EEF blog

Insights into UK manufacturing

Merlin sails on but BoE report shows cause for ongoing concern

Andrew Johnson August 05, 2011 11:01

This week has seen the major UK banks jump the gun on the Bank of England and effectively release the results of their lending to businesses against the ‘Project Merlin’ targets agreed with the government.

We’ve always said the Merlin agreement is positive insofar as it shows intent from the banks to get lending flowing. And the fact the banks are following through on their commitment by staying on track with their targets (although slightly under for SMEs) is encouraging.

But let’s not kid ourselves that this is the final answer.

Look at what the Bank of England’s July Trends in Lending report is saying:

  • Lending to businesses contracted in the three months to May;
  • Spreads (the cost on lending relative to a reference rate) are still worsening for smaller firms – even as they narrow for medium and larger firms (who tend to have other options anyway);
  • Interest rates are drifting up for the smallest firms (turnover under £1 million)
  • And the Bank of England’s Credit Conditions Survey for 2011q2 shows strong demand for finance from SMEs despite banks saying the opposite is true.

So as we look at a disappointing quarter 2 for the economy in general, and UK manufacturing in particular, is access to finance still a problem? Yes

Investment isn’t happening and while a lack of confidence in the outlook for demand surely takes the lion’s share of blame, access to finance is also part of that picture.

Crucially it’s a part that can be influenced.

Well intentioned as it might be, Merlin will not be the complete answer. We need to see more debate about additional action that might be needed to get finance and investment moving again.

Both the banks and the government have a responsibility to stimulate this debate.

Hiding behind Merlin's smoke

Andrew Johnson June 17, 2011 11:26

On Monday this week we had a story in the FT claiming that the real Merlin lending targets for UK banks didn’t actually appear in the final published document.

Instead ‘stretch’ targets, insisted on by the government were used – even though the banks have no expectation that demand will emerge sufficient to meet these figures.

Separately there are ‘real’ targets, which are about 10% lower, that the banks, happily enough, look on course to meet.

HMT seems at odds with Business Minister Mark Prisk on this but the whole story creates uncertainty around how tough the agreement really is.

No doubt this sets up a nice wheeze for both the politicians and the banks at the end of the process next February where both can save face on lending results.

The politicians can say they pushed the banks as far as they could and can make threatening noises all through the year about what will happen if the banks don’t meet the targets, all the time being less than frank about what these targets actually are.

Next year, the banks can justifiably point to the real agreement on lending, which they believe they will honour, and say that demand hasn’t materialised for the government’s ‘stretch’ ambitions.

Of course left out of all this game playing in the press will be what’s really happening to access to finance in the UK and whether it is improving.

From the start we were sceptical about the value of lending targets – gross or net, stretch or real – as a tool to deliver better credit conditions for UK firms. The targets are hard to enforce and potentially meaningless (if net lending continues to contract, credit could conceivably still be withdrawn from SMEs, as Vince Cable himself said in March 2010).

That’s not to say we want Merlin to fail. If it turns out that credit conditions improve and Merlin has had some role in that, great. And it’s encouraging to see from our latest credit conditions survey that availability of finance, including for smaller firms, appears to be improving.

But the bigger risk is that Merlin ‘succeeds’ however that’s framed and that debate on improving access to finance is shut down.

Already the government seems to use Merlin and the banks’ own set of commitments as an excuse for doing little to improve access to finance.

Commendable as the banks actions are, it shouldn’t be a surprise to anyone that they will primarily act in their own interest and not necessarily go as far as would be warranted in the interests of the wider economy.

We’ve consistently called for progress in four areas:

• Improved competition in the banking sector;
• Increased sources of finance outside banks;
• Better real business expertise in the financial sector;
• Better customer services.

Rather than hiding behind Merlin’s smoke and mirrors the government should be thinking hard how it can address these areas.

Cable talks SME lending in solo show at BIS Select Committee

Andrew Johnson June 10, 2011 15:24

This week saw Business Secretary Vince Cable turn up to the BIS Select Committee on Wednesday to answer questions on bank lending to SMEs.

His colleague from 1 Horse Guards Road, the Chancellor of the Exchequer, was invited too. But George Osborne politely declined, a move that seemed to frustrate committee chair, Adrian Bailey.

