Shining a light into the murky world of SME finance
Civitas, 12 July 2011
This month BDRC Continental, a market research firm, released its SME Finance Monitor, an independent survey of SME financing commissioned by the Business Finance Taskforce. The taskforce is composed of CEOs and senior representatives from Barclays, HSBC, Lloyds Banking Group, Royal Bank of Scotland, Santander and Standard Chartered. With the survey indicating that 59 per cent of loan applicants were successful, the British Bankers’ Association (BBA) have heralded the results as supporting their view that ‘many customers [are] clearly still concerned about the economic climate and so are less inclined to borrow’. In contrast the Federation of Small Businesses (FSB), pointing to the fact that only 15 per cent of businesses surveyed had applied for new or renewed credit, argued that many businesses still justifiably fear being rejected by banks. Who is right about the state of SME finance in the UK?
Before I tackle this question it is important to reflect upon a couple of words of warning delivered by Mike Young, the Independent Chair of the Survey Steering Group:
‘This report does not provide quick and easy answers to the claims and counter-claims swirling around in the debate about SMEs and banks. That is because it is an extremely complex issue, incapable of easy summary into “guilty” or “not guilty”.’
Furthermore Mr Young argues that progress will be made by ‘clearly studying the report, rather than reaching for a convenient figure or two to support their [those on either side] pre-determined position’. I have made an attempt to do this. Ironically the views of the BBA and the FSB have been reported alongside the one or two figures that could support either side, clearly such journalism falls into the trap which Mr Young, so presciently, warns against.
Looking closely at the detailed figures produced by the report there are a number of issues which stand out:
1. There were similar numbers of content and disappointed SMEs. Only 15 per cent of SMEs either applied for new credit, renewed credit or both. This is perhaps not an issue if it represented the only SMEs who needed or wanted credit during the period. However this was not the case, while 16 per cent of all SMEs interviewed had applied for everything they wanted, 15 per cent had not applied for something they would have liked to, leaving the vast majority (69 per cent) apparently happy not to apply. Thus there appears to be similar degrees of contentment and disappointment. It could be argued that the 69 per cent are also content, but they are only content not requiring credit and according to the results in the report they would have had a nearly even chance of being content or disappointed, had they applied for credit this year. One caveat to this result is that of the 15 per cent who did not apply and would have liked to, one third of overdraft applicants and half of the loan applicants were discouraged (directly by the bank or indirectly by perception of their chance of success) from applying. The others were concerned about the time, effort and expense involved in the borrowing process and the economic climate. This caveat does, in some part, indicate that banks may not be at fault for the disappointed SMEs, although it would appear that a very small amount of those discouraged from applying did so purely because of the economic climate.
2. There is a great degree of variation in the fortunes of different SMEs. Smaller, younger and less creditworthy firms are less likely to succeed in their application for a loan or overdraft than larger, older and more credit worthy firms. In terms of different industries, agriculture, construction, transport, hotels and real estate were more likely to apply for new or renewed credit than wholesalers/retailers, manufacturers, community groups and health related businesses, although the report only indicates that these businesses were less likely to apply, not more likely to fail.
3. The successful loan and overdraft application figures are meaningless in isolation. Banks and lenders may point out that 59 per cent of loan applicants and 72 per cent of overdraft applicants were successful in their applications, however this does not tell us very much about the state of the credit market. The main problem is that they are only a snap shot and do not indicate how credit conditions may be changing. The report does try and overcome this hurdle by comparing the results to that of a previous SME study, ‘Financing UK Small and Medium Sized Enterprises’ by the Centre for Business Research at the University of Cambridge, published in August 2008. Perhaps worryingly the comparison is not encouraging: In 2007 69 per cent of SMEs were using external finance down from 81 per cent in 2004, the figure decreases again in the BDRC report, dropping to 51 per cent in 2011. However this result is itself weakened by the fact that there is no evidence that there was any attempt, in comparing the results of the two reports, to control for firm-specific variables (riskiness, size, age, industry etc). Without controlling for these variables we cannot be sure that the reports are comparing like-for-like, and so we do not know how credit conditions have changed for the same type of business in 2004 compared to 2011. What is needed is a study which does attempt to control for these variables. One such study carried out by Dr Stuart Fraser, ‘the UK survey of SME finances for 2008’, indicated that credit conditions had deteriorated for firms in 2008 compared to 2007 and 2004. A study, similar to Dr Fraser’s, would need to be carried out for 2011 to see how credit conditions had changed for similar firms.
These issues are important because they relate to the underlying problems in the British credit market.
Firstly, there undoubtedly is a perception that banks are not lending, this should be of huge concern even if it isn’t entirely the fault of the banks. More needs to be done to encourage firms that require credit to apply for it, and part of this involves banks creating better links with the local business community.
Secondly, there are clearly some businesses which have far more difficulty obtaining credit than others. The worry is that these small businesses are being starved of credit because of the inability of Britain’s banks to serve them. An overhaul of the credit checking system is required so that decisions on credit are made on other issues, rather than just a credit score. Banks need to get back to working within their local economy, and lending decisions should not be dictated from a national or regional headquarters.
Thirdly, the 2008 study by Dr Fraser indicated that credit conditions had deteriorated for comparable firms, if this is still the case then it is quite clear that there has been a squeeze on credit in the UK. Many would argue that such a squeeze is unavoidable during a period of financial uncertainty and perhaps warranted to cut back on the profligate lending of the period preceding the recession. These points are debateable, especially as a great degree of poor loans went into property not businesses, more important however is the fact that the British financial system was one of the worst hit in the developed world. Creating a more resilient system, as nearly all parties accept is necessary, involves diversifying the financial sector, breaking up the oligopoly of the large banks, and instilling real competition where banks serve businesses and customers better.
The BDRC Continental study is an interesting one, and the following studies in the series will allow for an examination of future changes in the SME credit market. Such studies are to be welcomed if they shine a light into the murky world of SME finances, bandying figures around however only serves to obfuscate the situation and disguises the real weaknesses in the British credit market and financial system, which are far from being resolved.