Memorandum submitted by the CBI
INTRODUCTION
1. The Confederation of British Industry
(CBI) is the national body representing the UK business community.
It is an independent, non-party political organisation funded
entirely by its members in industry and commerce and speaks for
some 240,000 businesses that together employ around a third of
the UK private sector workforce. The CBI's membership includes
80 of the FTSE 100, some 200,000 small and medium-sized enterprises
(SMEs), more than 20,000 manufacturers and over 150 sectoral associations.
2. The CBI welcomes the opportunity to respond
to the House of Commons Business and Enterprise Select Committee
inquiry into financial support for SMEs.
3. Since the turmoil in the financial markets
began in September, the CBI has received numerous examples from
its SME members of how the credit crunch is affecting their business,
in particular their access to finance. These case studies are
supported by our survey data which shows that a substantial proportion
of SMEs have experienced deterioration in the availability of
capital since the onset of the credit crunch. This has manifested
itself in two ways; an increase in the cost of finance and more
stringent conditions imposed by the lender. It is less common,
but still prevalent, for a business to have new credit refused
or existing credit lines reduced or withdrawn.
4. For the most part these credit constraints
are a rational response by the banks to their own circumstances.
The banks own cost of borrowing has increased while their supply
of money has fallen. In addition the recession has increased the
risk of default by SMEs and falling asset prices have reduced
available collateral. The banks are also under pressure to respond
to the conflicting priorities of government; to increase lending
to SMEs and households while simultaneously increasing their capital
ratios. But SME members have also reported an increase in arrangement
fees and deterioration of their banking relationships, neither
of which can be fully explained by the changes to the banks operating
circumstances.
5. The potential of last month's pre-budget
report announcements to resolve SMEs' credit constraints will
be dependent on the scope and speed of implementation. Further
investigation is needed in order to pinpoint the precise problems
that are causing these credit constraints and, if required, further
solutions should be developed.
THE EFFECT
OF THE
CREDIT CRUNCH
ON SMES
Cost of finance
6. In October the CBI surveyed 204 senior
executives from a range of sectors, of which 116 were SMEs.[32]
The results show that the credit crunch is having a substantial
impact on the SME sector. Nearly half of the SMEs surveyed by
the CBI have experienced some deterioration in the availability
of capital for their business since the onset of the credit crunch.
The effect of the credit crunch has been more pronounced for those
businesses with less than 20 employees; two fifths described the
deterioration as significant compared to a fifth of SMEs overall.
More than 60% of SMEs expect to see the situation worsen over
the next 12 months.
7. The CBI's survey also asked how capital
availability has deteriorated. Seven out of 10 SME respondents
cited the increased cost of finance and more stringent conditions
imposed by lenders. Where the cost of borrowing had increased
for existing lines of credit, it was most commonly by less than
50 basis points. The cost of existing credit lines rarely increased
by more than 100 basis points, except in the case of the very
smallest businesses, one in 10 of which had experienced such an
increase.
8. The cost of new and renewed credit lines
has increased more substantially. One in five SMEs reported increases
of more than 100 basis points. Similar proportions also experienced
increases of between 0 and 50 basis points and 51 to 100 basis
points.
9. The deterioration in credit conditions
has been felt most acutely in relation to fund raising for working
capital and capital investment; over half of SMEs experiencing
credit constraints say it has occurred in these areas.
10. The CBI's survey results are supported
by case studies we have received from members. SME members have
reported that over the past year, as the economic situation has
deteriorated, there has been a tightening of credit from banks
and a decrease in the willingness to lend. Overall these case
studies show there have been notable restrictions in credit access
but finance is still available for those willing to pay a premium
and more effort is needed to secure it.
11. Many members have reported significant
increases in the interest rate on their credit. In some cases,
debt has been made more expensive when a bank has switched from
using the base rate to LIBOR to calculate repayments. It has been
reported that it is not just the credit rates that have increased
but also that the arrangement costs are substantially greater
than last year. One medium-sized company in the construction sector
has had its fees increase tenfold.
12. Some firms have had to switch banks
to get the best credit offer. For example one medium-sized manufacturer
used hire purchase services from its bank which had cost 0.6%
above the base rate. When the member sought to renew this service,
the price had increased to 6% above the base rate. The member
was quoted 0.8% above the base rate by another bank, which they
accepted.
Availability
13. More worryingly, the CBI's survey shows
two fifths have had an application for new credit refused and
three out ten had had existing lines of credit reduced or withdrawn.
14. CBI members report that even when a
credit offer is made, it is sometimes too expensive to accept.
For example, a small business in the technology sector took its
business plan to its bank's credit committee but the arrangement
fees quoted were prohibitively expensive and the bank asked that
these were paid up front, irrespective of whether a credit offer
would eventually be made. The business decided it could not pursue
credit with this bank.
Relationships
15. Some members also reported deterioration
in their long-term banking relationships. One small company has
been with its existing bank for 15 years yet it has experienced
what it feels is a significant lack of service in the past 12
months. Other members have reported that at very short notice
interest rates have been increased and credit facilities reduced.
