Review of access to finance for NI businesses. March 2013

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1 Review of access to finance for NI businesses March 2013

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3 Contents ExEcutivE summary i section 1: context Introduction to the Economic Advisory Group The Economic Context Terms of Reference 3 section 2: DEmanD For FinancE Introduction Demand Survey Comparisons with Other Demand Surveys Conclusion 16 section 3: supply of FinancE Introduction Lending Trends and Cost of Finance National Initiatives Local Initiatives Reviewing Finance Options for Northern Ireland Businesses Conclusion 38 section 4: views of the BanKs and other stakeholders Introduction Supply of Finance Demand for Finance The Irish Experience Provision of Lending Data Other Stakeholder Issues Conclusions 42 section 5: Discussion Summary of Findings Change in the Bank Lending Environment Is the issue of Access to Finance different in Northern Ireland to elsewhere? Is there Market Failure in Access to Finance for Businesses 46 in Northern Ireland? 5.5 Conclusion 47

4 section 6: recommendations 48 references 52 annex 1: ni access to FinancE survey 2012 sampling FramEWorK 54 annex 2: access to FinancE QuEstionnairE 55 annex 3: 17 actions of the BusinEss FinancE taskforce 71 annex 4: PrinciPLEs of BanKinG appeals ProcEss 73 annex 5: ExPEriEncE of venture capital FunDs closed 74 or BEinG managed out

5 Executive Summary Context As the UK economy struggles to recover from its longest and deepest recession on record, the issue of access to credit, particularly for SMEs, has become a major policy area for probing debate. The stock of UK lending to SMEs has been contracting since 2009 and a debate has emerged around how far viable businesses are able to access the credit needed to consolidate or grow. The UK government has responded with various initiatives to improve the flow of credit to business, most recently the introduction of the Funding for Lending Scheme by the Bank of England and HM Treasury. At the same time the global financial crisis has led the UK and other governments to undertake major regulatory and structural reforms of the banking and financial services sectors. Banks are under pressure to strengthen their balance sheets in order to ensure that the circumstances leading up to the crisis will not recur and this has placed constraints on banks capacity to lend to business. In Northern Ireland the fallout from the property boom, which saw high levels of lending by banks to business and consumers for the purchase of property, has further complicated the return to normal business lending. The property debt overhang has constrained the demand for and supply of credit and appears to have prevented potential business investment taking place. Another differentiating factor in Northern Ireland is the structure of bank ownership. Three of the four main banks are owned outside the UK. This has restricted their access to some of the initiatives to improve business lending, such as the Funding for Lending Scheme. Also banking regulation is not a devolved matter and this limits the power of the Northern Ireland Executive to take action to address the problems. The NI Executive has introduced its own Access to Finance Strategy to support businesses looking for finance 1. The issue of Access to Finance has been extensively raised by the business community in consultations with Ministers. Business representative bodies have expressed strong concerns that banks are not responding to the finance requirements of business. Following discussions with the DETI Minister, the EAG decided to undertake a review of Access to Finance for businesses within Northern Ireland as part of its work programme for 2012/13. Study Objectives The primary objective of the review is to consider the availability of finance to Northern Ireland SMEs, in order to establish what support is currently available, the level of uptake and the potential reasons for any deficiencies in the market. It is particularly important, given current financial circumstances, to seek to quantify the scale and nature of the problem both from the perspective of the demand coming from businesses and the supply of credit provided by the banking institutions. The work programme has focussed on seeking to quantify as far as possible the market for business finance in Northern Ireland from both a supply and demand perspective, in order to understand better the scale, nature and impact of the problem. Consideration is also given to whether there is a market failure and the nature of any such failure. 1 i

