Following the financial crisis the number of SMEs in the UK has risen. In 2014 there were over 5 million SMEs accounting for 99.9% of all UK businesses. Competition in providing financial services to small businesses has also increased but the main high street banks still dominate the provision of SME finance. The recent Competition and Markets Authority (CMA) report on business retail banking was a response to concerns that despite more competition in the sector, small businesses often struggle to get access to the finance they need to survive and thrive. Unfortunately the report’s recommendations were disappointing. As consumer campaign group Which? said “The steps outlined, to provide customers with better information and an improved switching experience, are welcome. However it is questionable whether these measures will be enough, not only to increase competition but also to ensure banks deliver a better service for their customers.” The same week, the FT reported that thousands of small businesses with Royal Bank of Scotland current accounts will be hit by monthly charge increases, some of more than 200 per cent, due to the bank’s attempts to streamline fees.
There are mixed views about how serious the problem is of access to finance for small businesses is, the nature of the problem and solutions to that. In December 2015, Iain Wright MP, Chair of the Business, Innovation and Skills (BIS) Committee, launched an inquiry into access to finance. In doing so he said “After real difficulties during the credit crunch, business access to finance appears, superficially at least, to be back to normal. But small businesses, in particular, still say that access to finance is one of their biggest obstacles to future growth.”
Evidence submitted to the inquiry painted a mixed picture. One the one hand BBB Chief Executive Keith Morgan said, “as you well know from other evidence that you have seen, banking markets have improved since the depth of the financial crisis, but it is still the case that the smaller you are as a small business, the shorter your track record, or the more ambitious your growth plan, the less likely you are relatively to get the finance that you need.” But others giving evidence thought the issue was more about small businesses having low levels of awareness about alternatives to retail bank funding and a failure to shop around.
Initiatives such as the Business Banking Insight were designed to promote competition and help small businesses navigate the increasingly crowded and complex world of business finance but it is too early to tell what impact this is having.
What is clear, is that for many of the smallest businesses, including start ups, Responsible Finance providers are still the best option. They not only provide access to affordable finance on appropriate terms but also provide wrap around support so that start-ups and those borrowing to invest or to manage cash flow have the best chance of success.
Responsible finance providers extend credit to underserved markets working directly on addressing barriers to accessing to finance across the UK. Research shows that the sector is on a growth trajectory, lending more and more each year and finding innovative ways to finance the start up and growth of businesses, which are so important to the economy. Last year, responsible finance providers lent £251 million, £98 million of which was to SMEs. Academic research into the sector has shown that for every £1 lent, responsible finance providers generate £7 of economic value, given the businesses and jobs they create and save. In terms of interventions, the sector is also excellent value for money; creating new jobs at 10% of the average cost of government programmes. The market segment that responsible finance providers primarily serve is SME lending up to £150,000, a market others see as high risk and generating insufficient profits.
In line with some of the responses to the BIS Committee’s access to finance inquiry, there are indeed signs of credit conditions improving moderately for businesses with more banks approving loan applications, according to research by the British Bankers Association (BBA). But on closer inspection, trends show that access to finance remains a major barrier for some businesses. In particular, for micro businesses the decline rate remains notably high – 37% for those with 0 employees and 22% for those with 1-9 employees. Based on reports from our member responsible finance providers, the largest demand they see (from businesses that have been previously formally or informally declined by a bank) is micro and small businesses seeking less than £150,000 for start up or growth finance.
Another development in the landscape for access to finance since the financial crisis is the rise of the alternative lending market. Peer-to-peer (P2P) business lending, invoice trading, and crowdfunding have all grown exponentially since 2012. P2Ps alone have lent £3.4 billion to SMEs since then. While this is a positive development in the face of the retraction of bank lending, we should consider whether these alternative lenders are increasing competition at the top end of the market for SMEs that can already access bank finance, or if they are unlocking finance for the segment of the market that persistently cannot access finance.
The evidence indicates that while there is certainly a mix of both, there is a skew towards the former. For those reporting applying for alternative finance (invoice finance or 3rd party lenders), the SME finance monitor reports a decline rate of 45% – higher than banks. From Responsible Finance’s annual surveys 86% of all SME clients had previously been declined by a bank (formally or informally). Only a small proportion (2%) had also applied to an alternative lender such as P2P. This evidence suggests that the risk appetite of the alternative lenders is similar to that of the banks, meaning that the micro, small, start up, and early stage segments of the market, seeking under £150,000 still face significant barriers when accessing finance.
As an example, a software developer and serial entrepreneur in the West Midlands was declined by a bank loan when he tried to start his new business, Synapse, in 2014 because his business was viewed as high risk and the finance sought was too low to be profitable. He was able to secure a £26,000 loan from ART Business Loans, a responsible finance provider, and since has grown his business from 3 employees to 28, and is generating a £1.5 million turnover. The responsible finance sector helps tens of thousands of businesses each year like Synapse, to overcome the persistent gap in access to finance that small and early stage businesses still face, and the drag to the economy that a lack of access to appropriate finance creates.
The issues that prevent responsible finance providers from providing more finance are well-rehearsed, such as access to capital and managing first loss funding. The responsible finance or CDFI model which works so well in the USA does so because of a dedicated CDFI fund. The decision to leave the EU has caused short term instability for many small businesses. But more importantly in the next few years, the loss of access to the European Investment Fund (EIF) which provides guarantees around first loss funding, may well impact on the availability of funding. This means now is the time for bold decision making and the creation of a dedicated fund to support the sector. As the USA CDFI fund states “Each business financed…each job created represents a critical step in the transformation of a life, a family, and a community.” No one can deny the value of that.