15th May 2011
Manchester corporate finance expert Malcolm Evans reviews the ongoing debate about what is the correct role of banks in funding enterprise: he believes that new and radical channels for providing capital:
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The Liverpool Chamber-hosted seminar of the British Bankers Association was both very real and also slightly surreal.
It was very real in that a succession of very senior banking figures spoke frankly and reflectively about where things had gone wrong in the past and about their determination that they would not do so again.
It was slightly surreal in that there was a gigantic elephant in the room – but I am not sure that enough people, particularly those in government, even properly realise its presence and its size in the context of the current banking debate.
Let’s begin by being clear about what happened a few years ago now. Property in the UK was horribly overgeared. The UK Public Sector was ludicrously overgeared. Large UK companies were overgreared. The SME sector was moderately overgeared.
To some extent the banks, which one must remember exist as providers of lower-risk debt, had drifted into quasi-venture funding to SMEs. Pressures for relentless growth within newly aggressively expansionist banking giants led to more relaxed flows of money into SMEs.
The process was fuelled by a feelgood factor of general growth and the relentless enterprise rhetoric of the age.
Then the U.S. bottom-end housing market tanked, Wall Street’s vendors of explosive rip-off instruments (sorry, “derivatives”) wobbled, the shock waves smashed into Europe and the sudden shutdown of wholesale credit markets brought the whole vortex of upwardly spiralling debt shuddering to a standstill.
It is worth revisiting these facts as they are already becoming distorted as they apply to growth capital for younger and smaller enterprises.
The banks were not brought to their knees by failing small and mid-sized businesses, although they suffered losses from having too much money, of too high a risk profile, out into this sector. Global credit restrictions and dangerously thin balance sheets were the immediate causes of banks’ plights. Consumer credit, property purchase credit and major corporate over-gearing were much bigger factors than anything in the SME markets.
However, the banks had become looser in their lending to smaller businesses. They had drifted from very clearly definable debt into a fuzzier world of betting on growth stories. It was a market they didn’t really plan to be in and it is certainly one which they don’t plan on re-entering anytime soon.
But, whilst this rebalancing of SME lending practice has reduced funding availability within the sector, it is also not a situation that is going to reverse anytime soon.
And this is the giant elephant – there is vastly insufficient creative thought being given to about from where funding to match the clarion calls for enterprise and growth will come.
We are becoming trapped in a sterile cycle of government exhortations to lend more to SMEs and of the banks, still very mindful of their recent reconstructions and ongoing rehabilitation, wishing to be seen to be compliant. But they are also very much not wishing to lurch back into places they should never really have been.
Hence we got last week’s scenario. There was genuine humility about past failings. Personally this does not really interest me that much – I believe that bank bashing has always been vastly overdone: there were far too many players bought into the endless growth discourse for there to be much merit in seeking a single scapegoat.
Then we were told of the recent attempts at reform. There is a long list of initiatives around transparency, customer experience and access to development and trade funding. Such things are welcome but to my mind they smack somewhat of a sideshow to the main event.
How do we seed enterprise and fund development that falls below the (high) threshold of acceptable commercial risk? That banks can make big profits does not vex me – they are businesses. On top of that they require good margins to cover even moderate risk, and that is without accommodation of the high capital reserves requirement.
Governments which demand both banking prudence and banking largesse towards riskier enterprises are being either disingenuous, or simply uninformed (or possibly both).
Another piece of muddle in the political equation is that of free trade, aka. non-interventionism, aka. light-touch regulation. Small state commitment always seem to be more honoured in the manifesto commitments than in reality by Conservatives in power (and I am a card carrying Tory).
All governments are massive meddlers in trade. From the simple extraction (and endless fiddling with) profit, employment and trade taxation, through endless regulations on activities, environment and employment, governments seem obsessed with commercial intervention. There is nothing “free” about trade at all, so any claims relating to the sancrosanctity of non-intervention are a non-starter.