6 Key Issues There is clearly a significant degree of frustration within the local business community over what is perceived by many businesses to be the unwillingness by banks to lend at reasonable rates. This is attributed to various reasons including a lack of understanding of business needs and a desire by banks to build up their capital to meet the requirements of the financial regulators. On the other hand banks have told us that they are open for business and willing to lend to viable trading businesses. In their view the problem is a lack of demand due to low levels of confidence. In fact, the research demonstrates that the market for business finance is complex with many layers and there are issues on both the demand and supply sides. The supply and demand curves have both shifted although there is some evidence that the demand curve has shifted the most. Demand for Finance: Previous business surveys have indicated that Northern Ireland businesses were having difficulties with access to finance. We have collated data on SMEs demand for finance from a number of sources to provide an up-to-date overview of the issue. Whilst we draw primarily on the results of a survey of 1,000 SMEs conducted in November 2012, we also review results of previous studies and surveys in order to understand how the situation has changed over time. The evidence shows this is a challenging time for Northern Ireland businesses. The combined impact of declining domestic demand, increasing input costs, and cost of servicing existing debt is putting considerable strain on SMEs. The majority state that they are in either survival or stabilising mode which influences their appetite for further debt and/or the types of financial products they seek. Some 58% of NI SMEs have external finance in place with overdrafts, commercial loans and credit cards being the most frequently used products. Even allowing for differences in sampling methodologies, the evidence would suggest that more Northern Ireland SMEs have external finance in place currently than the UK average 2. This is particularly so for overdrafts, which is typically a working capital rather than business growth product. Demand for bank loan finance in 2012 was relatively low at around 8% of SMEs which is within the margin of error of previous similar surveys carried out in This is similar to levels of demand for bank loan finance (Q3 2012) in the UK and in the Republic of Ireland again reflecting economic conditions. The bank loan success rate of 66% in the 2012 survey is also broadly in line with 2010 and is on a par with the most recent surveys in the Republic of Ireland and the UK. In addition to unsuccessful applicants for loan finance, those with particular difficulty accessing finance include the discouraged borrowers (20% of whom describe themselves as growing ) and those whose capacity to borrow is restricted by the need to service property debt. The majority of SMEs also struggle with the higher cost of finance, higher fees and more burdensome processes and procedures and around 10% report an increase in the fees charged for their overdraft facility or loan arrangements in Whilst the proportions of businesses seeking access to bank loan finance and those experiencing difficulty in doing so for various reasons is low, if these proportions are applied to the total population of SMEs in Northern Ireland, this still represents a significant number of businesses. Furthermore, when the economy recovers and the demand for bank loans, and other finance to support business growth, begins to rise, these difficulties of access to finance may become more acute. 2 The 2012 Annual UK SME Finance Monitor, which will be published later this year, will provide a NI/UK comparison on SMEs use of external finance and overdraft facilities. ii

7 Supply of Finance: The evidence that bank lending has been falling in the UK over the last five years is substantive. Bank of England data clearly show that new lending has been falling while repayments of existing debt have risen. The British Bankers Association (BBA) also suggests that businesses are still largely focused on repayment of debt. Credit demand has largely been subdued or negative as a result of the economic situation. Credit availability has been an issue but does appear to have improved in the last quarter of The Funding for Lending Scheme is believed to be a key driver of this change. Trends in lending to businesses in Northern Ireland specifically have been difficult to establish. The BBA agreed to provide the EAG with the most recent regional lending statistics on the proviso that the data would not be disclosed or published. Therefore, we cannot include any specifics in this report. This is a significant information gap which needs to be addressed. The available qualitative evidence indicates that the supply of bank credit is constrained. Banks state that they are open for business but acknowledge stricter lending conditions being in place. The reasons for restricted supply include the need to strengthen bank balance sheets, the overhang of bad debt accumulated prior to the crisis, funding challenges, and current and impending higher capital requirements including for SME loans and overdrafts. The evidence, both nationally and locally, points to higher borrowing costs for business. This reflects the increased risk and return required from the banking sector in its widest sense. It is also likely to reflect the fact that Northern Ireland businesses became used to a lower borrowing norm compared to their GB counterparts during the boom amid intense competition between banks to lend. Conditions and covenants associated with lending have also become more onerous reflecting the additional scrutiny and monitoring associated with the more adverse lending environment that now exists. Business has had to adapt rapidly to this shift in attitudes to lending by banks and many have been caught in a position where adapting to the change has been challenging. The evidence from our survey suggests that many SMEs do not believe that the current situation is normal and consider that banks have gone too far in the other direction in their assessment of risk. It will take time for businesses and their lenders to work through this process of adjustment to the new lending environment. There would at least appear to be a need to build a better understanding between banks and business both at an individual and collective level which should lead to a more sustainable future for everyone. There has been a strong national policy response to improve the supply of finance to business. This has included government initiatives through HM Treasury, BIS and the Bank of England. In broad terms it is clear that, in the main, national initiatives are not working effectively in Northern Ireland. The configuration of national initiatives is not conducive to the business demographic in Northern Ireland. Key issues centre on access, scale, awareness, relevance and commitment. Not all NI-based banks have had immediate access to the Funding for Lending Scheme creating an unfair advantage in the short-term at least. There is also a scale issue for some banks in accessing cheaper loans from the Bank of England through the Scheme. Awareness of interventions such as the EFG and Better Business Finance (BBF) initiatives is limited particularly the existence of the Appeals Process and on-line portals through the BBF. The Business Growth Fund has been used as an example of an intervention of limited relevance to Northern Ireland in that it does not have the critical mass of businesses to access funding of that scale. It is also clear that an issue exists around the commitment of some banks to their role in promoting national initiatives to their customer base. iii

