Examination of Witnesses (Questions 1-19)
MR DAVID
FROST, MR
ANDREW CAVE
AND MR
MICHAEL IZZA
16 DECEMBER 2008
Q1 Chairman: Good morning. Thank you
very much indeed for coming before this Committee today to give
us evidence ahead of our session later this morning with a representative
group of the banks. Can I begin, as I always do, by asking you
to introduce yourselves for the record.
Mr Frost: David Frost, Director
General of the British Chambers of Commerce.
Mr Cave: Andrew Cave, Head of
Policy at the Federation of Small Businesses.
Mr Izza: Michael Izza, Chief Executive
of the Institute of Chartered Accountants in England and Wales.
Q2 Mr Binley: I want to ask a general
background question. It has been suggested that the banks are
being stretched and pulled in two very distinct ways. On the one
hand they have got the problems of libor, around 3.3 still, I
think; at least three of them have 12% to pay back to government
each year for the injection of liquidity; and they have got the
whole fixed saver scenario, where people are still being paid
5% and 6% on those fixed term accounts; and so they have got a
lot of money they have to pay in that direction, and yet they
are expected to pass on base rate cuts in full and cut rates generally
on lending. Do you think that those conflicting areas of activity
are hindering the banks, or do you think they are handle-able
and should be handled more effectively than they seem to be at
the moment?
Mr Frost: It is a very difficult
issue for the banks—clearly being pulled in a number of
different ways and a number of different tasks that they have
to balance. My own view would be that it is not a question of
"can it be managed" it has to be manageable,
because if we are to get through this we need an efficient and
effective banking sector working with business.
Mr Cave: Clearly everybody is
in a very difficult position at the moment and the position you
have described the banks in is not dissimilar to the position
that small businesses find themselves in, being pinched at every
quarter. I do not think that those problems are the core reason
why lending is not what it should be; I think it is a lack of
confidence. There is the money there and I think it is the confidence
that we need to see return.
Mr Izza: I would just add to the
point Andrew and David have made that I see the problem slightly
differently because I think, on the one hand, banks are being
asked to rebuild their capital position and that is something
they are being asked to do through regulation. That is causing
the banks to de-leverage, which means they have less capacity
to mount. On the other hand, the Government are asking them to
lend more and to make more available. Both of those aims are perfectly
laudable, however they are not exactly easy to reconcile. I think
that pressure to rebuild the capital base is actually a very real
one.
Q3 Mr Binley: I agree with that.
We have a situation where the banks are facing sizeable difficulties
from those conflicting pressures, and we need to bear that in
mind when we move on to ask the next question I have in mind.
The banks say their lending has not decreased, yet government
and business organisations say that access to credit is getting
harder not easier. Can you tell me what is going on?
Mr Frost: It is a very difficult
picture and it is an emerging picture. We are carrying out research
at the moment over Christmas and into the New Year to get a real
fix. All I can say is that we have a substantial amount of evidence
on an almost daily basis arriving in our offices from businesses
which are facing a more difficult relationship with the banks.
Let me start by saying, if we are to get through what is clearly
a very, very difficult economic time at the end of it we will
require a cohort, a substantial group of businesses who are in
a fit state to drive us forward and drive us out of this. The
British Chambers of Commerce, whilst we represent from the very
largest to the very smallest, at our heart are medium-sized, often
family owned businesses, businesses of some very real substance,
frequently exposed to global competition, frequently involved
in international trade. These will be the businesses that will
have to get us out of this mess that we are in now. If we do not
find a way of supporting what are at the heart good quality businesses
over the next two to three years, then I personally find it very
difficult to contemplate how we can get out of this. What we have
seen is substantial job losses; unemployment is expected to rise
very substantially in 2009; it is the private sector which has
taken the hit from that; we are seeing a lot of money factoring
capacity; we have seen a huge increase in the number of public
sector jobs over the last eight years which is now unsustainable;
and we have seen the financial service sector and business service
sector being hit. If we are to come out of this, as I say, we
will need these good quality businesses which rely on, and have
relied on often for generations, good relationships with their
banks. So we have to make this relationship work; we have to make
it better. Clearly from the evidence that we have coming through
it is not all that it should be.
