In January 2013, the Minister for Economy, Science and Transport announced an independent review into access to finance for SMEs in Wales. Supported by a voluntary advisory panel from academia and business, the aim of the review has been to examine how effectively SMEs in Wales are served by existing sources of funding, identify areas of particular challenge and provide recommendations for action. There are five sections to the report, namely:
- Banks lending patterns to SMEs
- Alternative sources of funding
- The role of Finance Wales
- The principles of public funding for SMEs
- the case for a Development Bank for Wales.
Over the next five days, I will be publishing each of the sections individually so that those wishing to respond to the review can understand each aspect of the issues surrounding access to finance to SMEs that have emerged from the 10 month consultation.
This blogpost will examine the current state of lending by the banks to SMEs in Wales. It will update the data from the first access to finance report published in June 2013 and will examine whether the situation regarding access to finance from the banks to the SME sector in Wales has changed since then.
UK trends in bank lending
At a UK level, the latest available data show that, in terms of gross lending, a total of £308 billion has been lent to all non-financial businesses in the UK since September 2011 (Figure 1).
Of this, only 26 per cent (£80 billion) have been lent to SMEs and net lending, after repayments, for UK SMEs has gone down by £10 billion (for the banking sector, SMEs are those businesses with annual debit account turnover on the main business account less than £25 million; large businesses are those with annual debit account turnover on the main business account over £25 million). This suggests that there continues to be little appetite by firms for bank lending or, as some suggest, a lack of credit being made available to smaller businesses.
As of August 2013, there was a total of £420 billion of fixed term loans outstanding to the banks from non-financial business in the UK, with SMEs accounting for 36.7 per cent (£154 billion) of this amount. Therefore, and contrary to expectation, the Bank of England’s statistics suggest that there has been no substantial increase in the level of lending to SMEs during the last 12 months (September 2012-August 2013).
In fact, there has been an overall decline of £1.2 billion during this period and the only monthly growth in net lending to SMEs (excluding overdrafts) since September 2011 has been in March 2013 and May 2013, despite claims from the high street banks.
The other main form of debt funding from banks to SMEs is via an overdraft i.e. a short-term loan giving customers the right to overdraw their bank account by an agreed amount and which is normally repayable on demand. According to Bank of England data, there is a total of £34.6 billion of overdrafts with UK businesses, with SMEs accounting for 42 per cent (or £15.5 billion) of this amount. This has fallen by 25 per cent since September 2011, indicating that banks have been put under pressure, through Basel III arrangements, to reduce their risk through such lending to SMEs.
Various conversations with banks, customers and intermediaries also suggest that there has been acceleration in businesses having their overdrafts withdrawn because of a lack of utilisation and then being encouraged to move into invoice discounting. Whilst it is argued that this may be more effective for managing cashflow, this type of finance is not suited to every business and may cause difficulties over time.
Therefore, in terms of total loans and overdrafts, SMEs owe a total of £169 billion or 37 per cent of all lending to businesses in the UK. This equates to an overall reduction in debt finance facilities of around £25 billion (or a 13 per cent decline) since September 2011. At this stage, there is no clear evidence that this situation will change soon although hopes of a growing economy may transform the appetites of both the banks and SMEs towards increased lending and borrowing respectively.
Figure 1: Gross lending (excluding overdrafts) to non-financial businesses, 2011-2013.
There are also mixed messages regarding lending emerging from the latest version of the SME Monitor, which reported that in Q2 of 2013, 44 per cent of SMEs using external finance (loans, overdrafts, credit cards), up from 39 per cent in Q1. This was higher than the 36 per cent of SMEs who met the definition of a “permanent non-borrower”, expressing no interest in external finance. However, this growth is in non-core products offered by the banks with the use of core bank products (overdraft, loan or credit card) remaining flat at 33 per cent. Indeed, overdrafts are now only used by 18 per cent of SMEs, the lowest since the SME Monitor was created. Instead, the growth is coming from ‘other’ forms of external finance (such as leasing, invoice discounting, grants and loans from directors), with use increasing to 21 per cent, up from 15 per cent in recent quarters.
