On Monday Andrew outlined our recommendations for improving access to finance for SMEs. Over time access to finance has been becoming more and more difficult for SMEs. We have seen changes in a number of finance conditions that are adversely affecting SMES, the main ones being:
- The availability of bank finance has tightened: The Bank of England's Credit Conditions survey shows fewer lenders are reporting increasing the availability of finance for small companies and EEF's own Credit Conditions Survey shows some declines in the availability of borrowing for both new and existing lines of credit.
- The cost of finance has been rising: Spreads and fees on small business lending are increasing according to BoE's Credit Conditions survey.
- The terms and conditions of finance have changed: anecdotal evidence suggests personal guarantees are becoming more common and the covenants in lending agreements are being applied more rigorously.
SME access to finance issues are one of a number of factors holding back investment and ultimately growth
The OBR has successively downgraded forecasts for business investment in 2012 and 2013 and cumulatively, actual investment is down by more than £20 billion when compared to initial forecasts in 2010. Not all of this can be attributed to access to finance but there is enough evidence that shows us that this is a material issue:
- A recent EEF survey found that 37% of manufacturers have viable investments going unfunded due to problems accessing the finance they need. The equivalent figure was higher for SMEs, with almost half of saying they were unable to fund viable investment because finance was not available at the right cost, with the right terms and conditions or investors lacked knowledge of manufacturing businesses.
- Official data also shows a close correlation between business investment in the UK and total outstanding loans to businesses.
As Andrew pointed out in his earlier blog, we need to see SMEs investing and growing. Lowering the cost and increasing availability of finance for SMEs will go a long way helping them do just that.
We need more competition in SME banking
Access to finance challenges have been debated and discussed a lot in recent times. The Government has also acknowledged the issues and has introduced a number of interventions such as Funding for Lending, the Enterprise Finance Guarantee and Project Verde and more work is underway looking at an aggregation institution and the role of a business bank in grouping all government's finance interventions. We support these interventions and believe they will have an impact in the short term and at the margin but further action needs to address the underlying structural problems in SME banking.
Structurally, the UK SME market is very concentrated: 85% of the UK SME market is concentrated in four providers (and has become more concentrated over time). Studies have shown that markets with higher concentration in the banking sector have higher average lending rates than less concentrated sectors. Lowering concentration through increasing competition in SME banking would therefore be one way of reducing the cost of finance for SMEs.
There are other benefits of greater competition, particularly from the entrance of a new player into the market: A new bank would be able to provide an additional source of credit to SMEs, increasing the amount of finance available on the market. Not only this, a new bank would be able to take advantage of a healthy balance sheet to access cheaper lines of credit which could then be passed onto customers.
We believe there is a clear case for increasing competition in the banking sector and, with some fast action, improvements in the availability and cost of finance for SMEs could be visible within five to ten years. On Friday we will outline our specific recommendations for increasing competition in SME banking.