Q4 Mr Binley: Let me hit you with:
how would you make it better?
Mr Frost: I do not think there
are any simple solutions. What I would say at this stage is there
are three messages that are coming through to us: firstly, the
cost of money is going up—businesses are being charged for
things they were not being charged for in the past, for example,
arrangement fees; secondly, when it comes to future loans or investment
they are being asked for a much great level of personal guarantees,
which frequently they are not prepared to do; and, thirdly, it
is taking a lot longer to get deals cleared, and therefore when
an opportunity comes up for a business to perhaps buy the stock,
the assets have gone down and it needs a quick decision and it
is not easy to do that. If we can get that relationship to work,
if we can have an understanding, then I think that will happen.
I have to say, I am encouraged on a number of fronts by this Government's
establishment of the Small Business Finance Forum; I am encouraged
by the stream of announcements that are now coming out from the
banks that you are making clear pledges to support business. To
be quite honest, it is going to take a lot of time and a lot of
effort to make this happen officially.
Mr Cave: Going back to your original
question about the inconsistencies between what the banks are
saying and what small business and the Government are saying,
if you look at the data that the Government have collected I think
there is a slight question mark over that data; I think it probably
needs fine-tuning, and that is something that the banks pointed
out during the last meeting. One thing I would say is, from the
last Finance Forum, where the data was shared, there was no data
there that spotted an increase in the cost of finance—that
was not available. At the same time, to run along with that, the
FSB set up its Bankwatch programme which uses polling but also
the collection of case studies from around the country. On 1st
December our data revealed that 30% of small businesses have seen
an increase in the cost of finance. We will wait and see what
the data that the Government collects says and see how that fits
together in the New Year. It is clear from that, and from the
case studies, that that is the case. In terms of your second question
of how to fix it, I would go back to the point about confidence.
A lot of what we are hearing from the banks at the moment is very
good. There are some very interesting ideas and measures coming
forward, but at the moment it is words; that is not a criticism
of the banks, it is just a simple fact that they, like us and
everyone else, are looking for solutions but until there is that
confidence at grass roots level you are still going to have these
behavioural inconsistencies between what you are told by bank
chiefs here today and what is actually happening on the ground.
That is why I think the one single measure that is extremely useful
is the Government's proposal for the Small Business Finance Scheme
or rather, as we would prefer to see, something on a much larger
scale that has been proposed elsewhere, which will in the short-term
get things moving, oil the clogs and get confidence back into
the system.
Mr Izza: In the evidence that
we submitted to this Committee we provided you with some figures
that said 30% of businesses were finding it more difficult to
access capital than a year ago. I do not know how that squares
precisely with the data from the banks. I do not know whether
on a sector basis they are lending more to particular sectors
and whether other sectors are being starved of capital. That is
something I think we should wait to hear the banks explain. In
terms of: what would I do; what are the solutions? I think a number
of things have happened recently that are very positive in this
direction, but small and medium-size enterprises have to help
themselves as well. They need to get their working capital under
control, and traditionally this is a sector of the economy which
is not great at that. I welcome a number of the proposals that
were in the pre-Budget Report; we need to see those come through,
but some of them have the potential to help. I think it is very
important that if banks are going to treat small and medium size
businesses in the best possible way, those small and medium size
businesses need to be as well prepared as they possibly can be
to take evidence to the banks of their future viability, presenting
business plans, cash flows and taking professional advice where
possible.
Mr Binley: Finally, when the Minister
was questioned he intimated that he was monitoring the relationship
between SMEs and the banks. In terms of lending he was monitoring
the whole of that process. When pushed for figures he was unable
to give figures. This is one of the problems, is it not, that
we just do not have the facts. Would one of your messages be:
we really need some quick, real and meaningful information?
