Phil McCabe: Loss of faith between business and the banks

ONE year on from the launch of the British Bankers’ Association’s (BBA) Business Finance Taskforce, and small firms are clearly experiencing a crisis of confidence in British banks.

Despite several taskforce initiatives, news that lending demand is down is not surprising given reports of slashed overdrafts, steep interest rates and all round poor levels of service.

Earlier this year, the taskforce’s first quarterly finance monitor showed just how disillusioned entrepreneurs have become with leading banks. According to the report a total of 15 per cent of small businesses – or approximately 670,000 firms – needed funding during the past year but did not apply for it.

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In truth, this alienation has been evident for some time. In addition to the Government’s vague “credit easing” plan, it is important that major lenders re-invest in their small business services and reviewing the way they gauge risk.

This will require courage from the banks, moving away from the present over-centralised system towards devolved decision making – including bringing back the old-fashioned bank manager.

One argument banks often put forward is that they are increasingly being expected to hold on to more capital to help prevent against future credit crises. They say this will restrict their ability to lend to small businesses.

However, the UK’s major banks are again posting significant profits.

I agree with the response of George Osborne when this concern was put to him at a Treasury select committee. “I think they can do both,” he said.

Indeed, this is one of the main reasons behind the Government’s Project Merlin, under which the banks have pledged to lend £190bn to all businesses in 2011. In all, £76bn has been set aside for credit-starved SMEs.

However, figures for the first quarter of the year show that lenders fell at the first hurdle, missing their initial £19bn target by some £2.2bn. Subsequent improvements are still not enough and lenders’ risk criteria and the cost of borrowing remain restrictive.

Almost unilaterally the banks blamed this commercial lending shortfall squarely on what they termed as a decline in small business demand – raising the obvious question of how they expected to meet their increased lending targets from the outset?

We have consistently argued that the need for fair, cost-effective commercial finance remains as great as ever but the evidence shows that business owners are turning away from traditional banks in droves. Instead, they are looking to friends, family and even their own personal credit cards for business funding – not a sustainable situation for survival and a profitable future of any small business, or the prospects of strong economic growth.

What we need is greater competition between banks, and more scope for innovative funding models to be able to compete alongside traditional lenders.

Under the BBA’s new lending appeals process, banks should already be directing businesses towards other providers if they feel they cannot help them. Further, the Office of Fair Trading is looking at what needs to be done to help genuine alternatives to traditional financial institutions flourish, including possible temporary incentives for those less reliant on automated risk systems – which is one of the major reasons credit dried up in the first place.

But there is more to the argument than meets the eye. With the days of easy finance rapidly fading it is important that small businesses up their game by taking steps to prove they are creditworthy concerns.

While the Forum of Private Business is prepared to take on high street lenders when necessary, we must not lose sight of the real goal – improving relationships between businesses and their banks in order to boost the provision of affordable growth finance.

Confidence and trust are mercurial qualities. Many business owners have certainly lost faith in the big banks as a direct result of the way they have been treated, because of their apparent readiness to automatically place firms operating in certain sectors in a “high risk” category. But for others it is a question of perception. They have become alienated because of what they fear could happen to them – or their overdrafts – if they approach banks for funding.

These are the areas the Government and banks should address without delay. On the other side of the coin, it will require business owners and their accountants to ensure they prepare and present clear, informative and – most importantly – standardised financial data when seeking finance. All too often, banks report that lending applications cannot be processed effectively because this key information is virtually undecipherable. Combined with a strong business plan and well-reasoned commercial projections, producing this is a must in the new era of finance.

Phil McCabe is a senior policy adviser at the Forum of Private Business.