Category: SME Lending
The original article was published by Entrepreneur Country on 01/11/2013.
Cash flow problems account for a huge percentage of corporate bankruptcies and are a major cause of financial distress to UK businesses. £36 billion was owed to UK SMBs (small and medium sized businesses) at the end of 2012 due to unpaid and overdue invoices. More than 124,000 businesses said they have come close to shutting their doors permanently as a result of cashflow problems resulting from extended invoicing terms and late payments from their buyers.
Cash flow worries have led to a surge in adoption of alternative financing services. Crowd funding, invoice financing, angel investors and even government grants have emerged as options for businesses struggling with cash flow concerns. However, though easier to access than traditional finance such as bank overdrafts and loans, these forms of credit are more often than not relatively more expensive for SMBs than for their larger customers.
Championed by the UK government, Supply Chain Financing (SCF) is quickly emerging as the best alternative solution for low cost working capital finance for businesses.
In many ways SCF is the same as Invoice Financing/Factoring – the practice of receiving short-term credit against the security of an invoice as yet unpaid.
The critical difference between SCF and Invoice Finance (IF) is that it is the customer not the supplier that works with the lender, historically a bank, to enable seamless early payment of the invoices to its suppliers. Suppliers are offered the opportunity to receive early payment and can choose to opt in to the scheme or not. The “credit” comes in the form of a discount on the value of the invoice. For example, if a customer typically pays on 60-day terms, a supplier could receive immediate/early payment if they accept a small discount on the face value of the invoice.
The benefits of SCF to both the customer and supplier far outweigh those of other working capital solutions.
Firstly, the credit risk and thus the cost of the financing are related to the customer, not the supplier. Due to the direct relationship with the customer, the lender’s fraud risk is also reduced – there are no “ghost invoices” to worry about, no worry around disputes over payment or returned goods. These factors help make SCF the lowest cost option for working capital finance for a supplier. Suppliers can receive early payment on close to 100% of their invoice value. With IF, early payment is generally around 60%-80% of the invoice value.
Furthermore, SCF provides for total transparency in the use of the credit facility; the relationship between supplier and customer often becomes strained when a lender is chasing the customer for unpaid invoices in an IF solution. Invoices are pre-approved for financing as opposed to a supplier struggling to obtain the evidence they need for IF.
For the customer, SCF helps cement a robust supply chain and can actually make their cash work harder, enhancing their own working capital, and can potentially help generate a new and small income stream.
Win-Win for all involved.
SCF has traditionally been targeted at large corporates with a large supplier base. This is changing as technology and processes to assess risk are improving. New services, such Tradebridge, aim to facilitate SCF for medium sized businesses, helping them, and their suppliers, to access the benefits of SCF.
Mark Coxhead, Managing Director of an innovative new SCF business called Tradebridge said to me, “We utilise proven technology to help us deliver a simple, easy to use solution designed for medium sized businesses, typically with between £20million and £100million in revenues.
Our goals are to allow these businesses to realise the benefits of SCF without adding any friction or cost to their existing processes and to help their suppliers overcome cash flow worries. Our service also gives more control to the supplier, allowing them to get cash early for their invoices when and as they need.
Our technology enables us to cut out a lot of the overhead that larger lenders/banks have to cover in their lending rates. As such, we are able to offer market leading finance that is lower cost than that of other providers.”
Automation around invoicing is core to optimising the SCF process, and to invoicing in general. E-invoicing should, particularly in this age of technology, be the defacto method of billing between the supplier and customer; many solutions, such as Invoiceable, are free, others are in-built to common accounting packages.
Paper invoicing is the source of a great amount of confusion on invoice status. Paper invoices are difficult to track and thus create inefficiencies in the invoice approval process. PDF attachments to emails are not much better; they are invariably at risk of being ignored.
