If we rewind the clock a few years back, no issue attracted media attention like the state of the financial sector. Over the past couple of years, access to finance seems to have been pushed down the pecking order, with issues like fiscal consolidation, the trade deficit, general elections and more recently Europe capturing the bulk of newspaper headlines.
One of the many consequences of the EU referendum outcome is bringing access to finance issues back to the fore. The slump in bank shares following the Brexit vote has raised the alarm bells about liquidity in the financial sector and the possibility of banks reigning in credit as confidence dwindles about the economy’s ability to absorb this economic shock. The Bank of England (BoE) was quick to move by taking a range of steps to mitigate a potential tightening in credit conditions, including lowering the base rate to 0.25%.
But deficiencies in the access to finance space is not something new. Not for the BOE, not for EEF, not for the SMEs who have struggled to secure funding and certainly not for the Competition and Markets Authority (CMA), which has been running a two year investigation into competition failures in retail banking services for personal customers and SMEs. This investigation is set to conclude tomorrow with the CMA delivering its final remedy package.
Ahead of the CMA’s announcement tomorrow, EEF released its “Manufacturers’ attitudes towards external finance” report, aiming to gauge our members’ appetite – or more correctly lack of appetite – for bank funding.
Manufacturers are reluctant to access bank finance
Our results show that manufacturers are reluctant to access bank finance nearly a decade since the onset of the Great Financial Crisis. Indeed, a -28% balance of manufacturers are more likely to use external finance than two years ago.
That’s despite manufacturers – pre-EU referendum – planning for solid levels of investment and despite the availability of affordable credit after seven years of historically low interest rates. And that’s not because manufacturers think they can’t get credit; a balance of +69% are confident they would secure bank finance if they needed it.
It’s worth noting however that this proportion declines by business size, with a balance of +81% of large companies confident of accessing external finance compared to +66% of SMEs. This trend reflects incoming data over the past years that shows that while credit supply has improved considerably over the past 2-3 years, credit conditions remain comparatively constrained for SMEs.
So why are manufacturers shunning bank lending?
Manufacturers are confident they can secure finance if they need it and have solid plans to invest in their business. But they‘re unlikely to use bank finance to fund those investments. This begs two questions; why are manufacturers shunning bank lending and how are they funding their investment plans? We think we have the answers to both questions.
First, over the past few years, our discussions with manufacturers have suggested that they remain disengaged from the banking sector, with the legacy of the financial crisis still playing a significant role. The absence of product diversity, small differences in price, lack of transparency and poor banking relationships have also been cited as important factors. This has made manufacturers wary of leveraging their business with bank debt or rely on products such as overdrafts for working capital.
Second, manufacturers have built up cash reserves to finance their investment plans internally. In 2016, 55% of manufactures agreed they are holding more cash on their balance sheet compared to 42% in 2014. Crucially, more than half of manufacturers (53%) agreed that they will postpone or cancel investment if they cannot fund it internally.
Is there light at the end of the tunnel?
So, manufacturers have a strong preference for relying on their own resources to grow their business. But that indicates that overall levels of manufacturing investment are likely to be supressed compared to the counterfactual.
Not all is lost however; there are a few things that could lure manufacturers back into bank lending. Manufacturers have stated that demonstration of manufacturing-specific expertise (53%) at more competitive prices (59%) are important factors when choosing their main bank. An easier switching process could also prompt manufacturers to search for a better deal (60%), generating some churn in the market.
The type of financial products manufacturers are more likely to consider is also a useful guide for banks looking to attract manufacturing businesses. Manufacturers are still more likely to use ‘traditional’ finance products, such as medium-term debt (64%), asset finance (56%) and overdrafts (50%). On the other hand, alternative finance products are low down the rankings (19%), along with equity finance (30%), with manufacturers reluctant to give up a stake of their business to secure funding.
What’s more, the increasing importance of investment in intangibles could mean that the development of IPP-backed financial products could fill an important gap in the access to finance space and possibly entice manufacturers to re-engage with the banking sector.
What needs to be done?
This situation is far from ideal; if the new Government is committed to a more investment-intensive and productive economy, a solution is imminently required. This is even more so given that the Brexit vote is likely to further aggravate existing competition failings in the financial sector. Uncertainty about economic growth dampening businesses investment plans will not help either.
Hopefully, the conclusion of the CMA’s investigation – which is likely to include measures alleviating some of the concerns identified by manufactures in our report – will provide a significant opportunity to put these deficiencies to bed and ensure the financial sector is fit to support growth in the real economy over the long term. Wholesale adoption and swift implementation of the CMA’s remedy package by the Government will be key to this process.