8 The Enterprise Finance Guarantee (EFG) raises particular concerns. The CfEL, which administers the Scheme, acknowledge that the Northern Ireland banking market is different. They also believe that there is a particular issue around small lenders and accessibility to the EFG although this was not specific to Northern Ireland and should be reviewed in a wider UK context. The case that government intervention is required at a local level to increase the supply of finance to businesses has been keenly debated, particularly around venture capital finance. The development of the Northern Ireland Access to Finance Strategy is a positive step in providing alternative funding options to businesses seeking to grow. The existence of the new Funds will widen the options available to businesses to commercialise those ideas. However, some challenges still exist. This includes issues around the delay in rolling out individual funds and the existence of further potential gaps in the funding continuum. It remains too early to assess Funds performance and impact. However, their close monitoring will be critical to providing an understanding not only of their individual impacts but crucially in presenting an opportunity to identify potential market failure/gaps in finance provision facing Northern Ireland businesses going forward. Degree of Market Failure: The evidence from our review of the demand for and supply of bank finance suggests that there are a number of structural market failures 3 affecting the supply of debt finance to SMEs. Our conclusion is that these market failures mainly relate to imperfect or asymmetric information. These information failures may also have become exacerbated in the current uncertain economic conditions as lenders have become more risk averse and there is greater uncertainty. In addition, there appear to be information market failures affecting the demand side for businesses seeking finance. SMEs may not fully understand the potential benefits to their business of raising finance or their likely chance of success in gaining finance, which ultimately means they do not apply. This may restrict the growth of businesses. Business owners can also lack knowledge of funding sources available or lack the skills to present themselves as investable opportunities to investors. There is still a widespread perception amongst businesses that the market is failing, despite the best efforts of banks to advertise their willingness to lend. There has been a market correction over the last 5 years as banks have moved away from a property-based lending approach to business plan-based approach that is based on the ability of business to generate returns that will fund their lending. The cost of borrowing has also risen as banks seek to rebuild their balance sheets and improve their liquidity and this has changed the way in which banks lend. There may, therefore, be a degree of market failure in the sense of a lack of information/ awareness/ perceptions in business of these new conditions. There is also no doubt that the property debt overhang is causing problems in the market in that viable trading businesses with property exposure are experiencing more constrained access to finance. Without the unlikely event of some form of forgiveness of this debt, it will take some time for banks to work through their books and for this overhang to work its way through the system. In the meantime this will restrict bank lending to a significant proportion of firms, highlighting the need for business to develop alternative means of financing their business growth. 3 A market failure is defined as An imperfection in the market mechanism that prevents the achievement of economic efficiency. HMT (2003) Green Book: Appraisal and Evaluation in Central Government. iv

9 There is also evidence of an under supply of equity finance to young high growth potential businesses in Northern Ireland due to the divergence of private and social benefits from investing in these businesses. This is because investing in early stage innovative businesses can lead to a number of positive spill-over effects through innovation and knowledge transfers to other parts of the economy, which private investors do not take into account when making their decision to invest in venture capital. This has led to the establishment of Invest NI funds to encourage supply of this form of finance. These funds will allow the market to be tested to see if there is a latent demand for this type of funding. Recommendations The first recommendation reflects what we believe is a priority action and one that will be important in driving forward the implementation of the recommendations. The remainder of the actions are categorised by and should be implemented by banks, business organisations and government to improve the lending environment. For ease of reference, those recommendations considered most important by the EAG are underlined. implementation Panel As there are numerous stakeholders involved there is a need to deliver these recommendations in a co-ordinated and timely manner and with a high level of understanding/expertise. recommendation 1: We recommend that an independent implementation panel should be appointed by government to take forward the recommendations listed in this report. We suggest that this would involve a small group of experienced individuals tasked with facilitating action. It is envisaged that the appointment would be for one year initially after which there would be an assessment on progress achieved and consideration of the position going forward in light of changing economic circumstances, particularly when demand for credit returns. To draw on international experience, the panel chairperson or members may be from outside Northern Ireland. For banks Issues have been raised about the need to build greater business knowledge and understanding among banks, particularly around risk assessment and cash flow requirements. recommendation 2: We recommend that banks review the level of training provided to staff dealing with applications for business finance. This should include the development of a more detailed understanding of the financing needs of businesses on a sectoral basis. The Independent Reviewer, responsible for dealing with systems for appeals by businesses whose loan applications have been declined by UK banks, has reported that unsuccessful SME applicants in Northern Ireland make very limited use of the appeals processes compared with other UK regions. recommendation 3: We recommend that banks should work with the Independent Reviewer for the UK Banking Appeals Taskforce to strengthen and publicise the credit appeals process in Northern Ireland. Business organisations should also play a role in publicising the process. v

