Smaller banking institutions are thriving – and here’s why – Hanrahan

Despite the size and market dominance of the large ‘high street’ banking groups, many smaller banks are thriving. Looking at their balance sheets today, many of these specialist lenders have stronger capital stacks, broader lending appetites, and increased flexibility to support a growing number of often under-served client needs.

This notion of competitive strength is backed up by research. A recent report from Innovative Finance stated that challenger banks now provide approximately 60% of all bank lending to the UK’s small and medium-sized sector.

The report added that with some 40 new banks having been authorised since the financial crisis of 2008, the UK is far outstripping the rest of Europe.

It added: “This dominance marks a historic shift in the financial landscape, confirming challenger and specialist banks as the engine of funding for Britain’s entrepreneurial growth.”

This momentum among smaller lenders is supported by regulation – for instance, the Basel 3.1 carve-out for small banks (the Strong and Simple framework for Small Domestic Deposit Takers (SDDTs)) will reduce complexity and allow such institutions to become more efficient and productive.

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The deadline to opt into the SDDT regime is 31 March 2026, with implementation by 1 January 2027. This will be a keenly watched market development and one that could supercharge the SME UK banking industry even further.

Looking at Cambridge & Counties Bank’s balance sheet as one example, our cost of risk is currently at a historical low, with excess funding and capital available to continue our recent 20%-plus lending growth year-on-year. We are also not seeing a rise in distressed assets across the sector.

The view of the UK economy through the lens of our lending book is, despite macroeconomic and geopolitical tensions, relatively positive – as it is with other such lenders, meaning specialist banks have an increased appetite to write more business.

Trends that will support the growth of smaller lenders

Looking ahead, two market trends will, in my view, further extend the market share of smaller lenders.

The first is a conducive monetary environment: flat or decreasing base rates from the Bank of England will likely reinforce the positive momentum through greater demand for lending from small businesses, with smaller institutions able to meet their soften more niche or specialised lending needs.

The second is artificial intelligence (AI) and the all-encompassing role of technology in modern banking. One of the key reasons for the success of smaller banks is that while bigger institutions are increasingly looking for efficiencies through tech and AI, they are in danger of becoming more technology-led and, as a by-product, moving away from a people-centric business model.

In contrast, personal relationships remain core to successful, long-term growth – particularly in the context of working with commercial finance brokers and wider stakeholders in the real estate market. As part of their business model, larger banks are often hesitant to deal with non-standard lending situations and additional risks. The customer-centric approach of more specialist lenders is well-positioned to continue to fill this gap.

This is not to dismiss the benefits of AI completely, of course. There has been a bias for bigger banks to be able to adopt new technologies earlier and more effectively due to capacity and budget. The quick evolution of AI-centric back office capabilities in comparison to other technologies and tech developments, however, means that smaller banks are able to benefit more – and earlier.