Access To Finance Review Stage 2 review

Transcription

1 Access To Finance Review Stage 2 review Professor Dylan Jones-Evans Bristol Business School University of the West of England November 2013

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3 Table of Contents Executive Summary 2 Bank funding 2 Alternative sources of funding 2 Finance Wales 3 The Development Bank for Wales 3 Introduction 5 Recommendations And Action From Stage 1 Of The Review 8 Banks Lending Patterns To Smes 13 UK trends in bank lending 13 Trends in bank lending in Wales 16 Cost of lending 19 Rejection rates 21 Summary 23 Alternative Sources Of Funding 24 Trends in non-bank lending 24 Invoice discounting and factoring 25 Asset finance 25 Building Societies 26 Informal investment 26 Venture capital 30 Peer-to-peer lending and crowdfunding 31 Funding of social enterprises 32 Summary 33 Finance Wales 36 Cost of lending to SMEs 36 The cost of borrowing and EU reference rates 40 Finance Wales s strategy 44 GBER and De Minimis 46 Summary 48 The Way Forward 50 The five principles of public funding for SMEs 51 the Development Bank for Wales 57 Mission and objectives 58 Funding 59 Organisation 59 Summary 62 Glossary Of Abbreviations 64 1

4 Executive Summary Bank funding Whilst the UK banking sector states that it remains ready to lend, the data shows that the value of borrowing approved facilities to SMEs in Wales is actually falling by 30 per cent since Q Differentiating by size of firm, 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 also flatlined during the last 12 months. Whereas there have been efforts by the UK Government to introduce cheaper lending, this has not been translated into increases in the number of loans from the banks. The report estimates a total funding gap of around 500 million per annum for those businesses who want to get access to funding but have been refused support by the banks in Wales. This is clearly an upper limit as a proportion of those applying for funding may not be in 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. 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. Therefore, is a new challenger bank 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 and there have already been negotiations between the Welsh Government and the high street banks to develop a referral system for those businesses turned down for bank lending and to work more closely in developing the potential of growth businesses in Wales. Alternative sources of funding During the last 12 months, there has been increased use of invoice discounting, leasing and other forms of non-bank finance, possibly as a result of decreased lending by the high street banks. Building societies, however, seem to be withdrawing from being a potential source of funding for SMEs in the immediate future. Overall demand for funding remains relatively low partially due to a lack of understanding and awareness of different alternative sources of funding amongst the business community. The Welsh Government could look at using its resources to provide more information on these alternative sources of funding whilst also considering whether they should form part of existing lending schemes. There is considerable scope to improve informal investment and venture capital as a source of funding to SMEs in Wales. To date, informal investors have not been used as effectively as they could have been in supporting start-ups in Wales, despite the relative success of xénos. More could also be done to ensure that there is greater 2

5 focus on venture capital for growth firms at all stages of development within Wales. New support networks should be developed for growing firms, especially as financial support alone is not in itself sufficient to secure the success of early stage businesses. There have been positive discussions with peer-to-peer (P2P) lenders and crowdfunding firms and there is an opportunity for the Welsh Government, through working in partnership with such organisations, to stimulate greater use of these sources of finance in the future. Discussions with the banks suggest that one potential route for promoting P2P lending and crowdfunding would be via a direct referral system from Welsh High Street banks, Finance Wales and Welsh Government itself and this should be explored in further detail. The Welsh Government could consider investing in peer-to-peer funding as an alternative mechanism for financial support. This would be particularly attractive given the weaknesses in some of the current models in delivering finance to SMEs. The same could apply to crowdfunding through the development of a new co-fund, working with existing providers, which could help to stimulate the start-up market in Wales. The funding of social enterprises is an important area that was not the focus of this report although there may be synergies with some of the financial solutions being put forward for the SME sector. Finance Wales According to data submitted to the review, Finance Wales is offering higher rates of interest on borrowing to SMEs within Wales than it needs to under European Commission (EC) State Aid guidelines. The evidence gathered also suggests that Finance Wales has not utilised the full range of financial instruments available under EC regulations. For example, with two thirds of Wales classified as qualifying for the highest level of aid, General Block Exemption Regulation (GBER) could have been used to subsidise the interest rates on loans to hundreds of SMEs and been a significant policy tool for Welsh Government. In addition, there is no state aid impediment to Finance Wales offering cheaper loans to the vast majority of micro-businesses under de minimis regulations if it so wished. It remains unclear as to whether Finance Wales is still essentially operating as a commercially oriented fund manager in all but name. Given this, the Minister may have a view as to whether Finance Wales is fit for purpose or whether the organisation needs to be taken in-house into the Welsh Government so that it can focus on its economic development role for the Welsh economy. The Development Bank for Wales The evidence from the review indicates that public sector financial support in Wales seems to be fragmented and more relevantly, the organisation tasked with providing debt and equity finance to SMEs is not specifically focused on developing the Welsh economy. 3