10 The evidence suggests that there are communication issues between banks and the SME business community which impact negatively on the lending environment. There is a need to build a better understanding of their respective issues to address this concern. recommendation 4: We recommend that the British Banking Association and all banks with a presence in Northern Ireland should consider how communication between banks and the business community could be improved. This includes the role of the Business Banking Roundtable. Regional lending data is not published for Northern Ireland. This information is important in understanding the changing supply and underlying demand for business finance in Northern Ireland on both on an aggregate and sectoral basis. This will in turn contribute to a better understanding of the performance of the economy as a whole. recommendation 5: We recommend that the British Banking Association and all banks with a presence in Northern Ireland work together to provide data on the scale of lending to Northern Ireland businesses at an aggregate and sectoral level. This will help inform future economic policy development and help banks communicate to business the nature of the local lending environment. For business organisations There is an opportunity to develop initiatives that help support and simplify the way in which businesses deal with finance issues particularly in the current economic climate. recommendation 6: We recommend that the accountancy bodies, with the support of the representative business bodies, should organise a series of seminars to advise businesses on how to manage their finances through difficult trading periods. We recommend that the accountancy and business bodies should work with banks to introduce a common application form, business case and cash flow template to streamline the approvals process for businesses. Where feasible, Invest NI should adopt the same format for firms who wish to access finance from their programmes. For government National initiatives to improve the level of bank lending to business including the Enterprise Finance Guarantee (EFG) and the Bank of England Funding for Lending Scheme (FLS) are not working effectively in Northern Ireland. This recommendation is targeted at access to and the cost of finance for businesses. recommendation 7: We recommend that DFP/DETI, in consultation with banks, should review with BIS/ Capital for Enterprise how the EFG should be strengthened to encourage greater take up in Northern Ireland. We recommend that DFP should consider with the Bank of England the ability of all banks operating in NI to fully access the benefits of FLS and whether this can be improved. The development of the Access to Finance Strategy is a positive step in providing alternative funding options to businesses seeking to grow. It is still too early to evaluate the success of these interventions which will need to be kept under review. recommendation 8: We recommend that DETI/InvestNI should monitor the implementation of the Access to Finance Strategy including an on-going assessment of the interaction between the Funds as well as the funding outcomes for those successful and unsuccessful in securing finance. The Access to Finance Strategy should be delivered in a way that ensures there are no gaps in the funding continuum. It is important that the aggregate impact of the strategy is assessed. vi

11 There are wider issues on Venture Capital provision that should be considered. recommendation 9: We recommend that DETI should commission further research on the future strategy for Venture Capital/Equity Finance in Northern Ireland. It is important that this work is undertaken by someone with the appropriate technical expertise. The Review should consider the need for a better understanding of the demand for equity finance; issues around the skills/expertise within existing Funds and the potential to extend the geographical scale of the funds. The findings/recommendations from recent work by Invest NI and the Northern Ireland Science Park (NISP) should be considered. The report has identified a need for additional funds to enable entrepreneurs to develop products at the pre-commercial stage. recommendation 10: We recommend that Invest NI should increase the funding in the proof of concept, early seed funds, also ensuring there are sufficient funds for the follow on stages of commercialisation and growth. Underlying many of the problems of access to bank finance in Northern Ireland is the high level of property debt in what might otherwise be sound trading businesses. There is no easy answer to this problem but there is an opportunity to explore ways of addressing the problem in a more structured way. recommendation 11: We recommend that DFP and DETI should liaise with banks to understand the extent of property debt exposure among sound trading businesses, their approach to dealing with the issue and the implications for those businesses and the wider economy going forward. The departments should also be cognisant of the actions being taken in other jurisdictions to address this problem. A number of national initiatives to improve levels of bank lending to business are coordinated by BBF supported by the British Banking Association and the main UK banks, but there does not appear to be strong awareness or take-up of these initiatives in Northern Ireland. recommendation 12: We recommend that DFP should discuss with Better Business Finance how awareness and uptake of their national initiatives can be improved to ensure better alignment with the needs of local businesses in Northern Ireland. We understand that there are proposals to establish a new Business Bank in the UK which will be geared towards lending to small business. recommendation 13: We recommend that DFP and DETI engage with those responsible for developing proposals for a new business bank to support the proposals and to ensure that its design is appropriate and relevant to the needs of small businesses in Northern Ireland. vii

