THE FIVE PRINCIPLES BEHIND A NEW MODEL FOR FUNDING FOR SMEs IN WALES


During the last ten months, the access to finance review commissioned for the Welsh Government has undertaken an extensive analysis of access to finance to SMEs within Wales.

In June 2013, it made a series of recommendations in the first report that are currently being implemented by the Welsh Government. Some of these - including the development of a commercial finance comparison website, close links between the banks and business support, and the improvement of trade credit via the Welsh Government’s own procurement rules - have the potential to make a significant impact on access to funding for Welsh SMEs.

In addition, the launch of Start-Up Loans programme in Wales could provide a major boost in enabling many potential entrepreneurs to have the in initial funding they require to begin a new venture.

The evidence from the report suggest that major challenges still remain and that the current approach in providing access to finance in Wales is not fit for purpose. For the Welsh Government, it should be extremely worrying that Finance Wales has focused its mission, in recent years, on becoming a viable investment fund rather than on supporting the Welsh economy.

In particular, many will be surprised and disappointed at its failure to not only have lower interest rates as allowed under state aid rules but also to fully utilise the financial instruments available to it – such as GBER and de minimis - to provide affordable loans to Welsh SMEs during the economic downturn. This suggests that, in its current form, the organisation is not fit for purpose in delivering the economic development aims of the current administration in Cardiff Bay. Therefore, there now needs to be change in how the Welsh Government can intervene to ensure that businesses are fully supported to develop the Welsh economy.

One of the potential options is whether the Welsh Government should establish a new publicly owned bank. Both Plaid Cymru and the Welsh Conservatives have put forward considered options for this development whilst Professor Colyn Gardner was also commissioned by the Minister to examine the option for the establishment of a new Community Bank for Wales as a potential way forward. The evidence from these submissions may wish to be considered in greater depth by the Welsh Government, especially in terms of creating a financial institution with a wider remit.

However, the main focus of this review has been on the supply of funding to SMEs although the review has taken on board some of the main points from these alternative solutions as well as examining various models of financial support for SMEs developed elsewhere. Indeed, there needs to be a more pragmatic and immediate response to get funding flowing into Welsh businesses again especially, given the experience of the Business Bank, it is likely that that there would be numerous delays through state aid and procurement issues if a wholly new financial organisation were to be established, leaving Welsh business in limbo.

The review believes that five principles should form the core for any changes to the current way in which Welsh Government supports access to finance for the SME community and each will be discussed in turn before going on to propose an option that could work for the Welsh economy and which the Welsh Government could implement immediately.


1. Every viable business in Wales should get access to funding at an affordable price

This review was established not only to examine whether there was an issue related to access to finance for SMEs but, more relevantly, what the Welsh Government could or should do to intervene if there was a perceived market gap in provision from private sector providers. As the research into lending patterns by the banks has shown, lending to SMEs in Wales remains fragile despite statements from the banking community that it has ‘millions of pounds to lend’, is ‘open for business’ and has one of the lowest rates of lending to businesses has seen in a generation.

A number of reasons are given as to why small firms in particular are not meeting the criteria set by the banks for affordable lending, including under-collateralisation, shorter credit history, lack of an agency credit rating and paucity of verifiable financial information which banks can use to make credit allocation decisions. Given this, it can be argued that the state could, if it so wished, provide specific interventions to alleviate these different types of market failure and provide a greater flow of credit to businesses.

This is the approach currently being undertaken by the UK Government with the creation of the Business Bank and the Funding for Lending scheme. In the context of Wales, the fiscal levers that are at the disposal of the Welsh Government are limited, although the recent announcement regarding borrowing powers from the UK Government suggests that there may be an opportunity to acquire funds from the capital market to support SMEs. There is also the opportunity to use its own economic development function, as well as the highest level of European Structural Funding, to provide solutions to address the lack of funding available to businesses.

Currently, Finance Wales is the main alternative supplier to the banks of debt and equity funding for SMEs in Wales but, as the evidence has shown, the cost of borrowing to Welsh businesses is above the EU reference rate for its loans despite being owned by the Welsh Government. This is different to other countries, with evidence from the European Union showing that there are numerous financial instruments that offer a lower cost of borrowing to SMEs than Finance Wales.

