House of Commons - Business and Enterprise Committee

Enterprise Finance Guarantee scheme - Business and Enterprise Committee Contents

Memorandum submitted by the Association of Chartered Certified Accountants (ACCA)

GOVERNMENT SUPPORT FOR BUSINESS—ACCESS TO FINANCE

INTRODUCTION

1.1 The Association of Chartered Certified Accountants (ACCA) is the largest and fastest-growing international professional accountancy body with 131,500 members and 362,000 students in 170 countries, whom we support through a network of 80 staffed offices and centres around the world. ACCA has its headquarters in London and 54,000 of our members and over 60,000 of our students are UK-based.

1.2 The expertise of our senior members and in-house technical experts allows ACCA to provide informed opinion on a range of financial, regulatory, public sector and business areas, including: taxation (business and personal); small business; pensions; education; and corporate governance and corporate social responsibility.

1.3 ACCA welcomes the opportunity to submit evidence to the Business and Enterprise Committee's inquiry on financial assistance schemes for small and medium-sized enterprises (SMEs). Accountants are the financial advisers of choice for SMEs,[14] and as such our members in the UK and around the world have been at the forefront of business support in these challenging times. Our response is also guided by the views of the ACCA SME Committee, an independent panel that brings together small business owners, practicing accountants, leading academics, small business representative bodies and lenders. It is the only non-governmental group that encompasses such a broad membership.

1.4 We welcome the attention that has been paid to small businesses' needs throughout the financial turmoil that erupted in September and the economic downturn that followed it. However extreme the current circumstances, the Government needs to be mindful of the lessons learnt from the last two decades of business support interventions. Schemes have for years been plagued by low penetration rates,[15] poor cost effectiveness[16] and inadequate evaluation.[17] The principles of appropriate business support remain the same: acting on market failure, setting clear objectives, promoting accountability and ensuring effective delivery.[18]

1.5 The Enterprise Finance Guarantee (EFG) scheme was originally intended to be a high profile initiative for supporting SMEs. In practice, it lags far behind other offerings, most notably HMRC's tax deferral scheme, for both awareness and impact. Questions remain as to how effective the EFG will be, with uncertainty about the rate of take up,[19] low awareness among businesses[20] and the stigma of "high risk" that may accompany the loans.[21]

SUMMARY

The Enterprise Finance Guarantee (EFG) is a well-designed scheme, providing adequate flexibility and addressing roughly the right size of businesses and loans. Crucially, it makes available sufficient funds to address market failure without underwriting failed businesses.

However, the scheme has not been adequately supported by lenders, who lack adequate incentives or sufficient awareness among staff to promote EFG to their customers. It has also been misrepresented by the media as a more generic small business subsidy, which has been highly misleading. Finally, it is restricted by the Government's target risk profile, which, driven by European State Aid rules, is too low to encourage a great deal of new lending.

There is no one best way to address failures in the SME credit market. The Government needs to respond not only to the lack of liquidity but also to the increased risk-aversion and dearth of information that contribute to tightening credit. We have argued for some time now that a combination of retail and wholesale credit guarantees, as well as subsidised training for financial skills and access to financial advice, could help restore the SME credit market to health.

EVIDENCE

2. What are your views on the threshold for annual turnover of £25 million for applicants?

2.1 Having argued for a higher turnover threshold for some time,[22] we welcome the fact that EFG can target businesses with much higher levels of turnover than its predecessor, the SFLG. There is still room for extending the guarantee to all SMEs—ie raising the turnover threshold to £35 million. A business with turnover of over £25 million could still be medium-sized,[23] face limited access to capital and, most importantly, have an extended network of suppliers and customers who would be affected by its failure. Regardless of the actual number of enterprises affected, streamlining eligibility criteria for different support schemes could encourage the overall level of uptake.[24] However, we also realise that a higher threshold could mean EFG straddling the small and larger business categories within lenders' own structures. The result would likely be one added administrative step within EFG approval— which may be one too many.

3. Is the amount of money available enough to enable businesses to continue operating?

3.1 We must stress that the purpose of the guarantee scheme should be to address the effects of market failure, not to underwrite failed business models. Its performance must be assessed on the basis of which businesses have benefited and how, not of how much lending has been made available. Still, from a quantitative point of view, the funds allocated to EFG appear to be sufficient.