A clear, robust and automated process around invoice handling can even free up previously hidden cash within an organisation. For customers, greater clarity about what has been spent, what’s outstanding and invoice status can lead to more rapid processing, helping them to avoid late payment. A transparent system also fosters greater collaboration between suppliers and customers, leading to new opportunities.
Invoicing terms are the main driver of cashflow issues facing SMBs in the UK today. The lack of cheap and accessible credit further exacerbates the issues SMBs face. Managing finances does not need to be so difficult; Supply Chain Finance offers a myriad of benefits to both suppliers and their buyers and is now accessible to a wider community of businesses. Technology has made SCF relatively pain free to implement and use and has helped to lower the financing costs. Implementing SCF should be a top priority for any Financial Director.
2012 was a tough year for small businesses. The Eurozone crisis rumbled on and economies stagnated or contracted. Government initiatives, such as the Funding For Lending (FLS) scheme in the UK have done little to relieve the cash flow pressure on businesses that, as Vince Cable, Secretary of State for Business, Innovation and Skills, trumpets, “are the lifeblood of the UK economy”.
The latest Bank of England figures show that net lending in the last three months of 2012 was £2.4bn less than in the preceding three months – despite banks participants in the Bank of England’s funding for lending scheme drawing down £9.5bn of available funds. The banks have ignored the cries of all around them to do what they are supposed to do – lend.
The release of the figures has exposed the FLS to an inevitable backlash from the media as well as from consumer and business bodies. George Osborne, Chancellor of the Exchequer, set up the Funding for Lending scheme as a solution to previous schemes, such as Project Merlin, which failed to deliver credit to cash-strapped businesses. However, the conditions under which banks could access cheap capital included large corporates tucked away within the small print, a more profitable and less risky customer segment for banks. The broad criteria have been exploited to the benefit of the banks and the detriment of small business.
Under banking regulation, lending to SMEs carries a heavy capital cost to a bank. On top of this, the return on investment to assist SMEs is also very low. As a result, the service small businesses receive from their banks is equally poor; getting a bank loan is like juicing a stone and the process and experience are far from easy or friendly.
The government has repeatedly failed to rectify its policy errors and implement the right incentives for banks to lend. The banks have received cheap and easy access to capital in exchange for only a token gesture to help the 95% out of 4.8 million businesses classed as SMEs in the UK.
Fortunately, a plethora of New Finance firms are stepping forward to challenge the oligopoly of high street banks and provide a real and transparent alternative source of funding and financial services for SMEs. These technology firms were born to better support businesses with a vision to deliver a fairer and more accessible portfolio of financial services.
The government is waking up to the value of these challenger services, pumping £110m to alternative finance schemes for lending to SMEs. This is the best indicator yet that these firms are now in the mainstream. Given the clear failure of the Funding for Lending scheme, firms such as Funding Circle, Squirrl and Funding Knight may offer the lifeline that small business, and our economy, needs.
Originally published in The Huffington Post, 15 July 2012.
The Bank of England and HM Treasury officially launched the “Funding for Lending Scheme” (FLS) on Friday 13 July (read the announcement and details here), yet another covert operation to shore up the banks under the disguise of helping small businesses and households to access cheaper credit and thus stimulate the economy.
Sure, some of the money will find its way to you, me and our businesses. However, I guarantee that the vast majority of the funds the banks draw down from the scheme (with obvious glee) will not make its way to those who need it most. The reason is quite simple; lending to SMEs and households carries a high cost for the banks in terms of capital requirement and consequently has the lowest rate of return of any of a bank’s activities.
We look to the government and their related bodies to effectively set tactical and strategic policies that instill the right incentives within the private sector to do what is best for the UK economy. Is the government providing the right incentives to the banking sector to open up lending to SMEs and households? No – and they know it. Banks will have a channel to access cheap capital; how they use that capital is not, and will not be dictated to meet the specific need of SMEs and consumers.