Chairman: I am actually going to leave
that question to one side because Adrian Bailey is going to ask
that later on.
Miss Kirkbride: I just want to go back
and probably Mr Izza would be the best person to answer this because
I think all on this committee do very much blame the banks for
a lot of the trouble that we are in today, but we are in this
trouble and now we need them to get us out of this trouble by
lending more. What you were saying earlier is of course one of
the principal reasons why they are not lending more, because they
are caught in a cleft stick of having to rebuild their capital
bases whist at the same time being beaten over the head by the
rest of us to lend more money for very, very important reasons
to businesses. I just wonder what your observations are on the
Government's rescue of the banks and how it was structured. For
example, Brian mentioned that although it is very welcome from
the taxpayers' point of view—a 12% interest rate—is
that really realistic when the Fed is asking 5% in America for
its return on capital for the injections put into the banks?
Q5 Chairman: This is the preference
shares.
Mr Izza: Chairman, I am not here
as apologist for banks but I do understand that the business environment
we are in today has changed markedly from a year go, it has changed
markedly from three months ago, and banks are re-pricing risk:
businesses that perhaps are seeing a decline in their trading
activity, or perhaps have seen asset prices and values fall, are
going to be looked at differently by banks seeking to lend. On
your specific question, I think that the recapitalisation of the
banks was not necessarily in the first instance to promote lending,
it was to bring stability back to the market because there was
a massive crisis of confidence. It actually succeeded in doing
that but one of the characteristics of this crisis is that we
are moving through different phases. We started with sub prime
loans; we moved through into liquidity problems; then the commercial
paper market dried up; we potentially have got a going concern
issue; and as we look forward into 2009 there are some other icebergs
that are sitting there that, unless we are careful about it, we
are going to encounter. I think that the Government's rescue plan
was appropriate for what was intended to do, but perhaps we need
another solution and other actions now to deal with the specific
issues.
Q6 Miss Kirkbride: Just out of interest,
what are the icebergs?
Mr Izza: One of them might be
that we understand in the next 18 to 24 months there is £200
billion of private equity, senior debt, and mezzanine financing
that is going to have to be replaced or renegotiated. There is
not enough capacity in the system to do that at the moment. That
is a problem for another day.
Q7 Mr Hoyle: Mr Cave suggested that
somewhere else there were better suggestions. The trouble is it
is where we are at, and he has got to put his partisan views to
one side and look at the situation as it is. I think you are hinting
at the Party you are a member of, but let us look at the situation
now. It is about liquidity; it is about inter-bank lending, which
is taking place; but it is about bringing other monies into the
market. Are big businesses part of the problem where they are
just not paying their bills and demanding that small businesses
wait but also, if you want to be paid early, they have to be discounted?
Is this not one of the problems?
Mr Cave: I would like to answer
that in two sections. First of all, it is an extraordinary suggestion
that I am partisan in some way. If you actually look at the way
this process has evolved, the Federation of Small Businesses came
forward with a proposal for a £1 billion survival fund for
small businesses which was, we were delighted, adopted in the
pre-Budget Report; and, from meetings we have had with officials,
is likely to be implemented in remarkably similar ways to the
ways we proposed. When we proposed that billion pound fund we
were pretty much laughed at by everybody for it being excessive.
Things are moving very fast, and I think we have since seen, yes,
a proposal has come forward from the Conservatives which is very,
very similar to what the Government have proposed but actually
involves more money. A billion pounds is great, it gets the oil
in the cogs working, but it is likely only to last for a matter
of two months we are told by the banks.
Q8 Mr Hoyle: But it can be reviewed,
can it not?