3.2 Market failure has focused on the financing of working capital, especially through overdraft lending.[25] In the final days of easy credit in the UK, the median SME overdraft was about £4,000. We have consistently argued for guaranteeing smaller loans than was possible under SFLG and are pleased to see that the EFG does so.[26] We estimate that the scope of the EFG scheme (covering loans from £1,000 to £1 million) excludes the smallest 19% and the largest 0.6% of overdrafts held by SMEs.[27] Although this suggests a case for guaranteeing even smaller loans, we anticipate that lenders may not be interested—even low unit administrative costs could make approving such small loans under EFG uneconomic.

3.3 From a broader perspective, the real amount of banks' overdraft lending in the UK has fallen by about 10% since mid-2007.[28] Realistically, not all of this reduction is the product of market failure, as the SME sector's turnover is now substantially reduced and insolvencies are still on the rise. But this estimate points roughly to a maximum level of intervention required to counteract market failure in banks' lending to SMEs, and this is in the same order of magnitude as the government's target of loans guaranteed (ca £1 billion against £1.3 billion offered by the EFG). All of this assumes that the guarantees can be offered in full, in time and to the right businesses. The total amount of lending currently released through EFG is just short of £200 million (£344 million if loans are eventually granted to all current eligible applicants), which is mildly encouraging.[29]

4. Are loan guarantees the best method of addressing the difficulties in businesses accessing finance and, if not, what is the best method?

4.1 The SME credit market is subject to a multitude of pressures and to seek out a single "best" type of support would be naïve. In our submission to the Business and Enterprise Committee's inquiry on financing SMEs in November, ACCA called for government support on multiple levels to ensure access to professional advice. We believe that financial support for SMEs should use the existing supply chain; share rather than bear risks, diversified where possible; treat supply chain risks as systemic; ensure cost-effective delivery and complement assistance with improved financial skills.[30]

4.2 Loan guarantees are, in principle, one good way of dealing with market failure in the credit supply chain; they can be very cost-effective and rely on the private sector to properly assess and share risks. The EFG in particular is very flexible and can accommodate a wide range of SME financing needs. But such guarantees need to be marketed and taken up widely, and must expose the taxpayer to substantial levels of risk if they are to deliver results. Thus guarantees can be more or less effective for reasons unrelated to the technical specifications of the schemes.

4.3 Because the weakness of bank balance sheets is a strong contributor to risk aversion among lenders, we have also advocated wholesale interventions on SME lending such as the Working Capital Guarantee Scheme. Unlike the EFG, wholesale schemes can still work well even if bank managers and staff, SMEs and intermediaries are completely unaware of them. However, as we argued at the time of the scheme's introduction, lenders need to engage heavily and be able to nominate relatively risky loan portfolios if this scheme is to work optimally.[31] Government seems instead to have focused on a relatively low risk profile, setting aside only £225 million against potential losses on what could be a £10 billion guarantee scheme. The Working Capital Scheme guaranteed £2 billion of loans between early March and mid-April, but unlike retail schemes such as the EFG, this amount is unlikely to grow proportionately with time. Lenders were, after all, given at least two months' notice before March in which to consider joining.[32]

4.4 Another significant issue affecting the supply of credit is that the SME finance market has lost information as well as liquidity. In the fluid environment of this downturn, banks know fundamentally less about the prospects of small businesses than they did, or thought they did, in 2007. Likewise, businesses can offer fewer assurances on the basis of past performance. But regardless of the economic cycle, many smaller businesses are run by people who are competent within their industry but financially unsophisticated. They are unsure about positioning funding requirements and evidencing the viability of the business—and this in turn leads to a lack of confidence when applying for credit.

4.5 This failure cannot be overcome as easily through guarantees as the lack of liquidity. Ideally, SMEs need to have access to additional means of signalling their creditworthiness. The government could help improve the flow of information to the credit supply chain by subsidising the preparation of richer financial information, including business plans and cash flow forecasts, as well as financial skills training for small business owners. In some parts of the UK, subsidised financial health checks are already available to SMEs using private sector advisers. The results are encouraging and could be replicated elsewhere.

4.6 Additionally, the government should urgently consider ways in which the EFG, or variants thereof, could be extended to a wider range of lenders and credit products. An area in need of particular attention is asset based finance, which many businesses use as an alternative to bank loans. Advances by asset based lenders rose sharply between June 2007 and September 2008 as wary businesses turned away from the banking sector. But as the threat of insolvency and late payment rose towards the end of the year, credit protection payments to clients more than doubled—and asset based lending tightened dramatically.[33]

4.7 Finally, a large range of organisations, from Local Authority Economic Development Units and Local Enterprise Agencies to Chambers of Commerce and other private sector business support entities can become conduits of "gap" funding if supported by state guarantees. By allowing Community Development Finance Institutions (CDFIs) to access additional loans through EFG, the Government has already established a useful precedent.

