Many firms get their break on a marginal loan deal from new banks trying to enter the market.
From an entrant bank’s perspective, riskier customers are the easiest to attract to build a profile and presence in the market as the incumbents have less incentive to hold on to these guys.
Time and again talking to members we were advised of foreign banks trying to break into the UK market in years gone by who provided them with finance early in their development.
I think we need to see more of this happening. Not only as an increase in the number of banking options serving our firms but as a spur to the banks already in the market.
Sir John Vickers’ Independent Commission on Banking reports in September and is charged with improving the sustainability of the banking system.
These proposals – and more importantly the government’s response to them – must also increase competition in the banking sector by lowering barriers to entry and making it harder for incumbents to entrench their position.
The full effects of an enhanced competitive environment in the banking sector are only likely to be felt in the long run but will make a big difference.
The second thing that needs to happen is that more alternatives to bank finance need to sprout up and flourish. The pre-crisis glut of bank debt also helped choke off such alternatives – and helped distort expectations of returns.
To be fair to the banks, one of their Taskforce commitments goes towards addressing this by creating a Business Growth Fund. The BGF will provide finance for growing companies looking for £2-10 million – the growth capital gap identified in the last government’s Rowlands Review.
Crucially though, the BGF focuses on equity. The same Rowlands Review also identified SMEs’ aversion to equity finance as a behavioural barrier to getting finance for growth flowing.
The recommendation was to instead focus on mezzanine finance – a hybrid high return debt product that gets around the aversion to equity. This recommendation remains unaddressed.
Alternative finance doesn’t stop at mezzanine though. We need more private lending, more venture capital, and a readjustment of investors to the post credit boom environment. And we need a more sophisticated financial landscape that progresses firms along the different forms of finance appropriate to their stage of development.
Action here may require thinking from the government about how the tax system encourages – or doesn’t – these types of investors. It may require more fiscal resources than are necessarily available or it might mean moving some around. But it must be a medium term priority that should be addressed during this Parliament.
With little or no extra money however, the financial sector could seek a better understanding of the businesses they invest in. A common complaint I’ve heard is that banks don’t understand manufacturing. But it’s not just the banks.
In venture capital for example, the easy credit years allowed high leverage to do the work on generating high returns rather than relying on expert understanding of particular industries. This isn’t all VC funds – but for the sector overall.
There are encouraging signs on this. The banks Taskforce reinstated a forum for banks and firms to discuss finance. And the banks are determined to reach out to businesses through their network of mentors.
The latter is very much in the vein of how banks can help firms understand finance better and improve their chance of a successful loan application. Laudable but it is focused on improving understanding on the demand side.
It misses the converse idea of banks themselves learning more about business and therefore the risks and opportunities for different kinds of business – that would improve understanding on the supply side.
And what about funds under management? How many people in private equity funds or VC funds are manufacturing experts for example? Some perhaps but not enough. Consider the banks’ Business Growth Fund – what real activity business expertise is being brought to bear in the design of this fund. There’s an opportunity here.
Perhaps most frustrating and visible – but also correctable – is banks’ customer services. The Taskforce again commits to improve these for example through a new lending code, new lending principles, and a commitment to independent review of declined lending applications.
But letting the banks regulate their own adherence to higher standards may at best lack credibility and at worst be ineffective.
On business expertise and customer services, the Business Growth Fund and the (misguided) Merlin – banks have put their cards on the table. The government has a responsibility through its engagement with the Taskforce to drive the banks further and through the coming 'growth budget' to do what it can to further improve access to finance - and where it can't act now give a clear signal of future intentions.