The level of low cost capital available to the banks under the FLS is a factor of the credit they already extend to non-financial entities in the UK plus any new loans made to this segment. Without lending a new penny, the banks are eligible to access £80 billion of cheap capital from the Bank of England. To access more, they can simply lend to their core customers within the large corporate space, those with strong credit rating that also feed the most risky activities of the bank’s capital markets division through their requirements for complex derivative products.
A loan portfolio consisting of SME loans is considerably more expensive for a bank to hold then a loan portfolio consisting of large corporate and (financial) institution loans. A scaling factor of 40% (of the loan) or less is used when calculating the capital a bank must hold to cover potential loss on a large corporate or financial institution loan, compared to a 100% scaling factor for SME and consumer loans.
Looking at loan revenues: on average, a bank may earn 8% on SME loans and 5% on large corporate loans. This 3 percent benefit in no way compensates the difference in the capital requirement (cost) between SME and large corporate loan portfolios when calculating the return on capital, a core metric for effectively allocating money across projects/business units.
For a complete picture, lets also note the off balance sheet activities of banks – the complex derivatives they trade in the capital markets division that can reap them considerable revenues but cost the bank nothing in terms of regulatory capital.
Banks are privately held entities. They do what is best to maximize return for their shareholders. If a bank has one hundred (100) units of capital at its disposal, it will, like any other private firm, look to allocate that one hundred in the most effective way to generate the maximum level of return on capital.
So, if you ran a bank and have one hundred units of capital available, what would you do it with it?
Given the incentive structure, in this case, the capital requirements dictated by regulatory bodies such as the FSA, Bank of England, the EC and the Basel Capital Accord, you would logically do as the banks do, allocate as little of that capital to lending to SMEs in order to maximize shareholder return. This is why Project Merlin, the effort by the Government to tie banks to lending targets, failed – though a token effort was made due to brand necessity, the proportion of loans made to SMEs relative to large corporates fell considerably and continues to fall. This is also why the FLS will fail to meet stated objectives – the incentives are simply not there for banks to lend to SMEs. Given the current trajectory of regulation, I would even stick my neck out and state that banks will look to exit the business of lending to and generally providing SME services within the next 10 years.
So what? Let them. We can do better. The alternatives are already here and innovation in the New Finance sector is progressing at a lightening pace. Entirely new banking models such as Fidor Bank in Germany, Holvi in Finland and Simple and Movenbank in the US will soon migrate to the UK. There are already several young firms focusing on niche elements of financial services to deliver exceptional, transparent and cheaper services to SMEs and consumers. There are firms providing Peer to Peer based access to credit, such as Fundingcircle, Zopa and Fundingknight, other firms providing lower cost access to currency and international trade services, such as Tradeshift, Currencyfair, Transferwise and Azimo.
The Government will continue to support the banks albeit stealthily; avoiding association to bypass the negativity of the media and population directed at the banking sector. Financial services is the comparative advantage of the UK, the thing we excel at and the rest of the world wants from us. UK financial services drives wealth creation for us all, and the government knows this. We should therefore stop waiting for policy led solutions to the system – they are not coming. We should take it upon ourselves to instigate the change we need.
Orignally published in Entrepreneur Country, 19 June 2012.
Here we go again – bailing out the bankers under a veil of helping out small business.
I read the following article, published in the Wall Street Journal (and I am sure elsewhere) with a knowing smile on my face.
Lets leave aside the irony of a bunch of wealthy politicians preaching to a bunch of wealthy bankers at an expensive and exclusive black tie event about how they are going to help “the little people” (I love the pic!), and focus on the proposal.
“Mervyn King announced plans to flood banks with cheap funds in an attempt to jump-start lending to British households and businesses….”.
Let me tell you a little about how banks work. They are privately held entities. Like other firms listed on the stock market, they do what is best to maximize return for their shareholders. If they have 100 units of capital, they, like any other private firm, will look to allocate the 100 in the most effective way to generate the maximum level of return on that capital.
Banks are not responsible for saving the economy, that is the job of the government through public policy and expenditure and by delivering the right incentives to the private sector to do what is best for the whole while also helping themselves.