Mr Cave: It can be reviewed. We
would like to see it reviewed and expanded. That is what I am
referring to there. When it comes to late payments, yes, this
is a big problem. One of the reasons why so many of our members
are looking for help from the banks is because they are waiting
for payment. This is a very difficult issue to tackle—other
countries have tried it and failed, but there are a couple of
things we would like to see proposed from the outset; that the
Companies Act is actually enforced as it was first intended—it
has never been fully enforced; and also Companies House, which
is essentially a filing agency at the moment, be turned into a
proper enforcement agency. Companies have to register their payment
terms with Companies House, but in recent years that has fallen
slightly to the wayside for some companies. We would like to see
that much more in evidence. We would like to see Companies House
have the proper resources to actually enforce that, and for Companies
House to be able to name and shame those companies that are not
playing by the rules because essentially this is antisocial behaviour
and it leads to job losses. It is something we feel very strongly
about.
Q9 Mr Hoyle: ASBOs for companies.
That is a new line but I quite like it. Anything that will work—I
will take ASBOs! The second part being that of course the Government,
quite rightly, has insisted that government departments wherever
possible pay between 10 and 15 days; and they have requested the
same of local authorities; but I have heard of evidence that says
local authorities are dragging people out for 90 days. Is this
true?
Mr Cave: We have heard that that
is the case. We have also seen evidence where a local authority
will send a letter to a small business that has already provided
a service saying, "We will pay up within a certain time if
you meet this criteria relating to something else". That
particular letter was then withdrawn after an outcry and a bit
of attention from the local media. I will be honest with you,
it is a bit early to tell. We are still talking to our organisation
on the ground. It is very positive that local authorities have
taken this step, and police forces around the country, but I think
it is early in the New Year when we will see the results.
Q10 Mr Hoyle: The NHS and everybody
else?
Mr Cave: Exactly.
Mr Frost: The question goes to
the heart of the matter. Businesses rarely go bust because of
lack of orders; they go bust because of lack of cash. At the moment
what is happening is they are caught in the crossfire. You talk
about the relationships with the banks but, on the other hand,
we now have issues with credit insurance; and then, of course,
you have this whole issue about payment terms both with customers
and suppliers. Everybody is putting the screw on and the poor
guys who are caught in the middle are these small businesses.
If we do not resolve this and, as I say, cash becomes king at
the moment, then you are going to see a wave of unnecessary closures
during the next 12 months.
Q11 Mr Clapham: Is there not another
side to this though? We heard, for example, Mr Frost say quite
clearly that the way out of this mess is to get the small and
medium size enterprises really working; and that, of course, means
engagement with the banks; it means a responsibility on part of
the banks to respond in a way that is going to facilitate that,
and yet that is not happening. Does it not suggest that the banks
really do not understand the small and medium size enterprises?
Mr Cave: That is a very interesting
question and it is one that we are asking and are having conversations
with our own members and with the banks about. I was having a
conversation with someone in the corridor about this—there
is a problem at the moment that there is fear on both sides of
the divide. Branch managers are scared of making the wrong decision
and, from our part, a lot of the small business owners are scared
about going and talking to their bank managers; they just want
to get on with their business and hope that everything will be
okay. It is human nature that if you think there may be a problem
there will be. We are always advising our members to go and talk
to their banks and to their accountants at the earliest possible
time to avoid problems. Equally, there are the behavioural inconsistencies
that need to be ironed out in the banks so that branch managers
have the confidence from their line managers to make the right
call. That is an issue. With regard to the second point to your
question—is there a lack of understanding on the part of
the banks as to what is a viable business and how to lend to businesses—a
lot of our elder members and elder businesses they do say that,
because they remember a time when there were more branch managers
and there was a better relationship on a personal level. I think
those personal relationships made a big difference, because you
had that trust and a much better understanding, rather than relying
solely on a business model which does not always reveal everything.
It is interesting—the current crisis has shone a light on
a problem in that area.
Mr Frost: I would be pretty worried
if banks did not understand small businesses. We really would
have a problem. I have no evidence that they do not, but I think
there are two issues that come out of it. Many businesses have
not experienced the economic times we have now in their lifetime.