6 The Welsh Government needs to develop an approach where public funding for SMEs is affordable, focused on economic development, is supplemented by business support and is oriented towards the needs of the business customer. It is also critical that the public sector does not displace the private sector but works alongside the banks and other stakeholders to address a market failure in the provision of finance to SMEs. Therefore, the review recommends the establishment of a Development Bank for Wales that will be created by bringing together all the financial support schemes for SMEs within the Welsh Government, the funds managed by Finance Wales and elements of Business Wales, as well as UK Government schemes such as UK Export Finance and the Business Growth Fund. It will: Act as a gateway for business and financial support to ensure access to the right type of support is provided to SMEs; Work in partnership with the banks and other public and private sector partners to provide loans, guarantees, grants and other financial instruments, all of which will maximise the state aid exemptions available to provide affordable debt finance to Welsh business; Develop specific consultancy and business support services for Welsh SMEs as found in exemplar organisations around the World; Gather, collate and provide detailed information on the SME sector in Wales to enable the Welsh Government and other partners to understand the dynamics of the Welsh economy; Establish close relationships with Welsh Government economic bodies including the sector panels, the enterprise zone boards, city regions and Industry Wales; Ensure a focused approach to the provision of financial and business services to microenterprises, regional SMEs and high growth firms. The Welsh Government is urged to examine the feasibility of this approach urgently to ensure that a viable and coherent approach to supporting SMEs in Wales is put into place as quickly as possible. 4

7 1. Introduction 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 1, 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. During the last ten months, an extensive and detailed consultation has been carried out through meetings with over 140 representatives of the banking sector, other financial institutions, the Welsh and UK Governments, intermediaries, academia and businesses. This has been supported by a substantial amount of data collated from various sources and interviews undertaken with a range of other publicly funded bodies in other countries, including Canada, Finland, Germany, Scotland, Sweden and the USA. In addition, the Welsh Conservatives and Plaid Cymru have submitted their own solutions to supporting funding for SMEs in Wales to the review, some elements of which have been considered by this review and integrated into the final conclusions. The report for the first stage of the review, published in June 2013, analysed the situation regarding the access to finance of SMEs in Wales and focused specifically on the role of banks. It also presented information on other forms of alternative finance that are available to SMEs. As part of the review, a number of recommendations regarding access to finance in Wales were made and, as this report will show, the Welsh Government has already moved quickly to implement a number of these during the last five months. Given this, the second stage of this report will update the information on bank support and alternative sources of funding to SMEs in Wales. It will also, following a request by the EST Minister, examine the strategy undertaken by Finance Wales in terms of supporting SMEs in Wales, focusing specifically on the cost of borrowing. However, the main aim of this part of the review was to consider whether the current situation in Wales regarding access to funding was fit for purpose and, if not, what should the Welsh Government do about it. So what does the review tell us? Very little seems to have changed in terms of lending by the banks to Welsh SMEs in the last six months. Despite the cost of borrowing being at historically low levels, the British Bankers Association s (BBA) own statistics show that lending to SMEs remains stagnant. The report also estimates that there is a funding gap of around 500 million in Wales between the demand from SMEs and the current supply by the banking sector. In terms of alternative finance, data from various organisations National Association of Commercial Finance Brokers (NACFB), Asset Based Finance Association (ABFA) and the Finance and Leasing Association (FLA) shows that there has been increased use of invoice discounting, leasing and other forms of non-bank finance during the last 12 1 These advisory board members are: John Antoniazzi, former partner at Deloitte in Wales; Katy Chamberlain, Chief Executive of Business in Focus; Professor Robin Jarvis, Head of SME Affairs, The Association of Chartered Certified Accountants (ACCA) and Professor of Accounting, Brunel University; Professor Phil Molyneux, Dean of the College of Business, Law, Education and Social Sciences and Professor of Banking and Finance, Bangor University; Huw Morgan, former Head of Business Banking, HSBC Bank plc; Chris Nott, Chair of the Financial and Professional Services Sector Panel and Managing Partner of Capital Law LLP; Professor Stephen Thomas, Professor of Finance, CASS Business School, City University London; Mark Woolfenden, Managing Director, Afonwen Laundry. 5