Then there is the natural desire to stimulate wealth creation, employment and sustainability. The present government may have done away with Regional Development Agencies but there is a whole slew of replacement activity around Local Enterprise Partnerships (don’t get me started!).
Despite the much-heralded culling of armies of business advisors (sic), there still seems to be an awful lot of them out there……..gatekeeping, signposting, synergising and god knows what else they purport to get up to in the name of enterprise stimulation.
And now we have the re-launch of enterprise zones, proven to be one of the costliest ways to stimulate net new jobs known to humankind.
Oh yes, the state will spend a great deal of money on packing people into shiny offices in the name of enterprise support and on pumping cash into shiny new offices in the name of enterprise stimulation.
But, beyond the people packing and the shed building, what about actually heading upstream to the wellspring of great enterprise – bright ideas and capital combining to generate growth and the creation of more capital?
How is it that successive governments will do just about anything – and at huge cost – to try to stimulate enterprise growth but will fight shy of the most direct measure of all, the allocation of capital? (Let’s just park the issue of EU competition issues around business supports for a moment – we could always just take the French option, which is that if they don’t like any particular directive, they just ignore it!).
What if we took the wage bill of all those “business advisors” still met by the public purse and added on the cost of the enterprise zones and distributed that sum by competitive application to smaller companies in, say, packages of £2,000 to £10,000? A start-up might avail of a new website, a larger company of a prize pool for staff performance. Everything could be receipted and checked but not in a way that the scheme became so hidebound in rules to render it next to inaccessible and impractical (as is the wont of many state initiatives).
This is just a single, simple and seat-of-the-pants example. What we need is a detailed debate about the core business of stimulating business.
Why don’t we put capital more directly to work? Some readers may point to various new regional investment funds, the Regional Growth Fund and other more recently announced development funds.
This is to miss the point. The RDAs passed the big European business investment funds over to the private sector – they never did much themselves if they could possibly pass the actual work on to private delivery.
This has immediately neutered the potential impact of this money: there is an automatic tendency where state investment funds are administered by private fund managers for the fees to be high and for the elongation of the fund to become a primary goal. This pushes the risk profile back up towards a banking threshold.
As for the RGF, experience to date indicates that it is becoming a capital budget replacement for local authority/establishment pet local projects in a time of reduced support. This is fine: but don’t pretend that it is somehow an enterprise-breathing gust of fresh air, blowing away the dust of decay with radical innovation.
What is not fine are the LEPs themselves. They have merely concretised the existing state and semi-state relationships within their given areas. They relied on an utterly false notion of there being a cohesive and pre-constituted “Business Community” ready to mobilise and somehow capable of taking over the existing town hall structures around which LEPs have formed.
From RDA to LEP; the journey from big budget glass palaces and shed building to small budget civic worthiness…….
As for the newer business growth funds being established with bank backing, this is a broadly welcome development. But the money will be available on much the same basis as existing VC – and there is no great shortage of lowish risk business development capital in this country.
The problem is that we seem incapable of crossing the assumed Rubicon to a pump priming mentality. Please don’t anyone roll out an ROI argument against this – the countless millions on advice and shed building and the all the rest achieves next to nothing.
The only category of enterprise which can support the low risk profile of commercially acceptable lending/investment is enterprise which is already proving itself capable of meeting commercially acceptable lending/investment criteria. Exceptions include the rare projects of such remarkable potential that specialist investors will take a punt.
It’s time to stop looking to the banks. It’s not their job. We need to look into our ideological hearts and start thinking about whether we dare to entrust aspirant capitalists and promising capitalists with capital via more direct mechanisms.
It’s time to stop messing about with indirect initiatives and to silence the rhetoric of enterprise platitudes from those who wouldn’t recognise a viable enterprise even if it came and knocked them out of their comfy public sector torpor.
It’s time to recognise that the UK will sink lower and lower down the economic league unless we get real about stimulating fresh enterprise and nurturing such that we have.
It’s time, actually, to start thinking the really unthinkable: it’s time to start thinking like capitalists.