The UK urgently needs to solve the problem of getting badly needed finance to cash-strapped SMEs, especially the smaller ones and start-ups. The present slow and still struggling economic recovery (and it is not nearly as strong as the emerging US one during the early months of 2012) may well be further slowed if this ‘finance gap’ is not closed.
There is now widespread acceptance that there is a real and serious ‘finance gap’ in the external funds provision to the UK SME sector, especially for smaller firms who are almost wholly reliant on the banks for external funds. Furthermore, this appears to be both a supply-side and demand-side problem. On the supply-side, the present provision of bank finance appears to be inadequate and is not apparently consistent (or ‘matched’) with the real needs of firms. On the demand side, many businesses are increasingly disincentivised from even approaching their banks for further borrowing – they appear to fear the stringent terms and other conditions that banks might impose on both any new borrowing (which is still a low probability event for many firms) and (more worryingly) on pre-agreed, existing, hard- won lines of credit. This is a serious problem now of ‘financial exclusion’ (which occurs when a firm or person is unable or unwilling to access needed finance).
These supply-side problems in lending to business are not wholly unique to the UK. At a global, macro-economic level they impact on the severity and subsequent speed of recovery of economic cycles. The new ‘Basel 3’ rules on banks’ capital adequacy regulations (these constrain the amount of risk that banks may take on in their lending and other activities) have highlighted and attempted to address the key need for increased bank lending in the downturn of the economic cycle in order to help ‘fire up’ the subsequent economic recovery. Indeed, this key role of bank lending was given a particularly high priority in the new Basel 3 regulations developed in the wake of the ‘credit crunch’ (2007-2009), the most severe banking and financial crisis that the world has experienced since the Great Depression of the 1930s.
But these Basel 3 regulations for banks are still ‘new’. They will take some time (several years) to be implemented fully and their effects (including any unintended consequences) evaluated. At the same time, the world (especially the Western world) is still living through the post-crisis period and all of its economic ‘baggage’ (which includes the major debt overhang in both the public and household sectors). At the same time, new potential crises are emerging, with the eurozone and sovereign risk problems ‘centre stage’.
The UK economic recovery and the SME ‘financing gap’ cannot be left to the mercy of these global tides of risk and recovery. At the same time it has to be appreciated that we are currently in a two-speed global economic world. The West (still struggling to recover and facing new systemic risk potential) and the East (fast growing, dynamic and increasingly competitive).
Bank lending and needed external financing generally are not only important for economic recovery during the bottoming-out phase of the economic cycle. They are also a key ‘driver’ of entrepreneurship, which is the lifeblood of a globally competitive market economy. This is why the external financing needs and any respective ‘financing gap’ of smaller businesses are so important. They have a longer-term economic significance that extends far beyond the overall size of any ‘financing gap’ that constrains today the ability of firms to operate successively in a competitive market and even survive. Longer term, this current financing constraint impacts on the ability of the small firm sector to innovate, provide gainful employment, to compete, grow and prosper. The small business sector is the crucible of entrepreneurship, innovation and longer-term competitiveness in a market-driven economy. It is from small businesses, the start-ups, that the future medium, large and globally successful companies eventually evolve.
Recent lurid headlines in the UK popular press underscore the underlying and serious problem of the SME ‘financing gap’. The recent headline ‘And Still The Banks Betray Our Small Firms’ is a good example of the strong populist and critical view on the lack of needed bank finance to support businesses. This latter article points out that the latest Bank of England figures show that UK bank lending to business has fallen in every quarter during the past three years.
The Governor of the Bank of England spoke out (on February 15) about the ‘harsh treatment’ of small businesses, which are are still suffering at the hands of the banks. He talked about the ‘market failures’ resulting from the lack of bank lending to businesses who are unable to grow and drive the economic recovery.
There have been no shortages of promises and assurances from the banks, but the reality is that bank lending still appears to fall short of pressing needs. The much vaunted ‘Project Merlin’ (in which the banks agreed to make extra lending to the SME sector) has not delivered. In the wake of these experiences, the UK Government is now even more strongly focused on solving the ‘financing gap’ problems (indeed, many would call it a ‘crisis’) of the small business sector. In mitigation, there have been (and are) many significant Government moves to help alleviate the problem.
The UK Chancellor has recently agreed, for example, to make an additional £20bn available to smaller businesses through cut-price loans arranged with the banks. This will be funded out of the Bank of England’s QE (Quantitative Easing) facility of £40bn, itself a partial response (via more ‘credit easing’) to these same SME financing problems.
