House of Commons Treasury Committee Conduct and competition in SME lending Eleventh Report of Session 2014–15 HC 204 House of Commons Treasury Committee Conduct and competition in SME lending Eleventh Report of Session 2014–15 Report, together with formal minutes relating to the report Ordered by the House of Commons to be printed 10 March 2015 HC 204 INCORPORATING HC 1008, SESSION 2013-14 Published on 10 March 2015 by authority of the House of Commons London: The Stationery Office Limited £0.00 Treasury Committee The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of H M Treasury, HM Revenue and Customs and associated public bodies. Current membership Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) Rushanara Ali MP (Labour, Bethnal Green and Bow) Steve Baker MP (Conservative, Wycombe) Mark Garnier MP (Conservative, Wyre Forest) Stewart Hosie MP (Scottish National Party, Dundee East) Mike Kane MP (Labour, Wythenshawe and Sale East) Mr Andy Love MP (Labour, Edmonton) John Mann MP (Labour, Bassetlaw) Jesse Norman MP (Conservative, Hereford and South Herefordshire) Teresa Pearce MP (Labour, Erith and T hamesmead) David Ruffley MP (Conservative, Bury St Edmunds) Alok Sharma MP (Conservative, Reading West) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross) Andrea Leadsom MP, Rt Hon Pat McFadden MP, Mr George Mudie MP, and Brooks Newmark MP were also Members of the Committee during the inquiry. Powers The Committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No 152. These are available on the Internet via www.parliament.uk. Publication Committee reports are published on the Committee’s website at www.parliament.uk/treascom and by The Stationery Office by Order of the House. Evidence relating to this report is publishe d on the Committee’s website at www.parliament.uk/treascom Committee staff The current staff of the Committee are Chris Stanton (Clerk), Anne-Marie Griffiths (Second Clerk), Adam Wales and Gavin Thompson (Senior Economists), Hansen Lu, Gregory Stevens (on secondment from the Bank of England), Callum Saunders (on secondment from the NAO), and Laura Saks (on secondment from the FCA) (Committee Specialists), Steven Price (Senior Committee Assistant), Alithea Williams (Committee Assistant), and Sanjay Odedra (Media Officer). Contacts All correspondence should be addressed to the Clerk of the Treasury Committee, House of Commons, 14 Tothill Street, SW1H 9NB. The telephone number for general enquiries is 020 7219 5769; the Committee’s email address is [email protected]. Conduct and competition in SME lending 1 Contents Report Page 1 Introduction 3 The importance of SME lending 3 Evidence received by the Committee 4 2 The state of the SME lending market 6 Current market conditions 6 Underserved segments of the market 10 Equity finance 11 Government schemes 12 Importance of perceptions 14 Communications from banks 16 Public debate on the causes of restricted credit to businesses 17 Availability of data 18 Data on alternative lenders 20 3 RBS Global Restructuring Group (GRG) 23 Treatment of customers in GRG 23 Allegations against GRG 23 Responses to allegations against GRG 24 FCA review into GRG 26 Conflicts of interest, customer perceptions and governance 27 GRG as a profit centre 29 Future of GRG 31 4 Mis-sale of Hedging Products 32 FCA Interest Rate Hedging Product review 33 Operation of the scheme 34 Alternative product redress 36 Criticisms of the FCA IRHP review 37 Drafting of the voluntary agreements 37 Possible conflicts of interest 39 Complainant access to the independent reviewer 40 Complainant access to case information 40 An appeals process? 42 The scale of the problem 44 Transparency of the voluntary agreements 45 Tailored Business Loans 46 Break costs and similarities with standalone IRHPs 46 Disclosure 48 Sales practices 50 Regulation of TBLs 52 Clydesdale’s review of TBLs 56 Challenging banks through the courts 58 Financial Ombudsman Service 59 5 Competition in SME lending 63 2 Conduct and competition in SME lending A history of competition problems 63 The current state of competition 65 How have new entrants affected concentration? 68 Why have competition problems persisted? 71 Barriers to entry 71 New entrants, branch networks and “critical scale” 72 Limited switching behaviour from SMEs 73 Product comparability and SMEs’ perceptions of banks 73 Concentration and linkages between markets 75 Mutual reinforcement of competition problems 76 Policies to improve competition 78 Multiple credit searches 78 Price comparison 79 Account switching for SMEs 81 A structural remedy? 