As the UK starts celebrating the beginnings of economic growth, Lawrence Tomlinson, the Department for Business' outgoing entrepreneur-in-residence, reflects on whether it is having an impact on access to finance and questions if the banking market place is capable of offering a sustainable lending to businesses.
Since 2008 horror stories about banking have filled the media. With a credit crunch, and one of the most painful recessions of modern history, the last five years have been difficult for businesses across the country. The pendulum has been swinging between messages of "banks are not lending" to "businesses don't want to borrow". So now we are seeing the grassroots of a recovery, what is the current state of access to finance?
When I joined the Department for Business, Innovation and Skills as entrepreneur-in-residence, I wanted to get to the truth of these mixed messages. The press were constantly reporting that banks were lending and "nine in 10 loans are approved" but as soon as I spoke to businesses they told me that access to finance was a nightmare. My concerns about pre-application screening were soon confirmed when Sir Andrew Large published his report into RBS' SME lending practices. Far from 90% of loans being approved, he found that when screening was taken into account, it was more like a 27% approval rate. More concerning still, my own investigations concluded that some banks, RBS in particular, were aggressively removing funding from businesses. The findings of the Tomlinson Report have been well reported and the FCA is currently investigating the key allegations.
In March this year, the Office for Budget Responsibility revised up its forecasts to 2.7% growth for 2014. There is certainly much more confidence in the market and people are feeling better about the UK's economic outlook. Recovery remains consumer-led however. Once PPI claims are all paid out and house prices start to plateau, we need to make sure there is growth in the real economy to sustain a positive trajectory. Supporting manufacturers and exporters to expand will be key to this. The ONS reported a 1% growth in manufacturing output in February 2014 but the sector as a whole remains 8.2% smaller than it was in 2008.
Access to finance is as important to businesses as any other utility, especially during a business' growth phase. If we are to get the engine of the UK economy gathering momentum again, we need to target finance directly at these powerhouse firms, giving them the tools to expand and invest. This means having active competition in the banking market place, driving good deals and outcomes for businesses. Competition not only provides more available products to these businesses but generates more trust as the customer has more ability to move between providers if they are unhappy with their service.
Whilst the government is putting much effort into increasing competition through schemes such as the British Business Bank, the market is still dominated by a small number of large players. In the SME market, 50-60% of all lending is from the two government backed banks, Lloyds and RBS Group. This has an impact on prices and consolidates the market so there is little choice. It distorts the market and any particularly successful challenger finance provider runs the risk of take over.
Part of the difficulty with securing finance for a growing business is that their EBITDA will reduce. This does not mean the business' performance has worsened, but is simply a reflection of the increased investment in the business. This creates problems for banks who base their credit approval on computer based models as they can only input values, which don't necessarily reflect the strength of the business.
It's hard for large banks to get this balance right, as they want to retain some central control to maintain consistency and accountability over credit decisions, but in reality the person best placed to judge the appropriateness of lending is the local relationship manager.
The dilemma between internal regulation of banks' credit approvals, and making good lending decisions, cannot be reconciled when banks have grown to such a size – the centre is simply too far from the decision making process. It is therefore unsurprising that smaller and more reactive banks, such as Handelsbanken, receive such positive reports of their lending decisions. We need more banks like this to truly get access to finance flowing.
We have also seen a lot of 'bad behaviour' from the big banks over the past five years and trust in the current banking system has been dramatically corroded. Businesses remain nervous of increasing borrowings for the fear of repercussions if something goes wrong. The businesses who will generate UK growth may already be operating well under their status-quo in a profitable and safe position. Growth requires foresight and an element of risk.
To tip the balance in favour of increasing investment, businesses will need to feel confidence in their lending provider(s). Whether reality or perception, it is deemed that there is a lack of banking competition and that a level of toxicity still permeates the big banks. The business community see that the banks have 'got away' with what happened in 2008, what is to stop them acting against the interest of the UK economy again?
If the big banks were small enough to fail, not only would this create a more vibrant banking market place, giving businesses a choice of providers, it would also increase confidence that there is a downside to banks' behaving badly.
So what is the state of access to finance at present? It is certainly improving; we are seeing growth and more confidence in the market with more businesses now preparing to increase investment. However, we must not get complacent. There is no discernable change in the banking market place to prevent 2018 becoming the next 2008. Businesses are not ignorant of this so trepidation will remain and growth will continued to be stifled until we see real change in the banking market. This requires breaking up the big banks to make sure we have a varied and responsive banking landscape that can fulfil business needs, be more accountable and demonstrate sustainability and stability for the long term.