Bank lending in Wales
The main source of information on regional lending from the banks can be obtained from the BBA, which publishes limited regional data on a quarterly basis, although this information only dates back to the third quarter of 2011. The updated statistics enable an examination to be made as to how Wales has been performing during the first two quarters of 2013.
- Current value of loan balances in Wales in Q2 of 2013 was £4.284 billion, which equates to no substantial change on the position at the end of 2012. The value of overdraft balances had increased, during the previous six months, from £623m to £656m. This represents 4.9 per cent of the total UK lending by banks (loans and overdrafts) to SMEs, with 86.7 per cent of all banking in lending in Wales being in the form of loans, slightly lower than the UK (88.7 per cent).
- During the 12 month period Q3 2012-Q2 2013, the banks approved 11,459 loan facilities for Welsh SMEs with a total value of £862.6 million. The average loan was £76,016, the lowest of any UK region, with an average loan of £58,403 for small firms and £185,359 for medium-sized firms;
- A total of 16,469 overdraft facilities were approved for Welsh SMEs over the same period with a total value of £305.7 million. The average overdraft for SMEs was £20,738, the lowest of any UK region with an average overdraft of £14,610 for small firms and £56,648 for medium-sized firms.
The average loan for businesses with a turnover of less than £1million (i.e. small firms according to banking definitions) remains relatively high (as compared to what would be expected from most micro-businesses) and suggests that micro-enterprises may not be getting access to the smaller loans they require (microcredit is defined by the EC, as a loan or lease under EUR 25,000 to support the development of self-employment and microenterprises (which are defined by the EC as less than 10 employees, and a turnover of less than € 2million).
This supports the finding from the first report namely that whilst bank funding is available to businesses in Wales, many newer and smaller businesses do not get the funding they require, at least relative to the rest of the UK.
To examine this trend over a period of two years, table 1 examines the change in the value of loan balances for Wales over time as compared to the UK.
Table 1: Change in loan book and overdraft balances, Wales UK, Q3 2011 – Q2 2013.
Overall, the comparison shows that the amount of loans and overdrafts to SMEs in Wales has actually increased by £55 million (or 1.3 per cent) between quarter 3 of 2011 and quarter 2 of 2013. In contrast, the amount of lending to SMEs at a UK level has decreased by £4.6 billion, a fall of 4.9 per cent. More detailed examination of the data shows a considerable difference in the lending profile of small firms and medium-sized firms in Wales. Whilst medium sized firms in the UK are facing difficulties in accessing finance, the loan balance for this size of firm in Wales has increased by 14.2 per cent over this period. In contrast, there has been a decline of £232m in the value of loan balances for small Welsh firms, which is the largest overall decline of any UK region over this period. This decline accounts for 40 per cent of the total UK fall in loan balance for small firms.
This supports the indications from interviews with stakeholders that it is smaller firms that are struggling to get loan funding from the banks. This view is also evidenced by the findings from the most recent Bank of England Agents’ summary of business conditions which suggests that whilst credit availability has continued to improve gradually, “Availability of finance remained polarised between very easy conditions for large companies, both for bank and capital market finance, and tight conditions for smaller companies holding few assets or operating in riskier sectors. For smaller companies, however, access to non-bank financing had increased further, and there were reports of greater activity by some ‘challenger’ banks albeit often in ‘lower-risk’ lending, such as asset finance.“
There has also been an 8.9 per cent fall in overdraft balances for small firms during this period (£33 million) although this is half that of the UK average. To explain this trend, banks have indicated that the reason that small firms’ overdrafts had been withdrawn or converted to invoice discounting was because of a lack of utilisation. For example, data from the BBA regarding overdraft facilities shows that only around 53 per cent is currently utilised by SMEs. Whilst this leaves almost half the agreed borrowing commitments available as ‘headroom funding’ for businesses to draw on, it is reducing year on year.
Whilst examining the decline in loan balances is one way of estimating the amount of funding that is available to Welsh firms, it is also worth examining the loan facilities that have been approved between 2011 and 2013. This data shows that whilst there have been fluctuations in the number of loan facilities approved for SMEs during the last two years, the number of loan facilities approved for medium-sized firms has remained almost flat (Figure 2).