So, by providing cheaper loans to banks is the government providing the right incentives to the banks to open up lending to SMEs and households? No – and they know it.
All the government is doing is helping the banks more easily raise capital. How they use that capital is not, and will not, be dictated. Yes, some of it will find its way to you, I and our businesses. However the vast majority will go towards the capital markets functions of the banks and in lending to large corporates. The reason is quite simple; lending to SMEs and households is the most expensive activity for a bank to conduct in terms of capital utilised.
A loan portfolio consisting of SME loans is considerably more expensive to hold then a loan portfolio of large corporate loans. Obviously the revenue the banks earn also defines the return on capital. Let’s say, on average, a bank earns 8% on SME loans and 5% on large corporate loans. This 3 percent difference in no way compensates the difference in the capital requirement between SME and Large corporate loan portfolios, which can be as large as 20%. Now also factor in the off balance sheet activities of banks – the complex derivatives they trade in the capital markets division that can reap them considerable revenues but cost the bank nothing in terms of regulatory capital.
So, if a bank has 100 units of capital available, what would it do it with it? Well given the incentive structure, in this case, the capital requirements dictated by regulatory bodies such as the FSA, Bank of England, the EC and the Basel Capital Accord, they would allocate zero of that capital to lending to SMEs in order to maximize their shareholder’s return. This is why Project Merlin, the effort by the Government to tie banks to lending targets, failed – though a token effort was made due to brand necessity, the proportion of loans made to SMEs relative to large corporates fell considerably and continues to fall. This is also why the stimulus package announced at the event covered by the Wall Street Journal will also fail – the incentives are simply not there for banks to lend to SMEs. Given the current trajectory of regulation, I would even stick my neck out and state that banks will exit the business of lending and generally providing SME services within the next 10-15 years. SMEs should be looking at the new finance/Fin-tech sector for support as it is fundamentally the future for SME finance and banking services.
As a spin on the Government proposal and the general conditions for banking at the moment, why don’t you help me take advantage of the situation? I promise at least 20% Return on Equity for any investor who will help me set up a bank. Here is my high level business plan – any takers? 😉
- I employ some currently unemployed bankers (adding value to the economy)
- We raise £1 billion of equity
- We use the £1 billion to buy as much high-grade securities as we can (minus set up costs), paying maybe 4-5% coupon
- We use the securities as collateral to borrow £9 billion from the BofE at overnight rate of 0.5%
- We buy another £9 billion of securities at similar rates as the first batch. At this rate, we are earning at least £400 million per annum
- We continuously roll the overnight position with the BofE, pledging more of the security pool in collateral if required on margin calls
- We go public. After costs, the bank is earning at least £200 million a year with a high capital ratio (10% equity-to-debt), and the balance sheet will be clean (all low risk securities). Potential valuation of 20-times earnings: £4 billion. We sell 25% of the company for £1 billion
- Put the £1 billion raised to good use – go back to Step 3
- When market cap hits £10 billion, sell another 10% of the company for £1 billion. Go back to Step 3 again
- Expand to US. Fed is lending at 0.25%. Repeat formula. Start focusing on PR and social issues, buy branch networks from defunct banks and start making actual loans to retail and corporate consumers
- Exit for a ridiculous valuation. We all win!
Originally published in Entrepreneur Country, 02 December 2011.
I watched George Osborne’s Autumn Statement on Tuesday with a great deal of interest. I was eagerly anticipating the statement confirming exactly how £20billion in funding will be delivered to SMEs, a story that had been circulating in the press for the previous few days.
See, here is what I understand; and it worries me. I would dearly love for someone to correct what I must obviously have wrong: the NLG benefits the banks and not SMEs.