8 months, although this has not been sufficient enough to alleviate the demand from the SME sector for funding. In terms of supporting growth businesses via sources such as informal investment and venture capital, there is a need to ensure that there is funding at all stages of the life cycle of such businesses and, more importantly, that every effort is made to leverage greater amounts of private sector funding into Wales. Finally, there have been positive discussion with peer-to-peer lenders and crowdfunding firms and there is an opportunity for the Welsh Government, through working in partnership with such organisations, to stimulate greater use of these sources of finance in the future. As part of the second stage of the report, the EST Minister also requested that a specific analysis should be made of the cost of loans by Finance Wales as this may be an impediment to the availability of debt funding by Welsh SMEs. The evidence gathered suggests that not only have the interest rates they charged by Finance Wales to Welsh SMEs been higher than the reference rates which provide guidelines to the cost of loans by state banks, but there has also been a failure to fully utilise other state aid regulations to support lower interest rates to SMEs. One possible explanation for this approach is Finance Wales s mission, since 2007, to become an independent and self-funded investment fund. However, this is a strategy which seems to have taken precedence over a role that, during the difficult years of the economic downturn, should have focused on supporting SMEs in Wales as part of the Welsh Government s economic development remit. Therefore, the Welsh economy is in position where SMEs are still facing difficulties in accessing funding from the banks and, as yet, there is no significant increase in alternative sources of funding although it is growing. Public sector financial support seems to be fragmented and more relevantly, the organisation tasked with providing debt and equity finance to SMEs is not fit for purpose, as it is not focused on developing the Welsh economy. Given this evidence, the review has concluded that if Wales is to have an effective publicly supported financial ecosystem that benefits the economy and supports SMEs to grow and develop, then five principles must be adhered to. These are: Every viable business in Wales should get access to funding at an affordable price The primary role of government-backed funding for SMEs is to drive forward economic development 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 It is critical that business and skills support is offered alongside financial support to businesses in Wales rather than as separate elements Funding solutions should be customer-oriented. Therefore, the review recommends the establishment of a new Development Bank for Wales that would adhere to these principles and become the single source of public funding for Welsh SMEs. To achieve this, it will bring together the various business grant schemes within the Welsh Government, the funds managed by Finance Wales and various elements of Business Wales programmes. It will also partner with the UK Government to provide finance from programmes managed by UK Export Finance and the Business Growth programme. 6

9 Following careful consideration, we believe this is the most pragmatic and immediate response to get funding flowing into the SME sector to enable it to grow and develop its potential. Wales remains the poorest region of the United Kingdom and the future success of its economy will be determined by the ability of its businesses to become more competitive and innovative. To achieve this, the public and private sectors must work together and take advantage of every available tool that the nation has at its disposal to not only provide the funding the economy requires for growth and development but, through the creation of a Development Bank for Wales, create a model of excellence for others to follow. Professor Dylan Jones-Evans Bristol Business School 7

