Pointmaker CREDIT WHERE IT’S DUE EASING MARGINAL LENDING DECISIONS TO SMES JAMES CONWAY AND MICHAEL O’CONNOR SUMMARY There is a strong perception that many SMEs A quick, simple, low cost and effective way of are struggling for credit; and that new achieving this would be for the government to set mechanisms of financing SMEs have to be up an Ignition Capital Scheme. In this scheme, looked at. Hence the Chancellor’s the government would provide mezzanine announcement of “credit easing”. financing (of typically 20% of the total loan value) for those projects which would under normal Lending to SMEs has contracted over the last economic conditions be considered a good risk two years with average monthly new terms but which in today’s conditions do not quite meet lending to small businesses having fallen by the bank’s lending criteria. 31% between 2009 and 2011. The existing banking infrastructure would One reason for this may be a lack of continue to be responsible for risk management confidence due to the current economic crisis. and due diligence. The interests of the bank and Many SMEs may be more interested in of the government would be closely aligned. reducing debt than in taking out new loans. This approach would unlock a minimum of £25 Indeed, survey evidence suggests that only 2% billion of investment in SMEs for every £5 billion of SMEs have applied for a loan within the last provided by the government. In addition, as a 12 months and emerged with nothing. portfolio of the government’s mezzanine loans However, many SMEs may have been would be an attractive investment opportunity discouraged from applying to borrow because for the private sector, it should be easily of a perception that the banks are not lending saleable. The original funding could thus be currently. Restoring SME confidence in the quickly repaid to the government; or a second availability of financing for viable projects will phase of the Ignition Capital Scheme could be be crucial to the growth of this sector. launched. 1 INTRODUCTION “Everyone knows Britain’s small firms are agreement, contrary to some of the criticism, struggling to get credit and banks are weak. has been useful. But there is a deeper problem So as part of my determination to get the and that is why new mechanisms have to be economy moving, I have set the Treasury to looked at.”4 work on ways to inject money directly into parts of the economy that need it such as Historic low interest rates and quantitative small businesses. It’s known as credit easing.” easing have done much to alleviate the financial crisis. Liquidity has been improved, and the cost Chancellor George Osborne, speech to of funding minimised, giving the banks capacity Conservative Party Conference, 3 October 2011 to continue lending at an aggregated level. However, the economic downturn, in Calls for better access to credit for small and conjunction with increased regulatory capital medium-sized businesses (SMEs) abound. In requirements, has caused the banks to apply response, in February 2011, the Coalition more stringent criteria for loan applications. On brokered the Project Merlin deal, which top of that, reduced business confidence has committed the four main high street banks, limited the demand for borrowing. plus Santander, to providing £76 billion of credit for SMEs in 2011 (a £10 billion increase The Coalition is now seeking a method of on the previous year).1 directing targeted finance to assist small businesses, which have been earmarked by Figures for the first three quarters of this year many as the key driver in restoring strong suggest that the banks are roughly on course 5 economic growth. According to the BBC’s to meet this target – with £56.1 billion having Robert Peston, sources in both the Treasury and been lent to SMEs already.2 the Bank of England are of the opinion that the Despite this apparent success, there is a semi-nationalised banks “are not stimulating the strong perception that many SMEs are still provision of credit to the businesses perceived struggling for credit; and that new mechanisms to be intrinsically riskier, but whose prospects for long-term returns are also best.”6 of financing SMEs have to be looked at. For example, Sir Mervyn King has said that: “Only the banks are in a position to assess credit risks for SMEs. What we have to do is to find ways of giving incentives to the existing banks in order to lend more.”3 While the Secretary of State at BIS has said that: “I think the Merlin 4 www.guardian.co.uk/politics/2011/oct/10/project- merlin-not-enough-cable-admits 1 Project Merlin – Banks’ Statement http://www.hm- 5 High growth SMEs key to UK employment growth treasury.gov.uk/d/bank_agreement_090211.pdf says Experian 2 Additional data for lending to UK