Credit must go where it is due

First published in the Financial Times on 10th April 2012.

Banks are restricting lending to industry

Is lack of finance the reason why small companies are struggling to grow? Or is that merely an excuse for overcaution, weak management and unviable propositions?

I spend much of my working life reading business plans, analysing projects that need capital, investing in smaller companies and discussing the challenges they face.

 Unquestionably, the flow of sound deals I see has declined since the financial crisis in 2008. I suspect that much of the reduction is because economic conditions have deteriorated, and so owners feel less confident about raising equity or borrowing money.

But it is also certain that bank credit has got harder to obtain, and is more expensive than it was. The interest margin that banks charge has risen steeply; the security they require for loans has increased very materially; the amortisation of any facility is much more onerous; and fees are bigger.

The abiding impression is that undercapitalised banks are restricting lending to industry in order to rebuild their capital ratios. The banks deny this and say there are simply not enough creditworthy borrowers.

It has been suggested that Britain needs an enterprise bank, established by the government, with a mandate to lend to small and micro firms. The Federation of Small Businesses recently published “ALT+ Finance”, a useful document that points out that Germany and the US have, respectively, the Sparkassen and Community Reinvestment Acts, which oblige certain financial institutions to support local small businesses. And late last year, a pamphlet entitled “Blueprint for a British Investment Bank” was published. It pointed to institutions such as the Nordic Investment Bank, Germany’s KfW and the European Investment Bank as examples that we could replicate.

I am instinctively suspicious of government interventions in free markets. I worry that such a bank would be run by civil servants who would make lending decisions based on political grounds and end up squandering taxpayers’ money by backing the wrong entrepreneurs. It would be essential to make sure any such organisation is managed on commercial lines, and does not simply lend to applicants rejected by the private sector.

Even though the British banking industry is at present an oligopoly with insufficient choice for business customers, markets are, as ever, adjusting. New players such as Metro Bank, where I serve as a director, are forcing the incumbents to work harder. Virgin, Tesco and Co-op have grand plans in Britain, but whether any become a big force in business lending remains to be seen.

Invoice discounting, trade finance, hire purchase and leasing remain sources of funding for hundreds of thousands of companies. This type of funding has contracted far less than conventional term lending and overdrafts during the downturn, thanks to the relatively safe nature of asset-based financing.

For smaller companies that can offer lenders stock, debtors or equipment as security, this is often the best form of finance.

Meanwhile, online marketplaces are springing up, offering peer-to-peer lending. Funding Circle is perhaps the best-known UK provider, giving lenders an average yield of 8.35 per cent on their cash. Rivals include Zopa and RateSetter.

Of course, start-ups have rarely been financed via straightforward debt. They have generally relied on equity of one type or another. Formal venture capital is really only relevant for substantial enterprises.

But I know from my partial ownership of Beer & Partners, an investing network, that angel investment has expanded in recent years, and crowdfunding may prove a useful addition to the repertoire of places founders can go for money.

America passed the Jobs (Jumpstart Our Business Startups) Act recently to encourage this form of investment. Now any investor can back a private company via a digital platform – an option previously only really open to accredited wealthy individuals. There are concerns that under the new legislation fraud will mushroom, but groups such as Kickstarter and IndieGoGo seem to have avoided this problem to date.

I suspect the current credit gap will gradually be filled thanks to better margins for lenders, leading to improved banking returns. For the sake of British industry, I hope this correction happens soon.