Figure 2: The value of loan facilities approved for small to medium sized enterprises in Wales, Q3 2011-Q2 2013
Figure 3: The number of loan facilities approved for small to medium sized enterprises in Wales, Q3 2011-Q2 2013.
In terms of the value of loan facilities being offered to SMEs in Wales (Figure 3), this has declined by 58 per cent since Q3 2011 with the value of lending to mid sized firms falling by 140 per cent over this period (from £159 million in Q3 2011 to £66 million in Q2 2013). In fact, it would seem that the main decline occurred between Q3 2011 and Q2 2012, with the number and value of loans to medium sized companies reaching equilibrium and staying there for the last 12 months. A similar pattern has been observed for overdrafts, with the value of such facilities for mid-sized firms in Wales falling by 67 per cent in the last two years.
Cost of lending
It is not only the supply of lending from the banks that is critical to SMEs but also the cost of lending. This review has found it almost impossible to get any relevant data from the high street banks on the cost of lending to Welsh businesses. In fact, there is an argument made that it remains difficult to get any data on the cost of borrowing as the spread over relevant reference rates that SMEs face on new borrowing can vary widely, taking into account various business-specific risk and credit quality factors. As a result, there is no single definitive measure of loan pricing, though statistical and survey data can provide broad estimates.
The latest report on trends in lending from the Bank of England (Figure 4) shows that indicative median interest rates and spreads on new variable-rate facilities to all SMEs has fallen slightly in recent months, according to survey data from the Department for Business, Innovation and Skills. This shows that the median interest rates for SMEs stood at 3.55 per cent in August 2013, which equates to a reduction of 1.84 per cent since November 2008.
For small firms, the median rate was slightly higher at 4.74 per cent - a reduction of only 0.93 per cent that suggests that those with limited negotiating power are paying more. Another indicator of pricing on loans to smaller businesses (PNFC) - the Bank of England’s measure of effective rates on new corporate lending for advances of £1 million or less - was broadly unchanged over this period.
Figure 4: Indicative median interest rates on new SME variable-rate facilities, 2008-2013
This is the median by value of new SME facilities priced at margins over
base rates, by four major UK lenders (Barclays, HSBC, Lloyds Banking Group and
Royal Bank of Scotland). Data cover lending in both sterling and foreign currency,
expressed in sterling; (b) Median by value of SME facilities (new loans, new and renewed
overdrafts) priced at margins over
base rates, by four major UK lenders (Barclays, HSBC, Lloyds Banking Group and Royal Bank of Scotland). Data
cover lending in both sterling and foreign currency, expressed in sterling (c) Smaller SMEs are those
with annual debit account turnover on the main business account less than £1
million (d) Medium SMEs are those with annual debit account
turnover on the main business account between £1 million and £25 million (e)
Weighted average of new lending to PNFCs of all sizes by UK monetary financial
institutions (MFIs) for advances less than or equal to £1 million. Data cover
lending in sterling. The Bank’s effective interest rates series are currently
compiled using data from 23 UK MFIs.
The reduction in interest rates over time was reflected in a recent survey from the Federation of Small Businesses, which showed that the cost of finance continues to reduce for UK small businesses.
In Q3 2013, the average interest rate to small firms was estimated at 5.5 per cent, down from 6.3 per cent a year before. Within this average, almost a third of small firms report being offered loans at 4 per cent interest or lower in Q3 2013 – up from the 22.3 per cent of firms at the same time a year ago.
At the other end of the scale, the share of firms being offered interest rates of 6 per cent or higher has fallen back notably, with just 7.2 per cent of businesses being offered rates of 11 per cent or over, down from 9 per cent in Q3 2012. Similar reductions over time in the costs of loans have been found in the latest editions of the SME Monitor. For example, two thirds of the SMEs within the SME Monitor Q2 survey stated that they were paying 6 per cent or less for fixed rate loans (with 23 per cent paying less than 3 per cent).