5. To what extent will the loan guarantee encourage new lending by banks?

5.1 Clearly the scheme has had some success in encouraging bank lending, but results are not yet satisfactory. There is little appetite among banks to promote the EFG scheme and anecdotal evidence suggests to us that unless would-be borrowers make a point of asking for the EFG option, few lenders will look into it.

5.2 Banks will fail to make the most of EFG if they do not inform and train staff at all levels in administering the scheme. Progress has been mixed.

5.3 Banks will also fail to make adequate use of the scheme if customers find the EFG terms unacceptable. The Government has made an effort to improve terms for borrowers by clarifying the use of security in EFG loans[34] and offering a discount for early payment of guarantee premiums. However, the issue of security is still very contentious.

5.4 The scheme will also encourage very little new lending if the government is not prepared to tolerate distinctly higher levels of risk than the banks are. This means that the 9.5% default rate imposed on the overall scheme is a severe limitation.

5.5 For new lending to take place, banks themselves need to use the guarantees to provide riskier loans than they otherwise would. There is a perception that banks are making "deadweight" loans under EFG—loans that they should be happy to make anyway. This is no doubt reinforced by the requirement for banks to confirm that "the applicant's plans are viable and would meet our usual commercial requirements for a loan." This was a reasonable term for the startup-oriented SFLG, but not for its successor.

6. To what extent are banks making this scheme available?

6.1 Accountants on our SME Committee are convinced that availability of EFG guarantees is still very limited. It relies largely on the discretion of bank managers, and the awareness of staff at all levels. Many successful practitioners were hard pressed to name a client that had succeeding in accessing EFG-guaranteed funds. The SME Committee was recently assured by Adam Jackson, Director of Enterprise at BERR that his department is prepared to investigate cases of non-availability branch-by-branch and asked members to report these to BERR as they emerge.

6.2 We have no reason to doubt these commitments and welcome them as evidence of a helpful attitude at BERR. The government's increased influence over the major high street banks may mean that it can better monitor and direct implementation of the EFG than it was able to do for the SFLG. However, SME representative bodies and intermediaries will not always be able to point out failures where they occur—this could jeopardise important relationships on the basis of anecdotal evidence. Grassroots information is needed, and banks can facilitate its collection by providing contacts for such reporting in all their dealings with SMEs.

7. Do businesses in some areas of the UK have more difficulty in accessing the scheme than businesses in other areas?

7.1 We have some concerns about access to EFG in deprived areas, among ethnic minority entrepreneurs and discouraged borrowers in general. The Government needs to carefully monitor uptake of the scheme and collect relevant data on the profile of businesses that EFG is reaching, ensuring that any potentially discouraged borrowers are appropriately targeted.

7.2 In remarks to the ACCA SME Committee in March, BERR's Adam Jackson noted with regret that the Government cannot monitor the uptake of guarantees among ethnic minority businesses, or indeed any specific categories of users, as its attention is focused on the big picture. We understand this trade-off but would call for government and private agencies outside of BERR to step into this role.

7.3 We also acknowledge the recent BERR initiative to allow CDFIs to access additional loans through EFG as a step in the right direction. CDFIs claim to have helped create or save 33,000 jobs in 2007-08, a number which will hopefully increase as a result of this intervention.[35]

8. Does applying to the scheme impose an administrative burden on applicants?

8.1 A substantial amount of information is required from applicants, although not much more so than in purely commercial lending. According to government guidance, would-be recipients of financial assistance may need to prepare "an up-to-date business plan, audited accounts, indications of current performance and financial forecasts (profit and loss, cashflow and balance sheets)".[36]

8.2 While none of this information is excessive in commercial terms, we wonder whether the Government realises how difficult it is for small businesses to provide such documentation without professional financial advice. Only 29% of SMEs have a written business plan. More SMEs (35%) go without financial advice at all than turn to even the most popular source of advice (accountants, at 31%).[37] By subsidising the use of professional advice in order to produce this documentation, the Government could both improve the flow of information about SME finances and encourage EFG applications.