10 2. Recommendations And Action From Stage 1 Of The Review The first part of the review into access to finance examined the current situation regarding various aspects of funding to SMEs in Wales and made sixteen recommendations. Following the publication of the review, it was agreed that Welsh Government officials would begin to implement the recommendations immediately and this section provides an update as to progress to date. Recommendation Recommendation 1 Welsh Government needs to ensure that Wales, and Welsh businesses, gets a fair share of funding from the new Business Bank. Recommendation 2 The Welsh Government needs to consider whether mechanisms such as microlending or community-based lending to smaller local businesses should be encouraged and supported. Recommendations 3 to 6 relate specifically to bank lending policy. Recommendation 3 Security against the loan and affordability of repayment, rather than the cost of borrowing, have been cited in the interviews with banks, intermediaries and small businesses as being one of the main obstacles to accessing bank finance. Therefore any intervention by the Welsh Government should focus on these two critical obstacles. Recommendation 4 Local decision-making by banks is seen by many businesses as critical in ensuring that their business case is considered fairly. Yet there is very little evidence of this happening with higher-level credit decisions being made outside of Wales. Given this, Welsh Government is encouraged to open up discussions with the main banks to ensure that Welsh regional managers make the final credit decisions for all Welsh businesses. Action The Minister for Economy, Science and Transport has written to the Secretary of State for Business, Innovation and Skills, Vince Cable and met with the acting Head of the Business Bank, Keith Morgan, seeking to ensure that Wales is fairly served by the Business Bank. The Welsh Government will consider this recommendation within the broader framework of the review. The Minister for Economy, Science and Transport has sent the Stage 1 Report to the Chief Executive of the British Banker s Association and Regional Heads and Chairmen of the main high street banks. The Minister has met with several high street banks to discuss the issues raised in the Stage 1 Report. A Guide to Welsh Government Business Funding Programmes has been produced by the Welsh Government and presentations have been made to several high street banks. Welsh Government officials are developing new joint initiatives with the banks to improve Welsh SMEs ability to access finance. Welsh Government will maintain an open dialogue with the banks to continue to improve the funding landscape for companies in Wales. 8

11 Recommendation Recommendation 5 There needs to be greater transparency in the lending process. This is to ensure that SMEs, especially those without any formal financial support internally, know exactly what is required in terms of preparing an application to the bank (business plan, cash forecasts, support from an intermediary). In exchange for the provision of this information, banks would then agree to examine each potential funding request in more detail as opposed to basing their decision using the credit-scoring software that is normally applied to the majority of applications. Such a banking covenant could ensure greater transparency and accountability within the lending process and Welsh Government could work with the BBA to pilot such a scheme in Wales. Recommendation 6 Welsh Government should examine the disconnect between the business support programmes it offers and the funding supplied by the banking community in Wales. It needs to consider how it can work more closely with banks to ensure that they recognise the support available to Welsh firms and by promoting its take-up, improve the quality of business proposals and information supplied to the banking sector. Recommendation 7 Welsh Government should raise the issue of the detrimental effect of Basel III rules on SME lending directly with the UK Treasury and BIS. This will enable the UK Government to make representations directly to the Basel Committee on Banking Supervision to recommend that SME lending should be excluded from consideration in terms of determining suitable capital and liquidity within the banking system. Action The Minister for Economy, Science and Transport has written to the Secretary of State for Business, Innovation and Skills, Vince Cable and the Bank of England highlighting the detrimental effects of the Basel III requirements on SME lending. 9