The Bank of North Dakota (BND) stated that it did not charge high interest rates because that would be tantamount to setting up the business to fail and there was no rationale in borrowing costs that amounted to “a dime in every dollar” going back to the state when it could be used within the business to create jobs. An interview with Finnvera, the state owned Finnish Bank, showed that a public fund could offer lower rates of interest generating a healthy surplus through its operations. Currently, and whilst operating under the EU reference rate regulations, Finnish SMEs can gain access to borrowing at a cost of between 1.5 per cent and 6 per cent. Unlike Finance Wales, Finnvera has made a decision not to support businesses which it considers to be a bad risk.


2. The primary role of government-backed funding for SMEs is to drive forward economic development

During the recession, publicly-owned financial institutions played a vital role in supporting SMEs and their financial requirements. For example, the Small Business Administration (SBA) in the USA worked closely with local financial institutions to distribute loans to small businesses whilst in Germany, the Sparkassen (savings banks) have played a vital role in ensuring that funding reaches businesses operating within the local area that each bank serves. Indeed, the dual focus of German regional banks on both their financial position and their wider social role has meant lower rates of return on capital but delivered greater stability and long-term support for small firms.

As a recent review of the German banking system noted, “There has to be part of the financial system in Britain that operates not as an end in itself but to serve society and the real economy. Without this there is little prospect of rebuilding the economy on the basis of real products and real services that produce real wealth for the benefit of the nation” .

In Wales, various funding initiatives promoted directly by the Welsh Government are related to economic development priorities, including job creation. In contrast, the mission of Finance Wales had, until recently, been focused on establishing itself as the leading fund manager in the UK. It has been argued that both can complement each other but during a time of economic hardships experienced during the last five years when access to finance was difficult for SMEs in Wales, the primary and overriding focus should have been on supporting businesses to create jobs and yet Finance Wales’s JEREMIE Fund remains well behind on its targets to create jobs under the ERDF programme.

Contrast this with the situation in Finland where the state owned bank not only saw the number of businesses applying for public financing increase by 12 per cent, but focused its efforts on introducing counter-cyclical loans and guarantees to finance working capital for enterprises whose profitability or liquidity had declined because of the economic crisis. It was estimated that without this funding, the number of job losses in the Finnish economy would have been twice as high as actual job losses (23,700) in 2009 and 2010.

Therefore, the role of any publicly funded programme to support access to finance for SMEs has to focus on economic policy goals as its first priority but can also support the individual goals of SMEs at the same time, shown in Figure 1 which illustrates the public funding philosophy adopted in Germany.


Figure 1. Broad promotional funding landscape in Germany.





3. It is not the role of the public sector to displace the private sector but to address a market failure in the provision of finance to SMEs

At a recent event to discuss access to finance for SMEs, there was consensus that it was not the role of the Government to make direct investments in SME financing, but rather to encourage an atmosphere in which SME lending could occur, as well as to increase the effectiveness of schemes to encourage funding. Others have noted the need to identify well specified market failures to avoid competition with the private finance sector and, where possible, to work with the private sector to the benefit of both the funding scheme and the wider development of the financial community.

Whilst some have argued for the Welsh government to create a publicly owned institution that then competes directly with the banks for SME customers, one could argue that Finance Wales has already evolved into such an entity and is in the Welsh market looking for deals against the high street banks and other providers. As one respondent noted “Offers of funding to clients from our investment fund have been displaced on more than one occasion by competing offers from Finance Wales….we do not feel Finance Wales should be competing with private sector funds – or indeed any other sources of funding. Surely it is not its role to displace other sources of finance. By competing with others it also discourages entrants to these segments of the business finance market”.

Interviews undertaken during the review suggest that one of the strengths of publicly owned institutions such as BND and Finnvera (see case study below) is that neither organisation sees itself as competing with the banking system and is instead a complementary partner in supporting SMEs. For example, the BND was created to partner with other financial institutions and assist them in meeting the needs of the citizens of North Dakota. Well-structured credit guarantee schemes can, if developed in partnership with the Welsh Government, spread some of the risk and thereby enable banks to extend loans to firms that would find it difficult to access credit otherwise.

As discussed in the first stage of this review, the UK Government operates the Enterprise Finance Guarantee scheme although there have been no recent regional loan guarantee systems developed in the UK, which is very different to what is found in other parts of the World. For example, of the 3.9 billion euros disbursed to enterprises by EU financial instruments, 32 per cent were in the form of loan guarantees  with 134 funds offering guarantees as a financial product.