businesses, http://www.experianplc.com/news/company- including ‘Project Merlin’ data news/2010/02-12-2010.aspx http://www.bankofengland.co.uk/publications/oth 6 Sluggish UK economy means slower Lloyds er/monetary/additionaldata.htm revival http://www.bbc.co.uk/news/business- 3 http://www.bbc.co.uk/news/business-15443610 15634996 2 But do SMEs want more credit? Here the then net lending has declined significantly. picture is not clear. It would be foolish to Data from the British Bankers Association oblige banks to lend more to a sector that was suggests that average monthly new term more interested in reducing debt. On the other lending to small businesses for the first half of hand, it would also be foolish not to make sure each year has fallen by 31% between 2009 and that SMEs do have access to credit for sound 2011.8 The same data shows that net lending to business propositions as and when they seek small businesses has contracted by an to expand. The aim must be to find the least average of £332m a month during 2011 damaging means by which the government compared to last year. can encourage more business lending through These trends are replicated in the Bank of credit easing while minimising taxpayer England’s Trends in lending reports. These exposure and involvement, ensuring flexibility show that net lending towards both small to economic conditions and utilising existing market structures. businesses and SMEs has been declining since 2010.9 LENDING TO SMEs IS FALLING From the mid-1990s through to just before the SMEs are likely to be more heavily affected by onset of the financial crisis in 2008, lending a decline in lending than larger businesses: from banks increased hugely. The financial they tend to have fewer alternative funding crisis itself initially led to firms drawing down on existing loan facilities, enabling lending to 8 Statistics – Small Business Support – British continue to grow. But by the start of 2009, firms Bankers Association, September 2011 7 http://www.bba.org.uk/statistics/article/small- began to both deleverage and destock. Since business-support-may-june-201111/small- business/ 7 Supporting UK business: The report of the 9 Trends in lending – Bank of England – October business finance taskforce 2011 http://www.bba.org.uk/media/article/business- http://www.bankofengland.co.uk/publications/oth finance-taskforce er/monetary/TrendsOctober11.pdf 3 sources and in particular they do not have event’12 emerged with nothing – equating to access to capital markets. This is problematic around 2% of all SMEs overall. given that the cost of finance has been There is evidence, however, that credit is more increasing for SMEs, who are now paying 3% difficult to obtain than in the past. The over base rate, with the smallest SMEs paying as much as 4% over.10 proportion of SMEs successfully applying for or renewing a loan has declined from pre- What is unclear is whether this decline in financial crisis levels. In 2007, 85% of SMEs that lending is a supply or demand issue. On the applied for new or renewed loans got what one hand sits a large body of anecdotal they were looking for, while just 4% were evidence that viable businesses are unable to rejected outright. These figures are now 58% access funds. On the other, the BBA claims and 27% respectively. The banks have that credit is available but it is not being predictably become more restrictive about demanded as businesses are using the current lending – particularly to new, small businesses economic climate to reduce debt and build up which tend to be more risky. cash reserves. …BUT PERCEPTION THAT BANKS NO HUGE UNMET DEMAND… AREN’T LENDING As part of the Project Merlin package, the However, there is evidence that some SMEs market research organisation BDRC was are being discouraged from applying for commissioned to survey SMEs.11 Its report credit. 15% of SMEs overall define themselves tackled questions surrounding SME borrowing as ‘unrequited’; they did not apply for activity, reasons for applying/not applying to some/more borrowing when they wanted to borrow, and the key challenges that SMEs over the past 12 months. Significantly, for start- envisaged for their businesses in the future. ups the figure is as high as 28%. Their findings reveal both whether there is an The current state of the economy seems to be unmet demand for credit, and the extent to the most important reason why these firms which demand from SMEs for borrowing has decided not to apply. But 6% of all SMEs (in fallen because of the current conditions. particular smaller businesses) claim to be Their findings indicate that only 30% of all discouraged from borrowing because either SMEs are active borrowers; indeed, 47% never they fear rejection or have been put off by use external funding at all.