Key banks' exit from Ireland opens risks, opportunities as nonbanks step in

The exit of long-established lenders Ulster Bank Ireland DAC and KBC Bank Ireland PLC has strengthened nonbank lenders' foothold in Ireland, creating risks and opportunities in small business lending.

Nonbank lenders offer better technology and faster processing times and have increased their market share, especially in the small and medium-sized enterprises (SMEs) space, according to market observers. The central bank has, however, warned that financing businesses that may have been turned down for bank loans is a key risk.

Traditional banking has declined in Ireland since the global financial crisis when a burst property bubble led to the collapse and nationalization of several large banks, leaving the sector with large amounts of nonperforming loans to work through. Nonbank lending expanded rapidly over the past decade to fill the resulting financing gap as banks' risk appetite diminished and their number declined.

Challenging environment

Ulster Bank and KBC announced their exit from Ireland just weeks apart in 2021, citing a challenging operating environment. Ulster Bank's exit in particular, after 160 years in Ireland, was a shock to the market. After the pair closed their last Irish operations earlier in 2023, only three major banks remain in the market — Bank of Ireland Group PLC, AIB Group PLC and Permanent TSB Group Holdings PLC.

The withdrawal of KBC and Ulster Bank is significant as it further limits the financing options for SMEs, which were scarce to begin with, Aaron McGarry, banking and finance lawyer at Fieldfisher told S&P Global Market Intelligence. SMEs were hit hard in the post-crisis years as traditional banks' risk appetite "dropped off a cliff," leaving small businesses in real estate and other overleveraged sectors underserved, McGarry said.

The share of nonbank lending to SMEs is highest in the real estate sector, accounting for roughly 45% of new lending volumes in 2019 and 2020, according to the latest central bank data.

The share of Irish real estate sector SMEs with high leverage declined somewhat in 2022 and profits increased year over year, S&P Global Market Intelligence data shows.

Nonbank lending on the rise

Traditional banks still hold a bigger share of SME lending in Ireland, but alternative finance has accounted for an increasing share of new lending in recent years, McGarry said.

The volume of credit to Irish SMEs provided by nonbanks in the first half of 2023 was 6% higher than a year ago, the central bank said Nov. 23. Real estate-focused SMEs are receiving the largest amount of credit, it said. Irish SMEs owed nonbank lenders €4.5 billion in the second quarter of 2023, or 20% of total outstanding SME loans.

Nonbank lenders have helped mitigate a credit supply shock to Ulster Bank's business clients during its phased withdrawal from Ireland over the past three years, the central bank said in a study published in October. It found that business clients of the exiting Ulster Bank, owned by UK-based NatWest Group PLC, had a better chance of getting a new loan from a nonbank lender, and the loan sizes offered to businesses by nonbanks were also bigger.

Apart from their diminished risk appetite and dwindling number, traditional banks have also been slow to adopt new technologies that enable the quick transfer of funds or the seamless embedding of new services into existing corporate platforms, McGarry said. This gives alternative finance providers, some of which are fintechs, a competitive edge, he said.

"Alternative lending is an area that will grow far quicker than anything else for the rest of this decade," McGarry said.

Opportunities

Alternative finance M&A in Ireland has heated up in recent years with M&G PLC picking up a 40% stake in the country's biggest alternative finance provider, Finance Ireland PLC, in the summer of 2022. That deal followed the takeover of Capitalflow Group DAC, another major Irish alternative lender, specializing in financing SMEs, by Dutch fintech Bunq BV in the summer of 2021.

The remaining traditional banks obtained the bulk of customers from KBC Ireland and Ulster Bank and face capacity constraints as a result, a spokesperson for Bunq told S&P Market Intelligence.

"This provides an excellent opportunity for a specialist business lender like Capitalflow to develop and grow deep relationships with SMEs that are not being serviced correctly by incumbents," the spokesperson said in an email.

A key reason for SMEs to turn to alternative lenders is long loan approval times at incumbents, according to Irish SME Association CEO Neil McDonnell. Faster turnaround times are driving more SMEs to peer-to-peer lenders, such as Linked P2P Ltd., Flender Ireland Ltd., Grid Finance Impact Ltd., Spark Crowdfunding and Property Bridges, although they offer loans at a higher cost, he told Market Intelligence in a written comment.

"From a borrower perspective, we have no effective competition among lenders [with] only two large banks remaining, and no real local or regional finance offerings to the SME market," McDonnell noted.

Permanent TSB only recently rebranded as a "full-service," personal and business bank in late October, and started expanding its SME offerings after taking over part of Ulster Bank's Irish book.

Risks

The growing role of nonbanks for SMEs and other borrowers in Ireland could open up the market to more risk too, according to the country's central bank. Its recent study of Ulster Bank's withdrawal found that riskier businesses, which are typically less able to access bank financing are more likely to look for credit at nonbanks, which may bring greater medium-to-longer term risk, as well as benefits in terms of growth.

From a borrower perspective, "nonbank lenders have less stable funding sources than banks, with implications for the supply of credit to Irish SMEs," the central bank said in its June 2023 stability review.

As alternative finance and peer-to-peer lending providers step in to fill the gap left by traditional banks, authorities may also need to step up regulation of this part of the financial system where rules are less stringent than those for banks or are yet to be established, according to McGarry.

"There is not a lot of regulation either at a EU level or the Irish national level," he said.