Below, Jerome Le Luel, Funding Circle’s chief risk officer, shares his insights on the state of small business lending and how data science helps small businesses grow. Le Luel leads a global team of risk professionals who are experts at small business lending, and whose mission is to ensure that Funding Circle deploys world-class risk management techniques and controls to assess creditworthy borrowers, helping small businesses thrive while protecting investors’ returns.
Small businesses are not getting access to the finance they need
Small businesses are key drivers of the global economy: they provide 50-60% of economic value and around 60-70% of jobs. While the number of small businesses has grown since the financial crisis, the funding available from traditional lenders has declined. This is driven by the complexity of lending to businesses compared to individuals. The incredible diversity of small businesses requires a lender to account for not just the risk of the business itself but its industry, its economic region, the macroeconomic environment it is operating in and even the personal risk of its owners.
When facing these challenges traditional lenders have tended to focus on larger companies, because they are easier to understand. Where they do serve smaller businesses, they tend only to lend to those that already bank with them, as they already own the relationship and data they need to make a lending decision. These solutions result in poor borrower outcomes: restrictive access to finance and a lengthy and cumbersome application process.
A better way to borrow
Funding Circle was created to allow small businesses access finance by connecting them directly with investors. We have a relentless focus on applying data science and technology to help small businesses. Since 2010, more than 56,000 business across the UK, US, Germany and the Netherlands have accessed more than EUR 6.7 billion from 85,000 investors.
Throughout the entire customer lifecycle – from application to funding – data analytics are used to optimise everything from marketing, contact levels and loan pricing. Applying mathematical tools to small business lending in this depth is something that has never been done before. The result is a vastly superior customer experience; Net Promoter Scores (NPS) from Funding Circle borrowers average in the 80s, while banks typically see low to negative figures.
Data is key to good decision making – the question is how to use it
Publicly available data on SMEs is highly dispersed. By aggregating these different data sources and creating one single vision of the SME universe, it starts to make more sense.
While these ingredients are initially available to all, with over eight years of lending experience Funding Circle has been able to build very unique and powerful proprietary data sets. These provide a 360° view of small businesses, solving for the complexity of the risk and diversity of SME lending. Consequently, ever-improving risk models are able to predict the probability of business default with a high degree of accuracy. Funding Circle has leveraged this to facilitate finance to tens of thousands of businesses—while keeping default rates stable—providing investors with attractive, stable returns.
Regulators have seen the benefits of increasing competition in the space of SME lending. Thanks to the introduction of PSD2 and Open Banking in the UK, platforms are now getting access to the last piece of data that banks were trying to keep for themselves. Adding another data source to the knowledge base provides even more insight into small businesses. All of this creates a virtuous funding circle that drives continual improvement and competitive advantage.
Small business lending is complex, but possible with the right tools
Ultimately, effective risk management is about collaboration. In terms of organisational setup, fintech firms are less rigid than incumbents, enabling different people with different skills—tech experts, commercial underwriters, data scientists, data engineers, investment bankers, compliance experts to name a few—to work more closely together and solve problems by bridging the gap between the tech and finance worlds. This translates into fast, data driven decisions.
For the economy to flourish, small businesses need to grow. This can only happen if the financial system is rewired to align its interests with those of small businesses and investors. This was why Funding Circle was created; to use the right data, technology and people to create a better financial world.