Business finance — the price isn’t right (yet)
Business finance providers currently use different ways to represent price, such as X% (per month), or by only showing £ repayment amounts, making it hard to compare costs across different providers.
This was an issue I felt strongly amount when I was CEO at Growth Street, the first revolving credit marketplace in the world. Growth Street matches investors with UK businesses looking for an alternative to a bank overdraft. We took the decision early to be fully transparent on price, including full disclosure of the Annual Percentage Rate (APR), which compares the full cost of finance (i.e. interest AND fees) relative to the amount borrowed, over the period of one year.
APR is a familiar metric as it is a mandatory disclosure across various forms of consumer credit. However APR isn’t required when the borrower is a business. At Growth Street we didn’t think this was fair, so we led a campaign called APR4SMEs, calling on industry peers, regulators and government to adopt APR on business finance products.
And not without some success. The Competition and Markets Authority, following its investigation of the UK retail banking market, decided to include APR for business loans in its suite of remedies that make up The Retail Banking Market Investigation Order 2017.
The action taken by the CMA will make comparing costs easier for some businesses by making it mandatory to disclose an APR. However this measure only relates to unsecured business loans (and in the case of overdrafts, disclosure of an EAR), for amounts less that £25K. This means banks, as well as some alternative finance providers like iwoca, Fleximise and Just Cashflow will have to show APRs from August 2017.
Given the narrow scope of the CMA remedy, it will be interesting to see how various finance firms across the industry choose to comply. If finance is secured, for an amount greater than £25K, or not offered in the form of a loan or overdraft, then this requirement doesn’t apply — so firms offering invoice finance (e.g. MarketInvoice) or a merchant cash advance (e.g. Liberis) may deem themselves exempt. Alternatively firms may decide to publish APR across the board if they have to disclose it for part of their product set.
Given the CMA is tasked with improving competition, and businesses can raise finance in different ways, a more universal price comparison remedy would have been more useful.
A different CMA remedy, which supports Open Banking, may prove a greater catalyst for price comparison in the small business market — as banks will now be required to disclose specific historic account information and product fee structures over API. Take overdrafts for example: firms are required to disclose the EAR (Equivalent Annual Rate) which only takes interest into account, and NOT fees which can be substantial.
Under Open Banking, Price Comparison Websites will now be able to calculate the total cost and effective APR by examining actual usage against product specific tariffs — calculating interest and fee costs bespoke to an individual business. PCWs, acting in an independent manner, could prove the much needed catalyst to show standardised finance costs, which will not only make it easier for businesses to compare different providers of the same product, but also across different finance products too – term debt, overdrafts, invoice finance etc.
To encourage innovation and competition in this area, in two weeks time Nesta, as part of its Open Up challenge (another CMA remedy), will award 20 innovation grants of £50K each to participants focused on harnessing Open Banking to help small businesses. A further £3.5M of prize money is available to support the best ideas at later stages.
With incentives like these, UK businesses will soon know if the price is right.