From what I understand, the NLG scheme will allow BANKS to borrow in the money markets, most likely by issuing bonds, to the tune of £20billion, backed by a government guarantee. I.e. if the BANK goes bankrupt, the government will pay out to the owners of the bank debt. As a result of this guarantee, the banks can borrow at lower rates, essentially borrowing against the Government’s AAA credit rating. It is then assumed that the banks will pass on the cost saving to SMEs seeking loans. SME loans are not actually guaranteed themselves.
The problem – I can’t find any evidence to suggest that the banks MUST use the £20billion they raise to lend to SMEs. This is extremely concerning, and as I said, nagging me to the detriment of my sleep.
If my suspicions are correct and the banks are not obliged to lend the money to SMEs, they will not; for the same reasons they are not lending today. Credit risk and the high (highest) capital charge for lending to SMEs will not change. The opportunity cost of lending to SMEs will continue to drive the use of funds in other areas of the bank – lending to larger corps (a shift in capital that is clearly apparent in Project Merlin stats) or, more likely, into their capital markets divisions.
In essence, without a contract forcing them to lend the money to SMEs, the funding raised under the NLG will be used to bolster liquidity in day to day operations within capital markets, thus further increasing the profitability of this part of the bank, by increasing the scale of the activity that can be carried out. In a similar vein to Quantitative Easing (who holds large quantities of government debt? The banks. Who processes the transactions for other institutions selling bonds back to the government. and charge a fee? The banks. What happens when the government announces a QE programme which runs for several months? The price of the bonds goes up – more profit to…..yes you guessed it, the BANKS), the wool is somewhat being pulled over our eyes; the banks are guaranteed to benefit, SMEs will likely be no better off.
It could be that more detail on the mechanics of the NLG scheme will emerge that subside my concern. It could be, as I have stated I hope, that I have got this completely wrong. For once, I really want to be.
Originally published in Entrepreneur Country, 25 November 2011.
NESTA, the National Endowment for Science, Technology and the Arts, (www.nesta.org.uk) in collaboration with Sam Gyimah, MP for Surrey East, today published the long awaited report proposing recommendations to help improve British SME’s access capital.
The proposal is a good one. The paper addresses the mechanics; rather than the securitisation occurring at the bank level, the Government should purchase the loan portfolio’s from banks then securitise and sell this asset backed bond to investors, providing guarantees beyond a level of default on the underlying portfolio to insure against the catastrophic impact of mass distress/default on the loans. We have seen the consequences of mis-management of these types of assets before –they are part of the family of Asset Based Securities (ABS) that includes Mortgage Backed Securities (MBS).The paper touches on some of the obvious concerns of such a scheme. Will the scheme stimulate more lending by the banks? Potentially, as it frees up the balance sheet of the banks, compelling them to lend to SMEs as the continued Government purchase of the portfolio will deliver a source of funding for the banking operations – liquidity is one of the biggest concerns of the banks due to the issues in sovereign debt markets, their traditional source of raising cash.
What about Moral Hazard? If the banks know they can offload the loan portfolio to the Government, will they be more gung-ho in their assessment of risk when providing loans to SMEs? NESTA and Mr. Gyimah suggest that the banks be made to buy portions of the bonds themselves, across all tranches of risk (for a detailed description of how securitisation works, I would rather you refer to Wikipedia), thus continuing to be exposed to risk themselves.
The argument is a little weak in reasoning and one of my few criticisms of the report; banks have being doing this for a long time with ABS; it does not work as effectively as one might think. ABS bonds have a considerably higher credit rating than the underlying loans, especially with the Govt guaranteeing against default on those loans, as proposed in the paper. Thus the capital charge for holding the Bond is much much lower, regardless of the tranching that occurs. So, offloading the high risk to Govt, being forced to purchase low risk bond tranches, still promotes hazard and gives more capital for the banks to gamble with. The government, and thus the tax payer, will bear the brunt of any problems that occur. Fair dues to the authors who state:
“The issue of asymmetric information and the possible passing off of bad loans would be one of the main tasks of the managers of the new entity”.