The point was made earlier, when they do get into difficulties
or start getting into difficulties it is important that they are
taking proper advice, and not just rushing to the bank and saying,
"Help I can't pay the wages on Friday", because I think
I know what the response to that would be. I think the second
thing is there is evidence of banks making certain sectors no-go
areas. I think, for example, anything to do with property and
development, from the evidence we have, appears to be off-limits
at the moment. Those of us who have been around a bit—and
this is my third recession—would know that even in difficult
times there are companies that do very, very well indeed. There
are companies that are able to take advantage of opportunity.
I think therefore that the banks need perhaps to be cognisant
that not every business in certain sectors is essentially a no-hoper—there
are opportunities.
Q12 Mr Clapham: I hear what you say
but let me give you an example. I will not name the company but
I went down to see one of my small and medium size enterprises,
a printer, who prints the forms that the banks use, and yet the
business was rolling in but the credit was not and that was causing
a real difficulty. That suggests to me that there is a lack of
understanding somewhere. We come to the statistics that Mr Izza
referred to that 30% of small and medium size enterprises are
finding it difficult. That suggests that there is a misunderstanding
somewhere; and if there is a misunderstanding has that occurred
before the crises; was there a disengagement with small and medium
size enterprises before the crisis came about leading to a greater
misunderstanding in the crisis?
Mr Izza: Chairman, all I can add
to what has been said already before is that the evidence we have
is entirely anecdotal; but there is frustration among the small
and medium size entrepreneurs that they are not able to build
a relationship with people because they do not stay around long
enough; and because banks rely on automated credit-scoring systems
to evaluate whether or not a loan can be made that does not necessarily
allow for human intervention when someone really does understand
that this business has prospects.
Q13 Mr Clapham: Just turning to the
situation as it is at present. We have heard, for example, Mr
Frost give three points where he thinks the banks could be much
more responsive to the current situation. Are you satisfied with
the measures that have been put in place by the banks to actually
deal with small and medium size enterprise, or are there other
things that they could do? If there are other things that they
could do, what should they be doing?
Mr Cave: If you look at the measures
that have been announced over the last few weeks there are some
very interesting things there. Obviously the price fix that was
announced by RBS was very welcome, and we would like to see others
move towards that. The other interesting thing that RBS have proposed
is what they call the "grey beards", the mentoring service,
which very much deals with the point you have raised. We have
not discussed this in as much detail with RBS as I would like,
and it would be interesting to see why they have taken that decision
and whether that is a decision that should be looked at by the
other banks as well. If you look at behaviour, we had the Statement
of Principles that were approved last week which we were supportive
of, but we did have concerns about that and we had those concerns
adopted. In particular was the issue of switching bank accounts.
Our survey data from last year reveals that 45% of businesses
have trouble switching their banks. If you have got a problem
with your bank it is an open marketplace and you should be able
to go and move across but it proves very difficult for them. As
of last week, there is a commitment with the switching of bank
accounts that if you wish to switch the process should take no
more than five days, and hopefully this will become legally binding.
We are moving in the right direction, so I think progress is being
made.
Mr Izza: We would also very much
welcome the moves made in recent weeks, particularly by RBS and
Lloyds TSB; but at the moment it is too early to call whether
or not that has actually produced a change in behaviour, and whether
or not it will actually percolate through. The direction of travel,
certainly as far as those two banks is concerned, is very promising.
Q14 Roger Berry: Do you not think,
although welcome, that these are incredibly modest measures given
the scale of the problems? The switching of bank accounts in five
days, does the crisis not require something a bit stronger as
a response than these measures?
Mr Cave: Yes, you are right, it
does.
Q15 Roger Berry: I am sitting here
thinking there is a degree of unreality about the whole of this
discussion so far.
Mr Cave: You have got things moving
on two tracks really. You have got things that have to solve the
immediate problem, and you have also got the point that a light
has been shone on the problem in relationships between small business
customers and banks. We need to deal with that, but that is more
of a medium-term thing. Sorting the medium-term issues out now
will hopefully avoid this problem happening n the future. In terms
of the short-term changes, yes, none of this is going to scratch
the surface of it; but that is where I would come back to the
issue of confidence. The recapitalisation process of banks has
not been felt yet. We are not going to see changes as we would
like to see them until the early to middle part of next year I
would think. When you talk about the immediate problems that is
where you do need Government intervention in the form that we
are now seeing to actually get things moving.
