James Sherwin-Smith, CEO, Growth Street

Small and Medium Enterprises (SMEs) are the lifeblood of the economy according to our Chancellor. He’s right – SMEs are responsible for most of the UK’s economic growth and rise in employment. Without finance, SMEs will struggle to grow.

The Breedon Report (2012) studied this issue and forecasted that by 2017, UK businesses would face a funding gap of between £84bn and £191bn. Despite this warning, there has been relatively limited progress in increasing the amount of finance extended to SMEs, and after several years of contraction, it is only at the beginning of 2015 that we have seen growth in the stock of SME lending after several years of contraction.

Chart 1: Lending to UK SMEs

Annual rate of growth in the stock of lending. Lending by UK Monetary Financial Institutions (banks and building societies) to UK SMEs. Data cover loans (including overdrafts) in both sterling and foreign currency, expressed in sterling. Not seasonally adjusted.
Source: Bank of England[1]

Most commentary on SME “access to finance” focuses on volume. However, there are several, significant non-volume issues that impact access. We all need to look behind the quantity of finance to make sure the type, terms and price of finance are appropriate for SME needs.

Provision of business overdrafts down 49% over the last 13 quarters.

The availability of business overdraft lending has been significantly reduced.  Statistics show that there is a chronic undersupply of overdraft facilities to SMEs.

Bank of England data shows that the balance of overdrafts drawn by SMEs has fallen by 40%. In addition, according to the BBA, the number of approved facilities to smaller businesses is down 49%.[2]

Chart 2: Reduction in the supply of business overdrafts (2011-2015)

Source: British Bankers’ Association, SME Finance Statistics, 2015 Q3

Overdrafts are the best tool for managing cash flow efficiently, as beyond a fee for the facility, you only pay interest on what you borrow, when you borrow. This makes it an ideal solution for short term working capital.

The rise of less flexible, more complex, and more expensive alternatives to short term working capital problems are limiting growth.

In our view, banks are deliberately diverting eligible SMEs away from business overdrafts towards what are arguably more complex, and more expensive, invoice finance products. Data from the Asset Based Finance Association (ABFA) confirms this trend: advances have risen from £15.5BN in June 2012 to £19.9BN in September 2015 – a 29% increase over the period.

Chart 3: Growth in different asset based finance products since Q3 2012

Source: ABFA Quarterly Statistics to September 2015[3]

The price of commercial finance is not transparent

The Competition & Markets Authority (CMA) noted as part of its investigation into the supply of SME banking services in the UK:

“[I]t is difficult for SMEs to compare prices across banks. Prices are opaque and lending products are complex. Banks do not publish indicative tables of interest rates and management fees unlike other lending products such as residential mortgages.”

“[T]he generally bespoke nature of SME loan pricing, which will typically reflect the specific risks associated with a given SME customer, has meant that it is difficult to carry out an equivalent analysis of prices on SME lending products.”

If the CMA itself struggled to analyse prices, it is clear that SMEs need more support.

The CMA has proposed a price comparison website for SMEs. However, without an Annual Percentage Rate (APR) that is mandatory for all providers to supply, it is unclear how SMEs will be able to effectively compare prices.

Steps to improve access to finance for UK SMEs

Legislate to ensure APR is mandatory across all commercial finance targeted at SMEs

This single measure would help SMEs easily access and select finance on more competitive terms, by making informed choices between products and providers, supported by transparent price information.

Justin Fairhall, MD of the Lunchtime Company and Growth Street customer, said:

“It should be of considerable concern to all business’ that APR is not a legal requirement in the commercial world. It’s worrying that if I personally borrow from a bank, they have to tell me the APR, but if I borrow as a business, they’re under no such obligation.”

Implement the referral scheme enshrined in the SBEEA (2015) to ensure that businesses rejected for bank finance receive the products they need from alternative providers, on appropriate terms.

This provision of this new law is still not implemented, and businesses might have to wait until at least autumn 2016 for this to go live. In effect, a state utility is being created, with the work done by private contractors (aggregator platforms) that will look to maximise profits – who will ensure SMEs receive the appropriate finance for their needs?

It is also unclear what banks and the government will do to encourage more business finance applications. Most SMEs today are deemed ‘discouraged borrowers’ and are unlikely to apply to a bank in the first place.

Remove any remaining red tape that’s stopping the British Business Bank (BBB) from deploying capital to SME finance providers.

The BBB has two arms. The commercial arm runs an Investment Programme to help non-bank platforms lend to SMEs. The funding available was extended to £400M in 2014. However, according to the BBB 2015 annual accounts, over 40% of these funds were still yet to be committed, and less than 10% were actually being lent out.

Help to Grow (H2G) is a new initiative that has emerged from the non-commercial arm of the BBB (which also operates the Enterprise Finance Guarantee scheme.) H2G could be an important driver of finance for SMEs.

Act faster on the proposed remedies put forward by the CMA investigation into the supply of SME banking services.

The CMA process needs to run its statutory course, but many of the solutions will increase competition and could be accelerated now.

The latest indications from the CMA is that the timetable for this work is actually getting longer, not shorter, as they continue to seek consultation on the remedies proposed.

[1] http://www.bankofengland.co.uk/publications/Pages/fls/q315.aspx

[2] https://www.bba.org.uk/news/statistics/sme-statistics/bank-support-for-smes-3rd-quarter-2015

[3] http://www.abfa.org.uk/statistics/2015/Q3%202015/ABFA%20Statistics%20Q3%202015%20-%20final.pdf