The paper suggests using Experian to measure the credit worthiness of the underlying loan. Mmmm, I must confess to a little giggle when reading this section. xperian, Equifax and other business data/credit agencies have come in for a great deal of criticism in the press recently around the disparate methodologies and ratings of SME risk. Further, a 3rd party has no real vested interest (skin in the game) to do a good job, reputational risk aside. I would like see a group of specialists employed by the Government perform the risk assessment, with 3rd parties, such as Experian being used as auditors of the process. Another one for the managers of the scheme to resolve!
The expansion of securitisation beyond a unilateral Government scheme is discussed with supporting data from an intelligently administered survey through MORI. The suggestion that specialist non bank commercial lending institutions with a trusted reputation in SME lending, be permitted to also issue securitised bonds for investors provides a breadth to the recommendation that is applaudable. Free market forces, supported by the Government, the right processes and market structure, will inevitably lead to a better, more robust product then the Government acting alone.
Credit Easing and the potential establishment of a state controlled bank are considered and dismissed – well thought through and pragmatic arguments are presented that demonstrate the ineffectiveness of either solution to resolve the immediate pains being felt by SMEs while toeing the line of proposed regulation.
The other major proposal of note is one of “soft” (private sector led) structural reform of the financial sector; looking at new innovations and new models of lending that enable greater competition and/or focus banks on core capabilities (risk management), to better deliver services to consumers. Direct Bond Issuance, championed by Will King of King of Shaves fame, an unexpected but amiable figurehead for SME capital as a result of his “shaving bonds”, is put forward as a solution for larger firms.
Innovation in financial services is accelerating, the sector is unlikely to look the same in 10 years time. Matching those with Capital to those that need it, leveraging technology, new business models and focusing on specific strands of the financial services value chain, will evolve the industry for the better. Solutions such as Funding Circle (mentioned in the report), our own EuroTRX, MovenBank, Crowdcube, Zopa…will hopefully be the big names we all, business and retail alike, turn to for our financial needs in the future.
The UK’s SMEs have been crying, pleading, for a legitimate solution to their lending issues for several years. “Beyond the Banks” presents a well thought through and viable resolution that should give SME’s reason to cheer. Execution is key – Will the government act, and if so, how soon? We wait with baited breath for George Osborne’s statement next Tuesday; fingers crossed that he follows through with some of the report recommendations and provide the spark for the light at the end of the tunnel.
Originally published in Entrepreneur Country, 23 November 2011.
Credit/lending to SMEs continues to catch the headlines. The banks’ promises under Project Merlin are still not being met, though the situation has improved. Interestingly, the proportion of lending through various means of asset based finance has apparently risen, with ABFA’s recent press release specifically highlighting the growth of invoice finance over the past year.
ABFA (http://www.abfa.org.uk) do a stellar job of promoting the industry with the limited budget they have, but I believe more can be done.
Looking at ABFA’s own statistics: 48,172 companies used factoring or invoice discounting at the end of 2008 – a figure which has fallen to 41,486 by 30th June 2011. They also claim that,
“the latest figures show invoice finance clients are (again) choosing not to access all of the funds available to them. Total available funds this quarter were £22.2bn, with £6.5bn of finance available but not drawn.”
Can it be that the majority of clients are “choosing not to access all of the funds available to them?” I believe the truth is more likely to be that the figures are rendered somewhat meaningless by the 496 companies with annual turnovers in excess of £50m who represent 1.2% of clients by number but one third of the turnover in ABFA’s statistics.
The reality is that as far as the SME sector is concerned, the invoice finance industry, dominated by our well known and creaking high street banks, is running fast in the same spot, and has been for the past few years.
With the state of the traditional lending to SMEs being what it is, the window of opportunity for independent, non-bank firms within the asset based finance industry is tremendous. An opportunity to be the good guys, an opportunity to help the economy, resuscitate business, play a key role in getting the Economy growing again. They can work to change the perceptions of asset based finance and specifically invoice finance – make access easier for business and demystify the perceived complexity. Bolster marketing, re-position, innovate.