At the other end of the scale, the share of firms being offered interest rates of 6 per cent or higher has fallen back notably, with just 7.2 per cent of businesses being offered rates of 11 per cent or over, down from 9 per cent in Q3 2012. Similar reductions over time in the costs of loans have been found in the latest editions of the SME Monitor. For example, two thirds of the SMEs within the SME Monitor Q2 survey stated that they were paying 6 per cent or less for fixed rate loans (with 23 per cent paying less than 3 per cent).
Therefore, this evidence suggests that the cost of borrowing to SMEs remains low although evidence from the first stage review suggests that the main difficulty remains one of getting access to the loans with the banks still applying strict rules with regard to security, affordability and the viability of certain sectors. For example, one of the sector panellists noted that “the high street banks have "black-listed" whole sectors, in which our businesses trade, and have been very risk adverse regardless of the considerable financial strength, and low gearing, of our group. Without the latter I do not believe we would have been able to finance our investment strategy at reasonable rates.”
Rejection rates
As stated in the first report, if a business is declined lending following a formal application for a loan, it has the right to appeal the decision. This is because the UK banks, through the BBA, have agreed a new set of principles for appeals that are monitored and scrutinised by an independent team of reviewers, ensuring that the banks have implemented a fair, prompt and transparent appeals process.
According to the latest review, the banks have received almost 5,500 appeals since the inception of the new process in 2011, with 39 per cent overturned in favour of the customer and, as a result, an estimated £30 million in lending was put into the economy in its first two years. 4.6 per cent of the appeals have come from Wales, slightly higher than its share of the UK business population.
Detailed case data on a regional basis are only collected on those appeals which have been reviewed and the case selection is predominantly skewed towards reviewing those cases overturned in favour of the customer so that there is a better understanding of the reasons for overturns and whether any process improvements may be appropriate. In those cases, 46 per cent of the appeals were overturned in favour of the customer in Wales and it is worth noting that the main reason given the author of the review, Professor Russell Griggs, for the relatively high number of successful appeals was that banks rejected applications “too early” without giving them thorough consideration. This suggests that a considerable number of businesses that are, of sufficient quality to attract bank lending, are being turned down because of internal processes within the banks themselves.
Detailed case data on a regional basis are only collected on those appeals which have been reviewed and the case selection is predominantly skewed towards reviewing those cases overturned in favour of the customer so that there is a better understanding of the reasons for overturns and whether any process improvements may be appropriate. In those cases, 46 per cent of the appeals were overturned in favour of the customer in Wales and it is worth noting that the main reason given the author of the review, Professor Russell Griggs, for the relatively high number of successful appeals was that banks rejected applications “too early” without giving them thorough consideration. This suggests that a considerable number of businesses that are, of sufficient quality to attract bank lending, are being turned down because of internal processes within the banks themselves.
Whilst banks are obligated to inform those declined for lending of the appeals process, the latest edition of the SME Monitor suggests that amongst those initially declined, awareness of the appeals process remained low (only 15 per cent of those initially declined for an overdraft in the last 18 months and 7 per cent for those initially declined for a loan). It is also worth noting that most of the firms declined rated the subsequent advice given by the bank as to issues such as other sources of potential funding as poor (70 per cent for declined overdrafts and 62 per cent for declined loans).
As the first report noted, both the banks and Government could do more to ensure that those that are turned down for lending are not only given the opportunity to appeal but to look for alternative sources of funding. In the case of Wales, such action could be a major step in increasing lending to businesses.
As the first report noted, both the banks and Government could do more to ensure that those that are turned down for lending are not only given the opportunity to appeal but to look for alternative sources of funding. In the case of Wales, such action could be a major step in increasing lending to businesses.
For example, if the banks’ approval rates for lending are 70 per cent, as the BBA suggests, then this would indicate that, extrapolating the data from the regional data discussed earlier in this section on bank lending to SMEs in Wales, that there are nearly 5,000 Welsh firms that have been turned down for loan funding during the last 12 months and a further 7,000 for overdrafts. The total is probably higher given that a number of businesses are actively discouraged from applying formally to the banks for support. In fact, as the review into RBS lending practices by Sir Andrew Large recently pointed out, the bank discouraged a disproportionate amount of businesses from making formal applications and its staff were risk averse.