12 1. Context 1.1 Introduction to the Economic Advisory Group The Economic Advisory Group (EAG) was established in 2010 following a recommendation from the Independent Review of Economic Policy (IREP) to create an advisory body, comprising expertise from the fields of business, skills and economics, to provide independent economic advice on the Northern Ireland economy to the Minister of Enterprise, Trade and Investment. A secretariat is provided by the Department of Enterprise, Trade and Investment (DETI). Following discussions with the DETI Minister, the EAG decided to undertake a review of Access to Finance for businesses within Northern Ireland as part of its work programme for 2012/13. The primary objective of the review is to consider the availability of finance to Northern Ireland SMEs, to establish what support is currently available, the level of uptake and the potential reasons for any deficiencies in the market. It is particularly important, given current financial circumstances, to identify the real problems and, therefore, where potential solutions might lie. As the UK economy struggles to recover from the prolonged recession, the issue of access to credit, particularly for SMEs, has become a major policy issue. The Business Finance Taskforce was established by government with the cooperation of the major lending banks and has introduced a number of specific initiatives to improve the flow of credit to business. At the same time the global financial crisis has led the UK and other governments to undertake major regulatory and structural reforms of the banking and financial services sectors. Banks are under pressure to strengthen their balance sheets in order to ensure that the circumstances leading up to the crisis will not recur and this has placed constraints on the banks capacity to lend to business. In Northern Ireland the fallout from the property boom, which saw high levels of lending by banks to business and consumers for the purchase of property, has further complicated the return to normal business lending. The property debt overhang has constrained the demand for and supply of credit and appears to have prevented potential business investment taking place. Also banking regulation is not a devolved matter and this limits the power of the NI Executive to take any action to address the problems. The issue of Access to Finance has been extensively raised in the consultation responses to the Executive s draft Programme for Government and draft Economic Strategy and also in EAG s engagement with stakeholders. Business representative bodies have expressed strong concerns that banks are not responding to the finance requirements of business. One of the important reasons for undertaking this review is to seek to quantify the scale and nature of the problem, now and prospectively, both from the perspective of the demand coming from businesses and the supply of credit provided by the banking institutions. 1

13 1.2 The Economic Context A 2009 International Monetary Fund (IMF) review 4 found that recessions associated with financial crises tended to be more severe and long lasting than those associated with other shocks. This has certainly proven to be the case in many parts of the world, including the UK, which has suffered its longest and deepest recession on record. The UK entered recession in Q2 of 2008 and exited it in Q4 of 2009 but UK economic growth has remained weaker than expected. The economy shrank in three of the four quarters in The Office for National Statistics preliminary estimate is that GDP was marginally positive (0.2%) in 2012 from In December 2012, the Office for Budget Responsibility projected that the UK economy would grow by just 1.2% in 2013 and 2% in The Northern Ireland economy has performed particularly poorly relative to the wider UK economy over this period. The recently produced NI Composite Economic Index shows that the recession in Northern Ireland has been deeper and longer than in the rest of the UK. The private sector has contracted by around 15% from its peak in 2007 although there have been signs of a small recovery in the last year. Northern Ireland is one of only two regions posting a fall in output during Q4, It also recorded the fastest quarterly fall in employment across the UK regions. While the NI Annual Business Inquiry shows that SME turnover had remained largely stable between 2008 and 2010, investment in terms of capital has decreased by 48%. Many policymakers, nationally and locally, have expressed concern about the apparent lack of available finance to business, in particular for SMEs, during the post-crisis downturn. This is widely believed to be holding back investment and growth. The Bank of England s latest Trends in Lending report 5 highlights that the annual rate of growth in the stock of lending to UK businesses was again negative in the three months to November The stock of lending has continued to contract for both SMEs and large firms since According to the latest Credit Conditions Survey 6 demand for credit from small and large businesses fell in Q although the overall availability of credit to the corporate sector was reported to have increased significantly. Contacts of the Bank s network of Agents noted that credit was available for larger firms, especially those with strong balance sheets, while some smaller firms continued to report that they were unable to obtain credit. Most major UK lenders reported that a lack of confidence among some firms and the wider economic environment were weighing down on demand for credit. A debate has emerged over whether viable businesses are being denied the credit needed to consolidate or grow. Tim Breedon 7, in examining the role for alternative sources of finance commented that good economic evidence exists for both supply and demand problems in bank lending. He pointed to the fact that low levels of demand did not appear to fully explain the reduction in lending and also that terms had become more onerous. Breedon suggests that this reflected in part a return to more normal pricing for credit after a situation where credit had become too available and risk was wrongly priced. The difficult question is whether the provision of credit is constrained beyond the degree that would be justified by risk factors alone From Recession to Recovery: How Soon and How Strong? Terrones, Scott and Kannan, IMF World Economic Outlook, April 2009 January 2013 Q Boosting Finance Options for Business, March