Q16 Chairman: Is there any particular
difference of patterns small businesses are experiencing between
loan funding and overdraft funding? It is overdrafts they want
at present to get them through working capital situations rather
than loans.
Mr Cave: We have anecdotal information
on that, but we do not have any detailed survey data on the differences
between the two.
Q17 Mr Weir: You talked about the
cost of finance and that businesses were suffering; but it is
not so much in many cases, certainly from businesses that have
approached me, that the cost is rising but that it is not falling
in line with interest rate cuts. When interest rates are being
cut the banks are actually just putting up their cut of the interest
rate, so the interest rate charged by the business is exactly
the same as it was previously. Is that something you are finding
and, if so, what is the point of the Bank of England slashing
interest rates if it has no benefit to their business whatsoever?
Mr Frost: I think it is having
some benefit and feeding through, but clearly it is not falling
at the rate that business would expect it to. As regards the other
aspects of the cost of money, as I have said, the issue is charges
being introduced, arrangement fees for, say, £5,000 which
last year would have had no fee attached to them.
Q18 Mr Weir: Moving on to the Institute
of Chartered Accountants, obviously you have raised concerns,
Mr Izza, regarding the fact that many accounts may be in effect
qualified because the banks are not prepared to guarantee credit
lines in the future. Can you tell us a little more about this
and the effect that may have on businesses getting into a vicious
circle where they will be undermined because of the banks refusing
to guarantee credit for any length of time?
Mr Izza: When the directors of
a company prepare a set of financial statements they have to prepare
those financial statements on the basis that the company is a
going concern; so they look into the foreseeable future and they
see there is nothing that might cause the company, for example,
to go into administration or liquidation. Taking into account
all the factors, they will then prepare that set of accounts and
the auditors will then look at it and decide whether or not they
agree with the assessment that the directors have made. This year
end we had an extraordinary set of circumstances. Normally when
this exercise is being done it is the particular circumstances
of the company that are first and foremost. At the moment, when
people look at whether or not their business prospects are good,
they are looking at the environment they are in, and that is actually
a major factor. Being able to assess whether or not a bank is
going to lend when a facility comes up for renewal in six, nine
or 12 months, they just do not know now. We understand from conversations
that are taking places that banks, perhaps understandably, are
very reticent to give a commitment six, nine or 12 months out
because of the uncertainty surrounding the whole position. If
that is the case, if the auditors agree with the assessment that
the directors have made, they would issue a modified audit report.
That would say that the directors have disclosed in the financial
statements that there are potential issues and we agree, and we
draw your attention to paragraph 22. If they do not agree with
the directors' assessment they issue a qualified audit report
which says that the auditors have serious concerns about the company's
ability to continue. Historically, there have always been a number
of modified and qualified audit reports issued but we are talking
in a normal year of that being a very low percentage—certainly
less than 5%. This year end we could be talking about double digits,
and we are concerned recipients of these financial statements
might conclude, incorrectly, that this company was in trouble
and take action there, which is unfortunate.
Q19 Mr Weir: It almost seems a Kafkaesque
situation, because presumably in the case of most small businesses
the main people looking at these to decide whether they are creditworthy
would be the banks themselves who are causing the problem by refusing
to guarantee the credit line. What is the point of it all? Surely
if a small business is going to a bank looking for credit and
presenting their accounts which are qualified, due to the fact
that the bank would not give the guarantee in the first instance,
it just seems slightly mad to an outsider?
Mr Izza: There is a certain amount
of circularity about it, as you say. It is not just the banks;
it is investors; it is potential investors; it is landlords; it
is suppliers; and it is customers. They all use the statements
and they all might draw the wrong inference if they have not been
educated.
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