There has been much talk about the dearth of traditional bank loans to SMEs since the credit crunch, with the conventional narrative increasingly detached from reality as market confidence and conditions improve. But this jaded dialogue has disguised another issue: the rapid and seemingly unrelenting decline of the small business overdraft.
In fact, a survey published today and carried out by Funding Options shows that 30 per cent of small firms have had their overdraft reduced or removed in the last two years, echoed in Bank of England statistics showing SME overdrafts currently falling at a rate of more than £5m per day. Imagine an enormous vacuum sucking vital working capital out of the small business community, and you’re pretty much there.
Delving deeper, the economic picture is even bleaker. Promising sectors such as digital and creative rely most heavily on overdrafts, as they lack tangible assets such as vehicles and machinery, and it’s typically the high-growth firms that are most hungry for working capital. Withdrawn overdrafts also threaten to derail George Osborne’s Northern Powerhouse vision and further widen the regional divide, as northern firms are suffering twice as badly as their counterparts in London. Fifty five per cent of northern businesses have seen their overdrafts reduced or removed in the last two years, while only 25 per cent of London businesses have suffered the same fate.
None of this should come as a surprise. The withdrawal of small business overdrafts is an entirely expected consequence of new international capital regulations such as Basel III, designed to make our banks safer by forcing them to hold scarce capital against undrawn credit facilities. Reflecting this, the decline in small business overdrafts is a global problem, as highlighted in papers by the likes of the International Monetary Fund and World Bank. However, it is arguably even more acute in the UK, where smaller banks and building societies have not historically taken a major position in SME banking or lending.
The impact of capital regulations has a disproportionate effect on small businesses, many of which have regular borrowing requirements for both liquidity and growth purposes. The view that Basel III has a negative effect on SME growth is widely held, and increasingly, we are seeing that threat become reality. Yet in spite of small business overdrafts becoming history, the solution is not bank-bashing.
NO MORE BASHING
In reality, bank-bashing has only made things worse – however telegenic it may be for Parliamentary Select Committees. Constantly judged on their SME loan rejection rates, banks often avoid giving answers at all: “going round in circles” and “tearing my hair out” are the kinds of comments small firms regularly use to describe bank loan applications.
Instead, banks need to get better at giving a straight “no” when a firm is unlikely to fit their criteria, and collaborate more effectively with alternative finance providers. The good news is that the UK is probably second only to the far larger US market in its diversity of alternative lenders, with literally hundreds of providers now available.
In addition to the much-vaunted equity crowdfunders and peer-to-peer lenders – areas in which the UK is world-leader – brand new challenger banks have lent billions to SMEs since the credit crunch, and dozens of innovative institutionally-backed lenders have emerged.
Alternative finance is already available for many of the UK’s small businesses, and is being used successfully. Indeed, 40 per cent of those firms surveyed by Funding Options had applied for some form of alternative finance and – in stark contrast to bank approval rates – 82 per cent secured the funding they needed. The bigger concern is that of small business owners’ knowledge and understanding of the market. While some forms of alt fi – such as invoice finance or equipment leasing – may seem relatively mainstream, our survey showed 21 per cent of respondents had no working knowledge of any of them. That’s worrying, not least because these businesses will increasingly find themselves cut off from finance completely.
CHANGING THE NARRATIVE
So how can we connect SMEs to this thriving alternative finance market? Recent provisional findings from the Competition and Markets Authority’s enquiry into SME banking recommended making it easier for SMEs to shop around for loans. This is already possible – so let’s make it happen in months instead of years.
Equally, George Osborne has backed the creation of open standards, making it easier for SMEs to take control of their bank account history to shop around for finance. Here, the UK has an opportunity for leadership in what undoubtedly represents the future face of banking.
Finally, there is a crucial role for government. A recent report by Cambridge University and GLI Finance found that less than half of small firms are familiar with alternative finance, creating a potential £20bn hole in the UK economy. While the industry can help, accessing the huge and diverse small business market is notoriously difficult without government intervention. Past governments changed the game with campaigns such as Tell Sid and Don’t Die of Ignorance – surely this is another opportunity for bold vision.