14 1.3 Terms of Reference The aim of this review is for the EAG to: consider the available evidence on trends in both levels and costs of bank lending to SMEs and the effectiveness of current and past initiatives by banks themselves and the Government to try to increase the supply of credit; review existing research/evidence in relation to access to, and cost of, finance, benchmarking with other regions/countries where appropriate; undertake a mapping exercise of all existing Access to Finance funds/programmes, with a view to identifying the degree of overlap and/or interaction with each other; review the current financial support provided by DETI/Invest NI, and specifically the Invest NI Access to Capital Strategy, to ensure the appropriate composition and level of support is being provided in the right areas. This would include consideration of whether the specific needs of high growth and/ or exporting firms are being met; and examine the Venture Capital and Loan Fund (VCLF) market to identify what potential there is to increase the very low levels of VC and mezzanine funding in Northern Ireland and to determine if there is demand for VC and mezzanine funding among Northern Ireland businesses. The research work undertaken by the project team included the following: Survey of 1,000 businesses in Northern Ireland undertaken in association with InterTradeIreland Consultations with main banks in Northern Ireland Danske Bank, Ulster Bank, Bank of Ireland, First Trust Bank, Barclays, Santander Consultations with British Bankers Association (BBA), Bank of England, National Asset Management Agency (NAMA), Banking Appeals Taskforce, Irish Credit Review Office Meetings with a wide range of other stakeholders including business representative bodies, venture capital companies, Department of Finance and Personnel (DFP), Department of Finance (Republic of Ireland), Central Bank of Ireland, Northern Ireland Science Park (NISP), University of Ulster Discussions with Invest NI and focus groups with fund managers and investors/businesses Review of quantitative evidence on availability of credit and benchmarking with elsewhere The work programme has focussed on seeking to quantify as far as possible the market for business finance in Northern Ireland from both a supply and demand perspective, in order to understand better the scale and impact of the problem. Consideration is also given to whether there is a market failure and the nature of any such failure. The EAG would like to place on record its thanks to all those who took time to share their views in interviews and the workshops. The group would also like to thank the members of the project team including Johann Gallagher, Maureen O Reilly, Phillip McDonagh and from the EAG Secretariat Aidan McMahon for their work in bringing this project to a successful close. The report is set out under the following headings: Demand for Finance Supply of Finance Views of Banks and other Stakeholders Discussion Recommendations 3

15 2. Demand for Finance 2.1 Introduction An important aim of this review is to quantify the extent of the credit constraints and wider issues facing Northern Ireland SMEs seeking to access finance 8 at the present time. Funding difficulties become a particular cause for concern where they hinder the growth plans of potentially viable businesses. Previous business surveys have indicated that Northern Ireland businesses were having difficulties with access to finance and in this section we have collated data on SMEs demand for finance from a number of sources to provide an up-to-date overview of the issue. Whilst we draw primarily on the results of a survey of 1,000 SMEs conducted in November 2012, we also review results of previous studies and surveys in order to understand how the situation has changed over time. We analyse data on SMEs business performance, reliance on external finance, demand for bank loan finance and success rates, as well as collating data on the level of discouraged borrowers, informal applications and extent to which property debt is impacting of SMEs ability to raise new finance. Findings on SMEs awareness of various initiatives designed to assist businesses in accessing finance and perceptions about lending are also presented. We compare the results from the 2012 survey with previous surveys to show trends over time and gauge how Northern Ireland compares to other regions. InterTradeIreland is undertaking a study on Access to Finance for SMEs in Ireland and Northern Ireland which will provide further up-to-date comparative data on demand. The report will be published later this year 2.2 Demand Survey 2012 The quantitative evidence on demand was gathered in an independent survey of 1,000 SMEs undertaken in conjunction with InterTradeIreland 9. The telephone survey was conducted in November 2012 by Perceptive Insight, an independent market research firm. SMEs were asked about business performance and outlook, sales and growth prospects, financing options, success in accessing finance, engagement with funders, awareness of government schemes and perceptions of bank lending. sampling The sampling frame for this study is Northern Irish businesses with fewer than 250 employees. The sample was stratified to obtain a sufficient number of interviews to allow sub-group analysis by region and size of business. For example, larger businesses, by virtue of their turnover and the number of people they employ, have a greater impact on the economy. Therefore, as part of the sampling approach, larger businesses were over-sampled to allow analysis by this important sub-group. However, when reporting on all businesses the data is weighted to reflect the overall population (see Annex 1 for further detail on the weighting). The following table details the number of interviews that were conducted with businesses by sector and size. The sampling is broadly in line with the structure of businesses in Northern Ireland The OECD (2006) define credit constraints as occurring when SMEs cannot obtain finance from banks or other suppliers of finance even when they have the capability to use those funds productively. 9 A joint survey was conducted to maximise efficiencies and reduce the burden on businesses of completing multiple surveys on the same issue over the same time period. The questionnaire was administered as part of InterTradeIreland s regular Business Monitor. 10 The sampling by sector is consistent with the stratification used since the inception of InterTradeIreland s Business Monitor. 4