Therefore, the report estimates, by utilising this data, that there is a minimum of half a billion pounds lending ‘gap’ within the Welsh economy. A similar estimate can be made from the recent NAO report on access to finance for SMEs, which indicated that the ‘funding’ gap (the difference between the funding required by SMEs and the funding available) for the UK as a whole is £10 billion to £11 billion.
Whilst it is likely that a significant proportion of those turned down may not be ready for funding, if SMEs that do not receive finance from the banks could be supported with their application or to get access to other sources of funding, then this would have a significant effect on supporting business within the Welsh economy. There are a number of implications from this finding including ensuring that more Welsh businesses are ‘investment ready’ and there is more effective signposting to alternative sources of funding.
Whilst it is likely that a significant proportion of those turned down may not be ready for funding, if SMEs that do not receive finance from the banks could be supported with their application or to get access to other sources of funding, then this would have a significant effect on supporting business within the Welsh economy. There are a number of implications from this finding including ensuring that more Welsh businesses are ‘investment ready’ and there is more effective signposting to alternative sources of funding.
Summary of key findings
The first report highlighted some of the main issues regarding lending by the banks to SMEs in Wales.
Whilst the banks are stating that they are ready to lend, the data shows a very different picture, with the value of borrowing approved facilities to SMEs in Wales actually falling by 30 per cent since Q3 2011. Differentiating by size of firm, then the data shows that the borrowing levels of small firms have fallen during the last two years whilst the number and value of lending approvals to medium-sized businesses have flatlined during the last 12 months. This is a conundrum as the evidence is clear that the cost of borrowing is at its lowest levels ever with evidence that the Funding for Lending scheme is starting to have an impact on the interest rates charged by some banks.
Whilst the banks are stating that they are ready to lend, the data shows a very different picture, with the value of borrowing approved facilities to SMEs in Wales actually falling by 30 per cent since Q3 2011. Differentiating by size of firm, then the data shows that the borrowing levels of small firms have fallen during the last two years whilst the number and value of lending approvals to medium-sized businesses have flatlined during the last 12 months. This is a conundrum as the evidence is clear that the cost of borrowing is at its lowest levels ever with evidence that the Funding for Lending scheme is starting to have an impact on the interest rates charged by some banks.
Nevertheless, in recovering from previous recessions, banks have not had to contend with changes in the regulatory landscape that have changed the cost and balance sheet dynamics of providing credit. The funding drought that then affected the SME market, especially in the period 2008-2010, has also eroded confidence amongst the business community. Whereas there have been efforts by the UK Government to introduce cheaper lending with rates reducing as a result, this has not been translated into increases in the number of loans from the banks.
This has left a total funding ‘gap’ of around £500 million per annum for those businesses who want to get access to funding but were refused support by the banks in Wales. This is clearly an upper limit as a proportion of those applying for funding may not be a position to receive it from any source although it does exclude those that are reluctant to go to the bank for funding because of the current uncertain economic conditions or have been actively discouraged from doing so. Nevertheless, it gives an estimate, albeit a crude one given the lack of statistics from the banks themselves, of the finance required by the Welsh SME sector that is currently not served by the high street banks.
As suggested in the first stage of the review, a large part of this problem may be attributed to the way that banks are currently assessing risk, valuing collateral and whether to invest in certain sectors. In that respect, the question is whether a new challenger bank is needed within Wales - either in the public or the private sector – especially as it will face many of the same issues that are affecting the current set of high street banks? Alternatively, is there a more effective way for the Welsh Government of working alongside current providers whilst, at the same time, encouraging access to other types of alternative finance?
It is important that banks and the Welsh Government do not operate in isolation in terms of the provision of finance to SMEs. Following the first stage review, there have already been negotiations between the Welsh Government and one of the high street banks to develop a referral system for those turned down for bank lending although closer links between business support and access to finance could also sustain this process. In addition, another bank has stated its intention to work closely in developing the potential of growth businesses in Wales. Given this, regular formal meetings could take place every six months between senior officers at the banks and the Welsh Government to discuss the challenges facing the Welsh economy and the way to address these challenges together.