The industry body, which represents the UK’s fintech sector, published its findings in partnership with law firm Hogan Lovells. The report argues that current prudential requirements are imposing excessive burdens on challenger banks, constraining growth and limiting investment in the UK banking sector.
Challenger banks now account for around 60% of all lending to the UK’s small and medium-sized enterprises (SMEs), according to the British Business Bank. Since 2008, around 40 new UK banks have been authorised, more than in any other European country, making challengers and specialist lenders a vital part of the UK’s financial ecosystem.
However, Innovate Finance warns that upcoming regulatory changes, including the implementation of Basel 3.1 and the Small Domestic Deposit Taker (SDDT) regime, could reduce SME lending capacity.
The report highlights that current and proposed capital rules treat SME lending in the same way as high-risk wholesale corporate lending, which Innovate Finance calls “logic-defying.” It argues that this approach penalises simple, low-risk business loans and discourages growth among smaller banks.
Innovate Finance is urging regulators to adopt a “Think Challenger” approach: one that recognises the unique role and risk profile of challenger banks. The organisation warns that the current regulatory structure favours large incumbents and undermines post-crisis objectives to promote competition and innovation in banking.
Janine Hirt, chief executive of Innovate Finance, said:
“Our challenger banks are a genuine British success story, now providing the majority of funding to the small businesses that power our economy. It is vital that the regulatory framework supports – rather than hampers – this success. The current approach to prudential regulation risks imposing a disproportionate capital tax on the simplest form of lending, diverting tens of billions of pounds away from SMEs and directly undermining the government’s growth agenda. Regulators must adopt a ‘Think Challenger’ approach to ensure we are supporting innovation.”
Charles Elliott, counsel at Hogan Lovells, added:
“Challenger banks play an increasingly important role in the UK economy, driving innovation and competition in financial services. Given how important challenger bank lending has become in the SME sector, they are particularly relevant to the UK government’s growth agenda.”