Bailey suggested Osborne was the real organ-grinder to Cable’s monkey when it came to the banks, meaning a Cable-only appearance was more of a side-show than the main event.

Cable calmly deflected criticism of Osborne’s no-show, suggesting the two had distinct – but related – responsibilities – and in any case everyone’s calling the same tune. And with that the meeting turned to matters of substance.

While Cable didn’t come out with a whole lot that was new, he did raise a couple of interesting points.

Firstly, Cable repeatedly drew attention to the non-transparency from the big banks – with the exception of Lloyds and Santander – as to how they were linking CEO pay to SME bank lending.

This pay-link was a commitment under the Merlin agreement on bank lending reached between the banks and the government in February.

In Cable’s view, incentives of this nature were key to changing the internal culture of banks, which needed addressing in his view because the decline in ‘relationship-based banking’ was a major drag on lending to SMEs. Cable repeatedly came back to not knowing how the banks were applying their incentives – but that he really wanted to know. That’s the first inkling of any kind of a challenge to what the banks are doing from the government in a few months.

The second interesting point Cable made was with respect to competition.

Cable said that the Cruickshank report of 2000, which noted that the SME lending market was uncompetitive and high cost, still stood.

If he thinks that’s the current situation it implies he has in mind a new landscape that is characterised by more competitive SME lending and lower cost, linking, one would think, to the ICB’s Sir John Vickers’ call for additional branches of Lloyds to be sold.

Again this seems somewhat at odds with the banks, which themselves were represented at the Treasury Select Committee later the same day (albeit to discuss the ICB’s recommendations not SME lending).

HSBC’s Douglass Flint said a break-up of RBS or further sell off of Lloyds’ branches was not really the way to drive competition in SME lending. Customers will make their choices of institution based on the perception of a bank’s strength, possibly driven by brands.

And Lloyds’ Antonio Horta-Orsorio has, not surprisingly, come out strongly against extending the sale of Lloyds’ branches beyond the currently agreed 600.

It would have been interesting to have George Osborne’s take on it given City A.M.’s comment this week that HM Treasury and Lloyds seems to be ploughing ahead with selling just the 600 branches, which apparently will make it hard to add in more branches later.

So an interesting little appearance from Cable that shows despite relatively modest steps to date, the government is still thinking hard about SME lending and wants to see more from the banking sector on how it’s going to improve.

Good signs on credit availability but cost still a concern

Andrew Johnson May 31, 2011 11:09

Last week we were disappointed by data suggesting that on a pro rata basis, the banks were falling short of their target of lending to SMEs agreed in February with the government under the so-called ‘Project Merlin’. That data related to 2011q1.

EEF’s latest credit conditions survey, conducted in April and May, gives the first indications of credit conditions in 2011q2.

And as we have noted in the press, we are pleased that at last we have some good news on access to finance for SMEs in the UK. Our survey shows a net positive balance of companies reporting an increase in the availability of credit in 2011q2 – the first such positive balance since we started asking these questions in 2008q4.

Perhaps more important than this overall balance however, is that small companies in particular – those with up to 100 employees – are showing an even balance with as many small firms reporting an increase in availability as a decrease. This is a change as until now small firms balances for availability have been consistently negative.

Access to finance has until now been very much a two-sided story. Larger companies, which also happen to have more options available anyway, have consistently found it easier to access finance.

Smaller firms on the other hand have struggled. They rely on accessing credit through banks. Since the financial crisis banks have been less keen to lend to SMEs, at least partly because the banks needed to wind back their exposure after having over-extended themselves.

So an even balance for small firms is potentially a key breakthrough.

The next announcements to watch on credit conditions will be the Bank of England and BBA lending trends figures for April and May coming out in June.

But before we break open the champagne and pat the banks on the back, we need to recognise that the cost of credit continues to rise.

The availability of finance, on existing credit arrangements, shows a balance of -7.3% overall, falling to -13.3% for small firms in particular. This backs up what we hear from talking to firms that when they are refinancing with their bank, they’re finding the costs and conditions tougher.

And further, unfortunately, 2011q2’s survey showed a continuation of the trend in place over the course of the recovery, with a persistent balance of companies reporting an increase in the cost of credit.