16 number of interviews conducted with smes number % sector Agriculture Manufacturing 90 9 Construction Professional services Leisure, hotel and catering Retail/distribution services Other services size 1 to 10 employees (micro) to 49 employees (small) or more employees (medium) total 1000 source: Perceptive Insight, Access to Finance Demand Survey, 2012 Business size Previous surveys have shown that business size is an important characteristic in assessing demand for finance. The survey results show the variation in responses by firm size. Size influences the type and quantum of finance required and the likelihood of success. Most of Northern Ireland s businesses are micro enterprises. Around 99% of SMEs employ fewer than 50 and micro/small enterprises account for threefifths of private sector jobs in Northern Ireland, higher than the UK equivalent (46%). The survey results have been weighted to reflect Northern Ireland s micro-enterprise economy. The following sections summarise the results from the 2012 survey 11, under the headings: a) Current financial situation of businesses b) Experience of bank loan applications c) Other factors influencing demand for finance 11 see Annex 2 for a copy of the questionnaire 5

17 (a) Current financial situation of businesses Finance in place External finance is central to the operation of many businesses. SMEs were asked to indicate, from a predefined list, which if any of a number of financial products they had in place. Some 58% of Northern Irish SMEs have at least one external finance product in place. The number and type of financial products in place range by business size. Medium sized businesses are more likely to use external finance products than small or micro companies, and they are more active users of all products. Only one fifth of medium sized businesses currently operate without external finance. number of lending products smes currently have in place total micro small medium One product 27% 28% 20% 16% Two product 17% 16% 23% 16% Three or more products 14% 12% 31% 47% No external finance 42% 44% 26% 21% source: Access to Finance Demand Survey, 2012 % N = 966 Northern Ireland SMEs use a blend of financial products throughout the business life cycle. SMEs were asked what financial products they currently have in place from a list which included overdrafts, loans, credit cards, lease/hire purchase, trade credit, grants and invoice discounting. Overdrafts, commercial loans and credit cards are the three most popular products. Overdrafts are used by 44% of SMEs, just over one fifth (22%) have commercial loans in place, and 22% have credit cards. Invoice discounting is used by 14% of medium sized companies; micro enterprises tend not to use this product at all. Do you have any of the following types of finance in place at the moment? source: Access to Finance Demand Survey,

18 Business cycle stage SMEs current business cycle stage is a significant variable as it influences businesses appetite for finance, the type of (working capital or development capital) financial products needed and also the likelihood of success in obtaining finance. SMEs current business cycle stage reflects the austere economic reality they face. The results show that a significant proportion of SMEs are in survival mode. Around 44% of SMEs describe themselves as reducing/survival at all costs/winding down, with a further 40% stabilising. Less than one fifth are growing. The results vary by business size, with medium sized enterprises performing better than smaller ones. Over one third of medium sized enterprises are growing compared to 15% of micro enterprises. However, about one quarter of medium enterprises describe themselves as reducing/survival at all costs. SMEs in construction are the hardest hit, with over 60% in this sector describing themselves as reducing/survival at all costs. Which best describes the current position of your business? source: Access to Finance Demand Survey,

19 (b) experience of bank loan application Loan finance SMEs were asked whether or not they had sought any bank loan finance in Demand for bank loan finance, over this period, was low. Only 8% of SMEs actively applied for bank loan finance in 2012, increasing to 16% for medium sized enterprises. Most of the loans sought were relatively small; around two thirds of SMEs applied for 50,000 or less. Just 3% of SMEs sought loans greater than one million pounds. Requests for finance for survival are almost as common as finance for growth. Just under half of those who applied for a loan sought finance to grow their domestic activities, whilst 40% of SMEs used it to maintain the business as a going concern. A small percentage used the loan to finance export sales. in the past 12 months, did you seek any loan finance? source: Access to Finance Demand Survey, 2012 Discouraged borrowers In recent years, the issue of the discouraged borrower has come to the fore where, for a variety of reasons, demand does not always translate into bank loan applications. The survey sought to quantify the extent of the issue by asking SMEs if they had considered applying for finance in 2012 but chose not to. Almost 7% of SMEs fall into this category. Only about one third (29%) of these decided not to apply because they thought the bank would reject their application. The two other main reasons cited for not applying was it is too costly (22%) and uncertainty about the economic climate (23%). When analysed by characteristics, some discouraged borrowers appear to be self-rationing and not applying for finance on the back on their own high risk rating, for example, over 50% of discouraged borrowers describe themselves as reducing/surviving. About one fifth of discouraged borrowers describe themselves as growing and it is these potentially viable businesses that are most likely to be foregoing growth opportunities and having a consequential negative effect on the economy. Loan success rate Around 7 in 10 SMEs (69%) who applied for a bank loan in 2012 were either wholly (66%) or partially (3%) successful. The remainder were unsuccessful. Over 55% of those rejected were declined on the back of business related reasons such as poor credit rating, insufficient or risky potential of the businesses. The remainder (45%) were declined for bank related reasons such as change in bank lending policy, the bank is no longer lending to that sector, or the rates offered were too high. Whilst the sample size is too small to analyse by sector, unsuccessful applicants span across most sectors. 8

