds and business loans from alternative providers. This is by no means an exhaustive list of forms of alternative finance with many niche products available and new products regularly coming to market.

Why is Alternative Finance Booming?

The response of the Basel Committee on Banking Supervision, the banking sector’s regulatory body, to the global financial crash of 2007/08 was the Basel III Accord. This raft of reforms was intended to insulate the banking sector against future financial and economic shocks, ensuring that traditional institutional lenders improved risk management. One of the fallouts of the rules forming the Accord, such as increased internal charges for lending between banks and the devaluation of many kinds of company assets used as collateral, is that commercial lending from the banking sector has been severely restricted.

As a result, SMEs have found their access to corporate finance much harder to come by when turning to traditional mainstream providers. This has led to the rise of alternative finance providers who have stepped forwarded to fill the gap. Technology has also played a major role, opening the playing field to challenger financing providers. Commenting on this, Robert Wardrop, Executive Director of the Cambridge Centre for Alternative Finance stated:

“The structural changes brought about by the digitization of the finance industry has the potential to flatten the provisioning of finance to both individuals and businesses, around the world”.

Who uses alternative finance?

The stakeholders in alternative finance can be broken down into two main categories:

  • Lendees

The beneficiaries of alternative finance lending are largely SMEs who struggle to meet the now strict lending criteria of mainstream providers. This can be for many reasons but quickly growing companies often don’t have the value or kind of fixed assets that traditional financing models require. This is especially true of digital companies and service providers. The likes of Uber and other companies of this ilk, while being amongst the fastest growing in the world, would not have qualified for mainstream lending to fuel their growth as they have very few fixed assets.

Bigger established corporations are also increasingly beginning to turn to alternative financing options due to the greater choice and flexibility they can offer.

  • Lenders

Alternative finance lenders can be further sub-categorised into two groups. The companies which facilitate lending through bringing the required capital to market, conducting due diligence on prospective lendees, processing and subsequently managing the loans. The second group is the investors who provide the finance itself. Investors range from investment banks, family offices and private equity to retail investors buying alternative finance corporate bonds and engaging in P2P lending and crowdfunding.

The Future of Alternative Financing

As always, the market has responded by filling the gap left by the change in lending practices of mainstream institutional lenders. In the US 45% of lending to SMEs now comes from alternative finance providers. In the EU, despite a rapidly growing industry, this figure is just 13%. This shows that there is still huge scope for growth in alternative financing in Europe and the rest of the world, while the market in the US is still growing unabated. It is clear that alternative finance will develop further in coming years. Watch this space!

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