12 Recommendation Recommendation 8 Welsh Government should examine how it can help facilitate better access to the wide range of commercial lending opportunities that are available to SMEs through non-bank lending channels. This could be achieved through partnership with organisations such as the NACFB and the development of a specific commercial portal on lending for SMEs. Recommendation 9 There are currently low levels of informal investment in Wales that could be addressed by (a) raising awareness of equity investment by angels as a viable form of funding amongst growing SMEs and (b) developing an equity guarantee scheme to attract further investment by private individuals into Welsh businesses. These potential interventions, and the role of Welsh Government in supporting them, will be explored in further detail during the second half of the review. Recommendations 10 and 15 relate specifically to Finance Wales. Recommendation 10 Finance Wales has had a positive impact on formal equity investment within the Welsh business community. However, the Welsh Government will need to consider how it builds on this success, especially in terms of having a specific vehicle for equity funding in the future. It also needs to develop programmes that create demand for venture capital not only for new start-up businesses but also growth firms where equity investment is key for further development. Recommendation 15 As the sole shareholder, Welsh Government needs to determine the future strategic direction of Finance Wales and, more importantly, the role it should play in the future financial landscape for Welsh business alongside other providers. Action Welsh Government officials are developing new joint initiatives with funding organisations to improve Welsh SMEs access to information on the funding options available and to improve their ability to access such finance. This recommendation is examined further in the Stage 2 Report. The Welsh Government will consider this recommendation within the broader framework of the review. At the request of the Minister for Economy, Science and Transport these recommendations are examined further in the Stage 2 Report. The Welsh Government will consider these recommendations within the broader framework of the review. 10

13 Recommendation Recommendation 11 The lack of availability of trade credit is an issue that leads to many smaller businesses seeking short term funding for working capital from banks. The Welsh Government should explore how it can use its power as the biggest purchaser in Wales to encourage its own suppliers to adopt supply chain finance or similar schemes to support their suppliers. In addition, it could set an example by ensuring that all contractors operating within the public sector in Wales have to pay their suppliers within a maximum 30- day period (and ensuring that it adheres to such a policy itself). Recommendation 12 Further discussions will take place with building societies in Wales to assess their potential role in supporting SMEs to access finance, especially in terms of commercial property lending. Recommendation 13 The Welsh Government should examine how UK Government funds can be used more effectively to support businesses in Wales, potentially through the provision of matched funding through its own resources. In particular, as it currently does not provide any loans to those start-ups that create the vast majority of jobs in the economy, the Welsh Government needs to develop an appropriate mechanism for this type of support, based on the Start-Up Loans programme operating in England, although this should be applicable to all new businesses and not only those started by year olds. Action The Welsh Government is reviewing current procurement policies in light of this recommendation. Following further discussions on the role of building societies in supporting access to capital within the Welsh economy there seems to be reluctance from building societies to expand into other forms of financial support for the business community. Instead, the message is that they want to focus on what they are doing already and doing it better for their customers. Full details of these discussions can be seen on page 26. On 14 October the UK Government funded Start Up Loans programme was introduced in Wales. This will form an integral part of the Business Start Up Service and be administered through the existing Business Start Up provider network. Welsh Government Officials continue to liaise with the UK Government Officials to explore how Welsh firms can better access UK Government funding initiatives. 11

14 Recommendation Recommendation 14 There is a major opportunity for Welsh Government to take the lead in supporting alternative sources of funding such as peer-to-peer lending and crowdfunding, either through partnership or direct funding. It could also raise awareness of both types of funding through its various business support programmes. Recommendation 16 This review has shown that there is a lack of regional data, especially for Wales, as a devolved nation. If policymaking within the Welsh Government is to be based on evidence, then it is critical that UK organisations in both the public and private sector are made fully aware of the implications of devolution and the need for accurate data being collected at a regional level.. Action This recommendation is examined in the Stage 2 Report. The Welsh Government will consider this recommendation within the broader framework of the review. The Minister for Economy, Science and Transport has written to the Secretary of State for Business. Innovation and Skills, Vince Cable to highlight the issue of regional data collection. The Welsh Government is also working with some of the banks on initiatives which could provide more useful, Wales-only data. 12

15 3. Banks Lending Patterns To SMEs This section will update the data from the first report and will examine whether the situation regarding access to finance from the banks to the SME sector in Wales has changed since it was published in June UK trends in bank lending In terms of loans to businesses, 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 (Figure 1). Of this, only 26 per cent ( 80 billion) have been lent to SMEs 3 and net lending, after repayments, for UK SMEs has gone down by 10 billion. 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. Figure 1. Gross lending (excluding overdrafts) to non-financial businesses, Bank of England Statistics on monetary financial institutions loans to non-financial businesses, by size of business, 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. 13