Sadly this is not happening, well, not to the extent it should be. Some claim (the banks) that the British Banker Association statistics for company borrowing continue to show that demand for debt from companies, specifically SMEs, is not there, and that the continued fall in net borrowing is a result of companies paying back loans to wipe debt off their books in these gloomy times.
Certainly, reduced confidence in growth and the economy as a whole does make SMEs cautious in their ability to continue to service debt. But in this lies the solution and enlightenment; traditional debt finance requires continued interest payments, impacting a firm’s cash flow and further straining working capital – the cash available to a business to service its monthly operations. Injecting capital through Invoice Finance does not. To simplify: Cash in from debtor, repayment out to financer, debt closed. Eureka!
The incentives for selling invoice finance to SMEs are just not strong enough. If an invoice finance salesperson is trying to grow their loan portfolio by 10 percent, they are more likely to get there by making fewer larger sales than a whole lot of smaller ones, particularly as the time taken to sell the facility to a larger firm relative to a smaller one is still marginal compared to the potential return.
Many small businesses have lost faith in the banking sector and are looking at other means of finance. Research firm BDRC recently published a survey that found that bank refusals on borrowing applications/renegotiations have increased since the 2008. The mere fact that SMEs are turning to other forms of finance – Peer to Peer lending networks, retail bonds even pawnbrokers, suggest there is still a demand for capital. Asset based lenders should seize the opportunity.
Having spoken to many in recent months, I also believe that other non-banking financial firms, those that do not currently compete in the asset based finance arena, can add considerable value. There is a demand to access the market from a variety of firms: hedge funds, family offices, alternative investment advisors, private banks. These firms, more streamline in their operations with lower overheads, can deliver more competitive funding rates for business while still turning a decent profit on the risk they are taking. They are very interested in investing in new and alternative asset classes to diversify their portfolios and exposures.
It was interesting to read the following in the interim report by the Independent Commission on Banking Reform, published in April 2011,
“…..reforms that stabilise the UK banking system may also raise its costs. This may cause some activities to move to non-banks, foreign banks, or capital markets………. Non-banks may well be better-placed than banks to conduct some financial activities, and limiting the implicit government guarantee for banks may also encourage some activities to move out of the banking system. To the extent that shadow banks can safely remove risk from the banking system, an increased role for them will be positive for financial stability.”
The issue for non-banks is one of sourcing – they have no capability in this area nor in the area of due diligence. Sourcing and relationship management is a heavy cost even to existing participants in the industry and, coupled with consumer perceptions, makes client acquisition far from easy.
What is the solution? We all have an opinion, here is mine. Fragment the industry value chain. Narrow the focus of firms within the industry to a small set of core capabilities that they can excel at, let others take over the management of marketing, sales and distribution; going beyond the “lifestyle” brokers that proliferate the industry. Put more emphasis on consumer needs in the delivery of financing, make them more comfortable with the solutions provided. Leverage a new breed of innovative services that use technology to deliver massive scalability in terms of clients, services that demonstrate competency in marketing and sales and are driven by volume rather than deal size.
All participants, old and new, supporting service providers and potentially most importantly, businesses, will win– innovation at the industry level, not just at the product and process level, delivers the greatest rewards.
Originally published on Entrepreneur Country, 15 November 2011.
Following a period of discussion between the Government and the major UK banks, known as ‘Project Merlin’, a statement was made by the banks on 9 February 2011.As part of that, the banks stated a capacity and willingness to lend £190 billion of new credit to business in 2011, with £76 billion of this lending capacity allocated to small and medium-sized enterprises – 40% of the total lending target.
The Q3 2011 Project Merlin figures released today show that the major banks have once again failed to meet their quarterly targets. Banks lent a total of £57.4m to non-financial corporates, with £18.8 billion of that figure going to SMEs. The SME lending target for Q3 was £19 billion.