New reforms (recommended by the recent ‘Vickers Commission’ in the UK) aim to ring-fence retail (so called ‘utility’)and investment (or ‘casino’) banking within individual banks. However, this significant move is longer term (it will take at least eight years to implement fully) and it will be costly (up to £8bn a year is one estimate). These latter costs will likely be borne ultimately by banks’ customers.
There is no shortage of other ‘big ideas’. Professor Robert Skidelsky (of Warwick University, UK), a political scientist, has argued for a new British Investment Bank (BIB). In similar vein, Professor Phil Molyneux (Bangor University, Wales, UK ), a leading European researcher and international expert on banking, has advanced a strong case for a ‘mega state bank’ for the UK .
The recent March Budget in the UK was primarily (albeit somewhat ‘stealthily’) one that was helpful for London as one of the major financial centres of the world. This is important since ‘the City’ (London’s financial centre) is economically vital to the UK economy and one of its real success stories. At the same time, there was also a lot of help for the beleaguered SME sector. This help included a lowering of the corporate tax rate, increasing apprenticeships and improving broadband speeds in ten key cities. Simplifying the tax regime so that small businesses can now pay their tax on a cash basis was another helpful move. However, the number one issue for many SMEs remains the need to obtain needed funding to grow and to sustain this growth.
Britain’s biggest business lobby, the CBI (Confederation of British Industry), warned in February that small businesses in the UK cannot rely on banks for badly needed cash to grow. John Cridland (the Director General of the CBI) warned that other countries will ‘steal a march’ on the UK if this ’credit gap’, as he termed it, is not closed. The CBI argued the case for a range of funding alternatives to bank borrowing for small businesses. A rather radical proposal (at first sight) in this vein is that SMEs should be encouraged to issue bonds as an alternative to bank finance. But perhaps this is not so radical a proposal, but rather an evolutionary one. It was not so long ago, for example, that banks dominated in the provision of external finance to medium-sized companies, especially in historic bank-orientated countries like Germany. But the rise of capital markets and innovations like commercial paper (CP) issued in capital markets attacked this historic dominance and forced the banks to innovate and compete more effectively
The recent (March, 2012) UK BIS Taskforce Report ‘Boosting finance Options For Small Business’ has attracted a lot of interest and growing support. This Report argues that businesses have become too reliant on bank finance (which apparently falls short of demand) and (like the CBI) it develops strong arguments for alternative forms of finance and other changes. Led by Tim Breedon (CEO of Legal and General and Chairman of the Association of British Insurers), the industry Taskforce estimates that the ‘financing gap’ arising from the expected constraint on the continued unavailability of funding from banks and other sources could be £84bn to £191bn over the next five years. This is enormous and quantifies the scale and severity of the problem, which is clearly systemic (system-wide) and structural (the present institutional structure is simply not working).
The Taskforce believes that this gap could be addressed through several measures, which signals a clear vision that this problem is both systemic and structural. They suggested it would help, for a start, if smaller business were facilitated to be ‘better consumers of finance’ . For example, by clearing up the ‘alphabet soup’ of business support schemes and learning from other countries who do it well in supporting smaller businesses. In this context they propose an important role for the main professional accountancy bodies in advising and helping smaller businesses (and these professional bodies have already moved more strongly in this direction). Another key recommendation is the need to nurture and encourage the use of new and innovative financial instruments to raise needed finance in the UK financial markets that circumvent existing funding channels (like the banks).
Another important recommendation is to create two new agencies and to unify present Government interventions under a single brand. This would create an entity that discharges many functions undertaken by state-owned business support agencies, like KfW in Germany. The Taskforce suggest that such a new mechanism would tackle the existing ‘market failures’ that prevent businesses (especially the smaller ones) accessing bank finance.
The Taskforce recommendations are the latest and most important to date that address the present ‘market failures’ associated with the apparent inability of the SME (especially the smaller business) sector to access needed external finance from the banking sector (which is currently the only viable option for most smaller businesses). This is a detailed, well-supported and cogently argued Report. It addresses ‘head on’ the systemic and structural features of the UK SME ‘financing gap’. It builds on and incorporates the ‘good ideas’ previously mooted, and recognises the need to emulate as appropriate to the UK context the best practices of other successful countries in addressing these problems.
Tim Breedon and his Taskforce have done a good job. Let us hope that the UK Government gives this important Report the backing and resultant policy action it merits. The needed policy response should be rapid, substantial and sustained.
This is a ‘watershed’ report. The future competitive positioning of the UK economy in the global market may well hinge in significant part on how strongly the UK Government responds to the Breedon message. So far, though, Government support looks to be strong and enthusiastic (after all, it was Government that commissioned it!). At the same time, the implicit market threat to the banks may be the only effective lever to get them to innovate and respond in order to protect their historic, unique position in the provision of external finance to the smaller business sector.
Professor Ted Gardener