8.3 We also wonder how these information requirements are consistent with the UK government's support for the exemption of micro enterprises from the requirement to submit financial accounts, supposedly in order to reduce administrative burdens.[38]

8.4 Perhaps a bigger problem in the administration of EFG appears to be the approval times—Anecdotal reports suggest a period of between one and three months, which is a very long time to wait for what is essentially finance for day to day working capital.[39]

9. Has the scheme been effectively promoted to the private sector?

9.1 Promoting the EFG scheme has been delegated primarily to lenders themselves. Because EFG is a marginal product for most lenders, there are limits to how much effort lenders can reasonably expend in promoting it. Government's attempts to promote EFG through Business Link will also have been affected by the service's low penetration rate.

9.2 Unfortunately, the government has also implicitly relied on heavy but superficial media coverage to promote the scheme to SMEs. This has misled many would-be borrowers about the purpose and nature of EFG, which was portrayed as a straightforward subsidy for small borrowers. This led many to believe they were eligible when in fact they were not.

9.3 Intermediaries, including accountants, could contribute to increased awareness. However, they can only be successful in promoting lending guarantees if clients are reasonably likely to have a loan approved under EFG, which is at this point very hard to establish.

9.4 On a more positive note, we are pleased to hear that the government has conducted a "mystery shopper" exercise and has raised the issues that came up with participating lenders. We look forward to a continued programme of evaluation.

10. Are there any other views you think the Committee should be aware of?

10.1 The Committee may wish to consider the signals that loan guarantees send to the market. ACCA's SME Committee has raised concerns that a loan guarantee may signal that a business has been unable to obtain a loan on commercial terms and is thus a risky trading partner.[40] This is important because most of the credit used by SMEs comes not from banks but from their own suppliers—it is when these refuse to extend credit that results are truly disastrous.[41] If lenders could be allowed to adjust the level of guarantee involved, some additional information could be provided which would mitigate this problem.

10.2 Our SME Committee has also questioned whether the government is fully aware of how restrictive its target non-recovery rate of 9.5% is to the financing of businesses in an economic downturn.[42] Even in times of economic growth this would have been overly optimistic: for instance, 21% of businesses established in 2005 did not survive to the end of 2007.[43] We are aware that this level of risk-aversion is dictated in part by European State Aid regulations. We are not sure, however, that the Government has exhausted all room for manoeuvre in this issue.

10.3 Facilitating access to bank finance is only part of a range of financial support products that SMEs would ideally need in order to overcome market failure. Facilitating equity investment, for instance, should be a high priority, especially as we are assured that BERR would like to see SMEs carry more sustainable levels of debt in the future.

10.4 We appreciate that the present inquiry is concerned specifically with current measures for providing financial assistance to small businesses. However, we must stress that the popular narrative on small businesses in an economic downturn should not be allowed to restrict the focus of policymakers. Businesses success is not a matter of external financing alone. In turn, not all of the current lack of credit results from market failure, not all market failure relates to bank finance, and not all of it stems from a lack of liquidity.

10.5 There is a case for integrating the many financial assistance products currently available into a single portfolio of multiple interventions—from tax and business rate deferral, to loan guarantees and equity finance, to advice and financial training. Businesses could then tailor a specific programme of support to see them through hard times. Such a system would not only make support more accessible. It would also remove some of the stigma involved by turning "bailout" into "bootstrapping". The downturn has prompted some early thinking along these lines;[44] we look forward to a fully integrated product.

June 2009

14 BERR Survey of SME Finances, 2007. Back

15 Federation of Small Businesses (2006), FSB Survey, Lifting the Barriers to Growth. Back

16 Robert Bennett, Government SME policy since the 1990s: what have we learnt?, 2006. Back

17 National Audit Office, Supporting Small Business, 2006. Back

18 "Principles for government intervention on small business support", ACCA SME Committee, 2007. Back

19 Financial Times, 15 February 2009. Back

20 British Chambers of Commerce, March 2009. Back

21 Forum of Private Business, March 2009. Back

22 "Financing SMEs in the recession", ACCA SME Committee, October 2008. Back

23 The turnover threshold for SME status is currently £35 million , provided the business employs fewer than 250 and does not have assets in excess of £11.4 million. BERR, "Thresholds for Small and Medium Sized Companies and Groups". Back

24 The Government implicitly acknowledges the complexity of different eligibility criteria by providing a facility that helps users determine what types of assistance they are eligible for. Business Link, "Assess your eligibility for government guaranteed lending schemes" 2009. Back