16 Table 1. Loans to SMEs by region, Q Q Value of loan balances ( m) + All SMEs London South East South West East Midlands West Midlands East of England Yorks & Humber North East North West Wales Scotland 2011 Q3 92,443 19,737 12,325 9,900 4,962 7,780 6,692 6,207 2,716 9,779 4,229 8, Q4 90,970 19,504 12,417 10,285 5,078 7,913 6,788 6,231 2,766 9,769 4,365 5, Q1 90,303 19,130 12,138 10,425 5,158 7,931 6,841 6,228 2,723 9,538 4,360 5, Q2 88,983 19,032 12,004 9,834 5,077 7,770 6,669 6,112 2,705 9,529 4,269 5, Q3 88,199 18,608 12,076 9,878 5,003 7,695 6,613 6,058 2,710 9,439 4,341 5, Q4 87,571 18,465 11,963 9,823 4,968 7,655 6,577 5,995 2,701 9,369 4,287 5, Q1 88,402 18,505 11,953 9,880 4,942 7,682 6,575 6,258 2,716 9,488 4,326 6, Q2 87,878 18,257 11,832 9,846 4,956 7,721 6,620 6,274 2,697 9,314 4,284 6,078 No. of loan facilities approved 2011 Q3 49,910 7,774 5,874 6,036 4,183 4,123 3,872 3,516 2,023 5,373 2,949 4, Q4 43,074 6,270 5,238 5,178 3,615 3,637 3,492 3,126 1,625 4,814 2,526 3, Q1 47,191 7,338 5,310 5,934 3,296 3,852 4,504 3,116 3,012 4,644 3,336 2, Q2 38,802 5,897 4,372 4,958 2,414 3,214 4,042 2,653 2,202 3,709 2,748 2, Q3 37,662 5,363 4,026 4,964 2,398 3,218 3,924 2,530 2,043 3,722 2,779 2, Q4 32,353 4,950 3,154 4,346 2,061 2,540 3,018 2,202 1,777 3,278 2,394 2, Q1 38,384 5,572 3,853 4,757 2,052 2,813 3,864 2,666 2,425 3,474 3,169 3, Q2 36,779 5,548 3,510 4,317 1,972 2,867 3,612 2,213 2,676 3,352 3,117 3,596 Value of loan facilities approved 2011 Q3 7,330 1, Q4 6,529 1, Q1 5,550 1, Q2 4, Q3 4, Q4 4, Q1 4, Q2 4, New loans 2011 Q3 5,920 1, Q4 5,744 1, Q1 6,077 1, Q2 5,009 1, Q3 5,218 1, Q4 4, Q1 5,136 1, Q2 4,

17 Table 2. Overdrafts to SMEs by region, Q Q All SMEs London South East South West East Midlands West Midlands East of England Yorks & Humber North East North West Wales Scotland Value of overdrawn balances 2011 Q3 13,658 1,411 1,373 1, ,155 2,401 1, , , Q4 12,697 1,280 1,300 1, ,068 2, , , Q1 12,717 1,591 1,483 1, ,171 1,039 1, , , Q2 12,643 1,438 1,448 1, ,189 1,084 1, , , Q3 12,353 1,405 1,436 1, ,123 1,023 1, , , Q4 11,480 1,316 1,344 1, , , , Q1 11,648 1,339 1,411 1, , , , Q2 11,207 1,254 1,271 1, , , ,292 No. of overdraft facilities approved 2011 Q3 68,916 8,923 8,720 9,310 4,542 6,391 5,813 5,433 2,679 6,114 4,529 6, Q4 63,092 8,382 8,464 8,282 4,352 5,630 4,837 4,648 2,469 6,036 3,973 6, Q1 72,010 10,634 9,248 9,217 4,235 6,215 6,332 5,043 3,875 6,232 4,924 6, Q2 59,723 8,755 7,787 7,500 3,424 5,203 5,764 4,475 2,914 5,248 4,146 4, Q3 59,021 8,559 7,331 7,323 3,529 5,246 5,632 4,380 2,914 5,156 4,308 4, Q4 53,885 7,945 6,805 6,857 3,044 4,662 4,907 3,907 2,623 4,785 3,819 4, Q1 56,216 7,727 6,725 7,503 2,931 4,635 4,752 4,007 3,054 4,624 4,296 5, Q2 49,161 6,678 5,545 6,263 2,524 4,212 4,210 3,467 3,092 4,115 4,046 5,009 Value of overdraft facilities approved 2011 Q3 1, Q4 1, Q1 1, Q2 1, Q3 1, Q4 1, Q1 1, Q2 1, Q2 4,

