State bank not yet obvious solution - Part 2 - Growth Capital | EEF

State bank not yet obvious solution - Part 2 - Growth Capital

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10 days ago I blogged on the range of problems a state-sponsored bank is being touted to address by its various supporters.

Today I'm going to focus in on the problems we're most interested in and start testing whether a state bank is the best solution.

If anything, this has got even more topical following the [re]leak of a Vince Cable letter during our National Conference last week, which mentions using the government's shares in RBS to force that bank to lend more to SMEs, and Labour, also at our Conference, seem to be coming out more strongly in favour of a British Investment Bank.

The main problems we see in access to finance are:

• Lack of growth capital to fast-growing SMEs;• Costs and T&Cs on lending to SMEs through the banking system;• Lack of availability of alternative sources of finance.

Is a state bank the answer to the lack of growth capital for SMEs?

After WWII, the Bank of England and the major UK banks of the day created the Industrial and Commercial Finance Corporation (ICFC) to provide growth capital to SMEs. ICFC later became 3i.

The idea was to provide SMEs with a patient source of capital (either debt or equity) that they could otherwise not access being too small or lacking sufficient assets to access capital markets directly. This is an important but small subset of all SMEs – an important point when considering the scale of the institution.

As time went on though, 3i started to drift from its original mandate towards producing more commercial returns, inevitably focusing on larger deals where the costs per deal were lower and returns per deal higher.

Eventually the banks sold out of their shares in 3i, which became a publicly listed company on the LSE in 1994.

However, the original gap that 3i was set up to address remains – most recently re-confirmed by Chris Rowlands growth capital review of 2009.

So on the face of it there may be a case for some kind of institution to address the growth capital gap today. And indeed the last Labour Government and (briefly) the Coalition contemplated such an institution that was to be called the Growth Capital Fund.

This Growth Capital Fund was to be far from a state bank. It was to focus on a particular gap in the market where commercial lenders are not supporting a subset of SMEs – identified as firms with turnover of up to £100 million looking for £2-10 million in patient investment capital.

The GCF would structure its investments as ‘mezzanine finance' – a broad term capturing structures in between debt and equity. The thinking here was to counter the well-documented SME aversion to raising new equity.

The GCF however was dumped. This was mainly because the banks were reluctant to chip in funding (would be interested to know why this was) and instead independently decided to set up their own ‘Business Growth Fund'.

The Business Growth Fund is a £2.5 billion equity fund targeting the same growth capital gap identified by Rowlands. Although the BGF has a lot going for it, particularly its patience for returns, the one part of the Rowlands Review it has not followed was the deal structure – equity rather than mezzanine.

Seemingly the government has recognised that something remains to address. Complaints on access to finance by SMEs and a disappointing business investment performance in 2011, even as firms build up cash reserves seem to be prompting further action.

At the Autumn Statement it included a £1 billion pot of Business Finance Partnership funding under its ‘Credit Easing' announcement for non-bank lending channels to mid-sized companies.

We're pushing for some of this funding to support investments in supply chains where growth capital is difficult for some growing SMEs to secure. Government announcements on the first round of the BFP are due at (or perhaps before?) the Budget.

The two strands of action above from the banks and the government may well prove to be insufficient to address the growth capital gap in the UK. But it does suggest to me that we might want to be cautious before falling in whole-heartedly behind a state bank until we at least know what impact these interventions are having. A state bank to this problem is not yet an obvious solution.


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