20 Was your application to the bank in 2012 successful? source: Access to Finance Demand Survey, 2012 *caution should be exercised as the sample is small. informal applications Before proceeding with formal bank loan applications, there is evidence that SMEs are testing the water and seeking from financial institutions early indications of the likelihood of getting finance. In applying for a bank loan, around one fifth of SMEs made an informal approach but did not proceed with a formal application. A further one third of SMEs made an informal request for a bank loan and then went on to submit a formal application. The remainder submitted a formal application without seeking assurance that the application would be approved. The extent of informal requests may explain some of the divergence between banks and businesses perceptions on the loan approval rates. Banks appear to be filtering out potentially unsuccessful applicants at this stage; bank loan decline rates are likely to be somewhat higher if this did not happen. Property debt over-hang SMEs were asked a number of questions related to property to quantify the proportion of enterprises burdened with property related debt and the impact of this in accessing finance. About 8% of SMEs purchased property since 2005 that was financed by bank debt. This figure increases to around one fifth if only medium sized enterprises are considered. A similar proportion indicated that property debt is a relevant consideration both in maintaining existing terms for the business and in raising new finance for the business. Those with property overhang are four times more likely to have sought bank loan finance approximately 33% of those with property overhang applied for a bank loan in 2012 compared to 8% of all SMEs. Also those with property debt are also more likely to have been unsuccessful/partially successful in their bank loan applications. 9

21 at any time since 2005, has your company purchased property that is financed by bank debt? source: Access to Finance Demand Survey, 2012 Equity Finance Questions on equity finance were included in the survey to quantify its use by SMEs in Northern Ireland. The results confirm that demand for business finance remains heavily bank focused, with limited use of equity finance. Around 1% of SMEs sought equity finance in Given the low numbers, it is not feasible to do quantitative analysis on the characteristics of these firms. There is qualitative evidence from workshops hosted by InvestNI and the Northern Ireland Science Park (NISP) that demand for equity, particularly early stage funding, is increasing as businesses look to alternative sources of finance to grow. Equity finance is examined in more detail in Section 3. summary of demand for bank loans Overall demand for bank loan finance is low. The survey results indicate that the majority of SMEs that sought bank loan finance were successful; however, there is some evidence of problems, as shown in the diagram below. Whilst the percentages are relatively low, they still account for a considerable number of businesses. Those with issues accessing bank finance in the survey fall into a number of sub-categories: - unsuccessful applicants: those that applied for bank loan finance whose application was unsuccessful. As a proportion of the total VAT registered businesses, this equates to approximately 2.5% of all SMEs being declined/partially declined for a bank loan. - Discouraged borrowers: circa 7% of SMEs are discouraged borrowers defined as those who considered applying for finance in 2012 but decided not to proceed. About one third of discouraged borrowers decided not to apply because they thought the bank would decline their application. - smes with property debt: some 8% of SMEs indicated that they had purchased property with bank debt since This fi gure is around one fi fth for medium sized fi rms. Property debt is causing these firms difficulty in raising new finance and maintaining the existing terms of the business. 10

22 ni smes Demand for Bank Loan Finance 2012 all smes (100%) 58% have external finance in place 42% do not have finance in place 8% applied for a bank loan 7% were discouraged borrowers 31% unsuccessful 69% partially/wholly successful over 50% of these reducing or surviving 20% in growth stage *24% have invested in property since 2005 *48% have invested in property since 2005 * The number of respondents in these boxes is low source: Access to Finance Survey, 2012 sectoral overview The survey results show that there are particular problems in the construction, agriculture, retail and hospitality sectors. More SMEs in these sectors are struggling to survive in the current economic climate. SMEs in the construction sector, in particular, are under considerable strain. Around half of construction SMEs experienced a decline in sales in the last quarter and almost 80% indicated that the recession has had a severe adverse impact on their businesses. Around two thirds describe themselves as in survival mode (compared to 44% overall). The low demand for their services is compounded by rising energy costs and other overheads. Cash flow is also a huge issue for construction businesses. For those construction firms (11%) who purchased property with bank debt since 2005, it is impacting on their ability to maintain terms and raise new finance. Circa 70% of SMEs in the construction sector have external finance in place (compared to 58% overall). A higher than average proportion has overdrafts (52%) and credit cards (29%) in place. Trade credit is also an important product for construction SMEs, used by 35% compared to 12% overall. The proportion of Construction SMEs seeking loan finance is marginally below the overall average. Many in the retail and hospitality sectors also appear to be struggling. More SMEs in the retail and hospitality sectors have a worse than average score on many of the business performance and outlook indicators. Agriculture is also an outlier on many of the indicators. These businesses are dealing with rising energy and other inputs costs. Agriculture SMEs seem to rely on a range of external finance products including overdrafts (54%), commercial loans (22%) and lease/hire purchase (36%). Also, a much higher proportion of agricultural businesses applied for loans 28% compared to 7% overall. 11