Some may argue that the numbers still look good – a shortfall of £200m is not too bad. Couple this with the banks’ insistence that demand from SMEs for debt is low and the numbers looks almost rosey.
However, some serious cracks appear when we dig a little deeper, cracks that cast concerning hazards for business on the road to recovery.
The obvious first: the amount lent to SMEs in Q3 is 8.3% less than the previous quarter. Considering seasonality, demand for capital tends to increase in Q3 and Q4, principally as the business machine gets back into gear after the more relaxing summer months, gearing up for year end.
Proportionately and logically, given the intrinsic incentives of proposed capital adequacy regulation under Basel III and the Vickers report, it is clear that banks are shifting their lending strategy to more reliable credits: larger corporations. The proportion of lending to SMEs as a percentage of total lending in each quarter is Q1:35%, Q2: 38%, Q3: 32%.
Now the crunch: lending numbers reported by the BOE are on a GROSS basis – i.e. inclusive of existing facilities that are rolled over. Considering the onus on stimulating the economy and the widely repeated statement by senior politicians and economists that SMEs are the lifeblood of the stimulus, one would be fair to assume that more new money is being lent each quarter than is expiring as facilities are closed. WRONG.
Simple math: Previous quarter’s lending + new lending – expired lending = current quarter gross lending.
For Q3: £20.5 billion (Q2 gross to SMEs) + new lending – expired lending = £18.8 billion
New lending – expired lending = -£1.7 billion
Expired lending exceeds new lending by £1.7 billion!
For clarity: Banks did not make £18.8 billion of NEW money available to SMEs in Q3. In fact, they lent less new money to SMEs then was paid off by SMEs; £1.7 billion less, 9% of total lending for the quarter.
Without question, a reasonable percentage of facilities will have been rolled over. For illustration, let’s assume £10 billion for simplicity, though I hazard a guess that number is far greater. That would mean expired facilities totalled £5.25 billion while new lending equalled £3.55 billion.
Certainly, reduced confidence in growth and the economy as a whole does make SMEs cautious in their ability to service debt. This is further expounded by the perception, recently corroborated by the Federation of Small Business, that banks may pull credit lines at short notice or change the terms of lending agreements. SME facilities will be the first to be impacted should banks need to shore up capital themselves due to issues in other areas of the bank.
The banks are no longer the most effective means for SMEs to access capital. A number of new innovative services are coming to market to help address the pain felt by SMEs. These services seek to positively disrupt the industry by providing more power to and better meet the needs of the SME consumer. Services such as Funding Circle (www.fundingcircle.com ), MarketInvoice (www.marketinvoice.com ) and Zopa (www.zopa.com , consumer loans), have all made a splash. Recent figures suggest that as much as 10% of consumer lending in the UK may be facilitated by P2P services. Businesses, particularly SMEs should take note.
However, with this first wave of innovation, imperfections are inherent and there is undoubtedly room for further refinement of service to provide the best fit solution for SMEs. We, at EuroTRX, have sought to identify the gaps in order to shape a more robust and sustainable solution for SMEs. We don’t believe alternative loans are the answer. We believe that the predominant need is for working capital, and that an invoice exchange, delivered in the right way, will best fulfil the need.
Invoice financing in its current guise accounts for less than 5% of business funding in the UK; a criminally low percentage considering the relative benefits of invoice finance to traditional debt finance such as loans and overdrafts. No interest to pay that further impacts cash flow, more effective use of balance sheet assets, inherent security for funders (invoice buyers) thus nurturing more demand, and generally improved financials and ratios for the business borrower (invoice seller). The barrier has always been the complexity of the delivered service, the unnecessarily high cost and the lack of awareness of invoice finance. EuroTRX, when we launch, will change these dynamics for the better, delivering a more transparent, lower cost, sustainable and flexible service to SMEs by connecting them with non-traditional non-banking sources of finance in a user friendly online auction platform. We are determined to deliver the right solution for UK businesses.