82 The FCA’s competition objective 85 The FCA and the Competition and Markets Authority (CMA) 87 6 Alternative finance 91 Crowdfunding/peer-to-peer finance 91 Advantages of crowdfunding/peer-to-peer lending 92 Crowdfunding and competition 93 Risks of crowdfunding 95 Formal Minutes 96 Witnesses 97 Published written evidence 99 Conduct and competition in SME lending 3 1 Introduction 1. Small and medium sized enterprises (SMEs) form a large part of the UK economy. According to official statistics, there were 5.243 million private sector businesses at the start of 2014. 5.236 million had 0–250 employees and are classed as SMEs, of which 5.204 million had fewer than 50 employees and are classed as small businesses. SMEs account for 60 per cent of all private sector employment, and registered an annual turnover of £1.6 trillion at the start of 2014—47 per cent of the private sector total. A large majority of SMEs are sole traders—76% of all businesses are non-employers.1 2. The definition of the term SME can vary. Some define SMEs as firms with a turnover of up to £25 million a year, some as firms with fewer than 250 employees, and some use a combination of both employee count and turnover.2 SMEs themselves are highly heterogeneous. The Association of Chartered Certified Accountants (ACCA) wrote: […] ACCA has repeatedly cautioned against aggregation when discussing SMEs. The ‘SME’ label, applicable as it is to 99.9% of businesses in the UK, is so broad as to render most statistics and anecdotal evidence meaningless. This is even more true because demand for finance is significantly skewed, and a minority of SMEs will always account for the bulk of demand.3 The importance of SME lending 3. The Government believes that access to finance for SMEs is “key to the recovery and long term growth of the economy”.4 Research by National Endowment for Science, Technology and the Arts (NESTA) in 2009 found that the “6 per cent of UK businesses generated half of the new jobs created by existing businesses between 2002 and 2008”. Citing this research, the Department for Business, Innovation and Skills said: High growth firms are particularly important to the economy, driving competition and productivity growth. Research found that from 2005 to 2008, seven per cent of SMEs met the OECD definition of ‘high growth’. A similar proportion also achieved this over 2002–05 and 2007–10. Over a three year period, these high growth SMEs are credited with creating around a quarter of all new jobs among existing businesses.5 4. A large proportion of SMEs rely on external finance in some form. The SME Finance Monitor, an industry led survey of SME lending, found in Q2 2014 that approximately 40 1 Department for Business, Innovation and Skills and Office for National Statistics, Business population estimates for the UK and regions 2014, 26 November 2014 2 Bank of England, Lending to businesses – a new data source, March 2012; House of Commons Library, Small businesses and the UK economy, 9 December 2014; European Commission, The new SME definition, 2005 3 SME0011 4 Department for Business, Innovation and Skills, Evaluating changes in bank lending to UK SMEs over 2001-12 – ongoing tight credit, April 2013 5 Department for Business, Innovation and Skills, SMEs: The Key Enablers of Business Success and the Economic Rationale for Government Intervention December 2013 4 Conduct and competition in SME lending per cent of SMEs used external finance, with 30 per cent of SMEs using “core products”— loans, overdrafts and/or credit cards. Stephen Nickell, member of the Budget Responsibility Committee, told the Committee in December 2014 that SMEs are particularly vulnerable to changes to bank lending: Large companies, generally speaking, have access to alternatives to bank lending, the bond market and so on. Of course SMEs and small companies generally rely on or have in the past relied on the banking system.6 Indeed, one interpretation of the persistently low post–economic crisis productivity growth is a loss of bank lending to rapidly growing firms such as SMEs. Mr Nickell said: If push came to shove, I think we would argue that it is the consequences of the credit crunch that have led to this productivity puzzle. That is to say quite a high proportion of productivity growth is generated because high productivity firms start up and expand and low productivity firms contract and go out of business. There is some evidence to suggest that, because of the credit crunch, there has been a barrier to the expansion of high productivity firms and the starting up of high productivity firms. I am not too convinced about this, but some people argue that the credit crunch as part of the whole business has also led to low productivity activities surviving, so-called zombie firms and so on and so forth.7 Evidence