Can alternative finance platforms prepare for a looming recession?

Could a recession be creeping up on us? What are the indicators and what can alternative finance providers do to prepare for the inevitable? Niels Turfboer, managing director of online lender Spotcap, offers his thoughts.

The credit cycle is sometimes said to lead the economic one by about 18 months. In other words they turn down – or up – a year or more before the economy does. So what credit indicators are there that we are on the cusp of an economic downturn?

Firstly: Rising inflationary pressure. While Britain’s inflation rate fell more than expected during September this year, the fact that the Bank of England has raised interest rates twice leaves officials anticipating that a tight labour market could soon lead to high wages being passed on to consumers through inflation. The unwanted consequences of the uncertainty around Brexit could also weaken the pound as imports will become more expensive with company also being more cautious in making investment.

Secondly, in October this year, the Bank of England’s financial policy committee issued a stark warning over the rapid growth in lending to indebted companies, noting that lending standards were falling and that it would more closely monitor the risks to the UK.

Alternative finance providers, which are dependent on credit from investors or individuals, could be hit hard as a result. Raising capital could be more challenging. There are also concerns over how loan books might withstand the stress of borrowing companies not being able to repay their loans. Industry default rates are currently suggested to be around one to three per cent. However, these could increase during a recession, testing the credit and risk assessment models built by the different platforms, and potentially resulting in financial losses for the lender.

What actions can alternative finance providers take now?

Adequate risk management is crucial. This includes a clearly defined risk management strategy and a comprehensive risk management framework, which should be in line with bank regulations. The alternative finance industry has not yet been through a full credit cycles. Therefore, we can’t be sure how the different providers will hold up when exposed to changes in credit conditions and systematic risks. But those with a robust risk governance framework have a higher chance to come out of a downturn unscathed.

In addition, alternative finance providers with teams that have been through credit cycles and that are aware of systematic risks are more likely to have built businesses that are better able to withstand an economic downturn. Experience matters. They are also better in upholding the highest regulatory and reporting standards.

Finally, alternative finance providers should remember two guiding principles: When the economy is doing well, there is more room for inefficiencies. And once investments and spending slows down, the shake-out will be inevitable and the most efficient providers with the best product will come out on top. Secondly, greed isn’t good. Every business should focus on sustainable growth rather than just maximising revenue, as record user numbers and fast growing revenues can’t come at the cost of proper underwriting and risk assessment. Those alternative finance providers that compromise in these areas will be the first ones to fail during a recession.

An economic downturn will inevitably bring challenges for alternative finance providers, but ultimately help the alternative lending industry evolve. The good news is that the alternative finance providers that don’t get weeded out or snapped up will emerge stronger. An exciting prospect for investors, businesses and alternative finance providers alike.

Niels Turfboer is managing director at Spotcap, a global online lender. Meet Niels at the BCR's Alternative & Receivables Finance Forum on the 22 November and hear his insights on the UK shifting alternative finance landscape at 9.45am.