The real reason small businesses aren’t borrowing more from their banks

Anthony Browne
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ALMOST every politician I meet asks me one question. Often with a hint of menace, they demand: “why are banks refusing to lend to small businesses?” They say their postbags are full of complaints from small to medium-sized enterprises (SMEs) that banks are refusing to approve or renew loans or overdrafts. In reply, banks point out that they make money by lending, and insist it is a demand issue – that fewer SMEs are coming to borrow

But this drives politicians to fury: if SMEs didn’t want to borrow, they wouldn’t be complaining about the banks. From enterprise guarantees to the Funding for Lending scheme, making banks lend to businesses is a priority for the government. So what is really going on?

Whichever way you look at the issue, there has indisputably been a decline in demand for finance among SMEs. Over the past year, the number wanting loans or overdrafts has dropped by about a fifth. The trend is similar in the number of SMEs that actually apply for these products. Approval rates have stayed roughly stable, but fewer applications inevitably means lower lending.

But why do fewer SMEs want to borrow? Surveys suggest one main reason: lack of confidence in the economy (followed distantly by lack of confidence that they would get the loan). Like big companies and households, when small businesses are worried about the future, they don’t take out new loans. They pay off old ones and build up savings. The entire SME sector has become a massive net depositor, with its surplus over borrowing rising from £8bn to £21bn over the past year – a massive cash stockpile.

But that doesn’t explain complaints from SMEs. It also doesn’t explain why the 40 per cent of SMEs who exercise their right to appeal, after being turned down, get the decision reversed.

One reason is that, before the crisis, a less risky economy encouraged a lot of lending to small businesses. SMEs were sometimes given overdraft facilities almost as big as their entire annual turnover, when best practice says that it should be no more than 10 per cent. Banks are also under immense pressure from regulators to reduce high-risk lending, and many SMEs are finding the adjustment understandably difficult. Too often banks failed to sensitively communicate the new situation to their customers, took away experienced relationship managers, and used blunt decision-making processes. This is something they now recognise, and are working hard to change.

But is the lack of lending to SMEs undermining the economy? Over the past year, just 1.5 per cent of all SMEs had a loan rejected. Whatever problems the other 98.5 per cent had, it wasn’t caused by a lack of lending.

If an SME wants finance, it should apply. It might get the answer it wants.

Anthony Browne is chief executive of the British Bankers’ Association.