The Welsh Government has already been in discussions with three of the high street banks about the potential of this development which could, if implemented, give Welsh businesses access to funding across Wales. More relevantly, no new expensive branch network would be needed as this could be managed via the current structure of banking participants. In addition to working closely with the banks, it is clear that more can be done by the Welsh Government to attract and encourage greater levels of private sector investment into Wales, especially for high growth businesses, through encouraging informal investment and developing greater links with venture capital organisations.



It is a specialised financing company, owned by the State of Finland, which supplements the financial services offered by the private sector. Finnvera provides financing for various stages in the life of an enterprise: for its start, growth and internationalisation, and for exports (Finnvera has an official Export Credit Agency (ECA) status). In the first six months of 2013, it offered €420 million in financing to SMEs.

The Finnvera Group reinforces the capacity and competitiveness of Finnish enterprises by offering loans, domestic guarantees, venture capital investments, export credit guarantees, as well as interest equalisation and funding for export credits. Finnvera has about 30,000 clients and employs nearly 400 persons including more than 100 business analysts of corporate finance and development. It has a network of 15 regional offices throughout Finland and a representation office in St. Petersburg.

By providing financing, Finnvera strives to promote the internationalisation and exports of Finnish enterprises; the operations of small and medium-sized enterprises, especially in situations of change; and realisation of the government's regional policy goals.

The Ministry of Employment and the Economy monitors and supervises Finnvera and sets annual goals for its operations. When determining these goals, attention is paid to the Finnish Government Programme, the Ministry's corporate strategy, the policy objectives concerning the Ministry's branch of administration, and the goals of EU programmes. In 2012, Finnvera's strategy was adjusted so that the company is increasingly able to respond to new challenges in corporate financing. The focus of operations has now shifted more on speeding up the growth and internationalisation of companies and on improving the financing options available for start-up enterprises.



4. It is critical that business and skills support is offered alongside financial support to businesses in Wales rather than as separate elements 

Research has shown that various public organisations that are involved in supplying financial support to businesses also provide various types of business support to their clients. A recent evaluation of European financial instruments suggested that the provision of business advice is a key element of some financial intervention tools although this can depend on the development stage of business.

For example, the provision of advice and support for entrepreneurs who may have little business expertise is important although as the business grows, the founders and their managers may already have significant experience although they may also wish to buy in specialist support services. There are advantages in having a joined up approach to business and financial support so that a company can evolve as it grows towards different services being provided by such an organisation. There could also be benefits in terms of reduction in costs but also a stronger relationship with the beneficiary, which leads to better access to information (which is a problem for many banks) and a reduction in risk when lending. More importantly, financial and business support needs to be available at different stages of the life cycle of the business.

In the USA, the Small Business Administration provides grants and loans alongside its counselling and training programmes for small business. The Swedish funding agency Almi provides advisory services to customers at all stages of development from ideas to successful companies through both its own internal advisers and external sub-consultants.

Another example of how finance and business support can lead to benefits for business can be found in Canada. The BDC is Canada’s business development bank and promotes entrepreneurship by providing highly tailored financing, venture capital and consulting services to entrepreneurs. A recent review of its services showed that whilst sales growth among BDC financing clients was up to 14 per cent higher than that of non-clients, those firms that used both the financing and consulting services performed better with sales growth of up to 25 per cent greater than that of non-clients.


5. Funding solutions should be customer-oriented

As the first review has shown, there is a plethora of different public funding schemes that are available to businesses in Wales. These range from the ten grant programmes operated by the Welsh Government, the five different funds currently being managed by Finance Wales, UK Government schemes such as export guarantees and the Business Growth Fund, and various European funded initiatives to support innovative firms and high potential start-ups.

Add to this the different types of funding that is available from the private sector, such as loans, asset finance, and invoice discounting, as well as new types of alternative funding – P2P lending, crowdfunding - and the landscape therefore remains confusing to the average SME. According to a member of one the Welsh Government’s sector panels, many SMEs including large successful companies, are either unaware of or confused by the variety of schemes available, deterring some from seeking finance.

In its paper on establishing a new business bank, the British Chambers of Commerce emphasised the need for a single ‘brand’ for Government finance support and the consolidation, at a UK level, of various funding schemes into one organisation. This principle should be adopted for Wales and the Welsh Government should consider whether all funding schemes, including grant support currently operated within the Department for Economy Science and Transport, should be located within the same organisation. Not only would this have considerable efficiency costs and marketing synergies, but would enable the focus to be on the SME’s specific needs.

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