18 The other main form of debt funding from banks to SMEs is via an overdraft i.e. a shortterm 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 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. There are also mixed messages regarding lending emerging from the latest version of the SME Monitor 4, 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. Trends in bank lending in Wales As stated in the first report, the main source of information on regional lending 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 The updated statistics enable an examination to be made as to how Wales has been performing during the first two quarters of The latest data 5 shows the following: Current value of loan balances in Wales in Q2 of 2013 was billion, which equates to no substantial change on the position at the end of 2012 (table 1). The value of overdraft balances had increased, during the previous six months, from 623m to 656m (table 2). 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). 4 BDRC Continental (2013) SME Monitor Q2 2013: The changing mix of external funding? August 5 British Bankers Association (2013) Banks support for SMEs Quarter uk/download/

19 During the 12 month period Q Q2 2013, the banks approved 11,459 loan facilities for Welsh SMEs with a total value of 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 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. Table 3. Change in loan book and overdraft balances, Wales UK, Q Q M % change All SMEs Change in loan balances Wales % Change in overdrawn balances Wales % Change in loan balances UK - 4, % Change in overdrawn balances UK - 2, % Small firms Change in loan balances Wales % Change in overdrawn balances Wales % Change in loan balances UK % Change in overdrawn balances UK % Medium-sized firms Change in loan balances Wales % Change in overdrawn balances Wales % Change in loan balances UK - 3, % Change in overdrawn balances UK - 1, % 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 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 6 which suggests that whilst credit availability has continued to improve gradually,

20 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 7. 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 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, Q Q BBA (2013) Statistics Bank support for smaller and medium-sized firms, 2 nd quarter 18

21 Figure 3. The number of loan facilities approved for small to medium sized enterprises in Wales, Q Q In terms of the value of loan facilities being offered to SMEs in Wales (Figure 3), this has declined by 58 per cent since Q with the value of lending to mid sized firms falling by 140 per cent over this period (from 159 million in Q to 66 million in Q2 2013). In fact, it would seem that the main decline occurred between Q 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. 19

22 Figure 4. Indicative median interest rates on new SME variable-rate facilities, The latest report on trends in lending from the Bank of England 9 (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 , which equates to a reduction of 1.84 per cent since November For small firms, the median rate was slightly higher at 4.74 per cent 8 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. 9 Bank Of England (2013) Trends in Lending, October 10 loanpricingoctober2013.xls 20

23 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 11. The reduction in interest rates over time was reflected in a recent survey from the Federation of Small Businesses 12, 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 Q 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 Q 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 Q2 survey 13 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 14, 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 11 Both these measures may not entirely reflect the true cost of credit facing SMEs, as they do not include the impact of cash-back deals or changes in fees. In addition, these rates may be affected by changes in the risk profile of borrowers, which could vary over time. 12 Federation of Small Businesses (2013) FSB Voice of Small Business Index, Quarter 3, 2013, September 13 BDRC Continental (2013) SME Monitor Q2 2013: The changing mix of external funding? August

24 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 15 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. For example, if the banks approval rates for lending are 70 per cent, as the BBA suggests 16, 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 17. Therefore, the report estimates, by utilising this data, that there is a minimum of half a billion pounds lending gap within the Welsh economy 18. 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 19. 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. 15 BDRC Continental (2013) SME Monitor, 2013 Q2 report, July This is calculated by examining the total amount loaned to SMEs in the last month and then extrapolating the gap by using the rejection rate of the BBA to work out how much could have been lent to those turned down 19 NAO (2013) Improving access to finance for small and medium-sized enterprises, November 22