This is virtually unchanged with a negative balance of 28.3% for all companies reporting an increase in the cost of new lines of borrowing, decreasing further to -30.2% for small companies.

The fact that some small companies must be entering their second round of refinancing since the financial crisis implies that margins are persistently lengthening from the finance providers.

The cost of finance issue, particularly if we consider costs outside of headline rates, is suggestive of the need for higher competition in the UK banking sector.

And despite the availability result, the two speed finance recovery between small and large firms continues, especially on cost; suggesting a greater variety of sources of finance is very much still a relevant concern for SMEs.

Business Growth Fund launch - now we need to see access to finance improve

Andrew Johnson May 19, 2011 09:39

Today in Birmingham the BBA Taskforce banks are launching the Business Growth Fund (BGF), providing equity investments for growing SMEs with turnovers of £10-£100 million, looking for £2-10 million.

For the avoidance of doubt this is the banks’ fund, which they committed to as part of their Taskforce commitments in October. The Merlin agreement in February bumped it up from £1.5 billion to £2.5 billion (viz Cable on the radio this morning not a representative of the banks) but there is no government money in here, not even the £50 million previously set aside for the idea that preceded the BGF, the Growth Capital Fund.

We’ve welcomed the intent to address the growth capital gap, identified most recently in the 2009 Rowlands Review, that is holding back some promising UK companies from growing.

Even though this is funded by the banks, it does go towards supporting an increase in sources of finance outside of traditional bank lending – especially important for fast growing companies where bank lending is not appropriate.

This is an area where we have previously called for progress. And we’re further encouraged by positive noises about the BGF’s board including people with real business (even manufacturing!) expertise, again something we’ve been looking for in the financial sector.

However, the launch of the fund again highlights the limited progress being made in increasing the provision of mezzanine debt finance that the Rowlands Review recommended as the best way to address the growth capital gap.

This is important because often growing SMEs have an aversion to giving up an equity stake in their business and the control that goes with that. The BGF will take a seat on the board in the companies it invests in with stakes ranging from 10-50%.

How much this impedes the progress of the Business Growth Fund i.e. by discouraging take up will need to be closely monitored.

With the launch of the BGF all 17 of the Taskforce banks’ commitments set out in October are underway. And of course we have the government’s ‘Project Merlin’ agreement with the banks to increase lending to UK businesses.

However, signs of an improving landscape, particularly for SMEs have been slow to emerge following the financial crisis.

So now we get to the point of all this – improving access to finance. We need to see it happen – and sooner rather than later. And we need to start hearing from the government what that improvement looks like and by when.

The Prime Minister said on Tuesday that Merlin was very much his. While I couldn’t follow his logic on gross v net lending targets, I do agree with him that, so far, results in lending trends have been disappointing. Cable said this morning there's PwC analysis out on Monday looking at performance so far, my hunch is that this too will disappoint.

However, the PM believes the performance of banks needs to judged over the full year of the agreement not off partial data. Fair enough.

But the clock is nevertheless ticking for the actions of both the banks and the government to deliver results. And the benchmark isn't some number on gross lending, which could turn out meaningless if net lending is withdrawn from the economy. The benchmark is meeting the government’s own ambition set out in the Plan for Growth to see ‘more finance for start ups and business expansion’ and inadequate access to finance no longer holding back growth.

With the actions announced so far we’re hopeful of seeing access to finance improve but progress is far from guaranteed.

We need to be thinking now about what more could be done if present measures prove insufficient. Growing companies looking for credit and the UK recovery more generally cannot afford to wait.

This is an informal blog about manufacturing and the economy written by EEF's policy and representation staff. While it is written from an EEF perspective, contributions should not be taken as formal statements of EEF policy, unless stated otherwise. Nor does it cover all the issues on which we campaign - you can check these out in more detail at our main site.

We welcome and encourage comments, but we reserve the right to remove any that are offensive or irrelevant. We are not responsible for the content of external internet sites.

About EEF

EEF helps manufacturing businesses evolve and compete.  We provide business services that make them more efficient and management intelligence that helps them plan.  Our work with government encourages policies that make it easy for them to operate, innovate and grow.

Find out more at