Trade credit insurance
16. Additionally, in the past four weeks,
the CBI has received an increasing number of reports that accessing
trade credit insurance has become more difficult. There are two
ways in which SMEs who are unable to insure their debtors are
affected. Firstly, they may be refused credit from their banks,
which sometimes require SMEs to have trade credit insurance when
the business is dependent on one customer. Secondly, as they are
unable to insure their biggest customers, they have to ask for
payment up front. This increases the working capital requirements
of these customers, who may be unable to increase their own credit
lines in response. If they are unable to pay for goods and services
in advance, then the SME will lose their custom, on which they
depend.
SME LENDING CONDITIONS
17. In light of the evidence that SMEs are
credit constrained there is a need to assess the extent to which
this is a result of the conditions under which banks are operating.
On the whole, most of these credit constraints can be explained
as a rational response to these operating conditions. But while
these can explain the increase in price and the more stringent
lending conditions, they do not fully explain the substantial
increases in arrangement fees and the deterioration in customer-bank
relationships.
18. On the demand side, the economic recession
has increased the risk of businesses defaulting. Therefore, even
if banks are sustaining their appetite for risk and their credit
policies remain the same, more businesses will find it difficult
to achieve the minimum criteria and satisfy credit committees.
Additionally, house and commercial property prices have fallen
since the start of the year, meaning that less credit will be
available for those seeking to secure it against property.[33]
Banks are also experiencing adverse selection. SMEs not dependent
on credit have reduced their demand while those that do, and are
therefore more risky, have increased theirs. This results in more
credit applications becoming subject to greater and longer scrutiny.
19. On the supply side, banks have experienced
reduced ability to raise funds with which to lend to customers
and the price of funds which have been raised has increased.
20. In the past decade banks have made a
significant shift from depositor funding to wholesale funding.
The customer funding gap[34]
has increased from zero in 2001 to over £700 billion in 2008.
The cost of funds in these markets has been historically very
low, lowering the overall average cost of funds to the bank and
allowing cheaper financing to be passed on to customers. Since
mid-2007, the concerns over US sub-prime mortgages and the structured
credit products that were based on these mortgages, have led to
the effective closure of the securitisation (and other wholesale)
markets with the effect that there is a greater reliance on retail
deposits, which are a generally more expensive source of funds.
21. A major part of banks funding, and therefore
a driver of the ability for them to lend more, is inter-bank lending,
which has become more expensive. Historically, LIBOR rates have
been very close the Bank of England rate, as the risk premia associated
with the counterparty default was considered very low. In recent
months the risk of counterparty default has increased significantly
and so LIBOR spreads over the Bank of England rate have increased.
22. Bank lending is also constrained by
the conflicting priorities of regulators and the government. Regulators
and the government are anxious for the banks to re-build capital
strength in order to ensure the stability of the banking system.
To increase capital ratios, banks must bolster capital levels
and reduce capital requirements. Therefore there is an incentive
to reduce the amount of new and existing lending.
23. This objective is to some extent at
odds with the simultaneous desire from government for banks to
continue to support lending to SMEs. The government needs to ensure
that it is clear as to how it prioritises these objectives to
satisfy the need for a stable and robust banking system together
with limited long term damage to the overall UK and global economy.
PRE-BUDGET
REPORT ANNOUNCEMENTS
24. The CBI welcomed the access to finance
measures announced by the Chancellor as part of the pre-budget
report in November.
25. It is difficult to predict the impact
of the new schemes without details of how they will work. However,
the proposal for the temporary Small Business Finance Scheme should
ease some of the credit constraints on SMEs given that the government
intends to take a greater proportion of the lending risk and increase
the loan amount on offer, compared to the Small Firms Loan Guarantee.
If the scheme is to have the greatest impact possible, it must
be created quickly and delivered in an effective and non-bureaucratic
way.
26. The high demand for RDAs transition
loan funds demonstrates that government backed finance is needed
by many SMEs. For example, in the North East, 50% of the loan
fund was applied for within 24 hours of its launch.
POTENTIAL FOR
ACTION IN
2009
Action by banks
27. There are already a number of voluntary
initiatives underway to resolve the credit issues faced by SMEs,
many of which the CBI is involved in and support.
28. The CBI is keen to facilitate a constructive
discussion between SMEs and the banks and therefore we welcomed
the government's creation of the Small Business Finance Forum.
At the first meeting the banks committed to fundamentally revising
the British Bankers Association's Statement of Principles, which
sets out how banks and businesses work together. The CBI has contributed
to the revision of the Principles, which could be a useful tool
for providing certainty to SMEs, particularly of their customer
service expectations. The CBI believes that the Principles should
be a proper partnership agreement between banks and their SME
customers. They currently detail what a bank can expect of its
SME customer but say very little about what SMEs can expect of
their banking provider. In our comments to the BBA on the Principles
we called for more consultation with SMEs about their expectation
of banks and for the Principles to be much more accessible, to
both SMEs and local business bank managers.
29. The banks have also committed to providing
more data to the government on the availability, risk and overall
cost of lending to SMEs. The only publicly available statistics
on small business lending comes from the BBA.[35]
These statistics show that lending to small businesses continues
to grow year on year. Indeed, LloydsTSB have reported that their
lending to SMEs has grown by 18% over the past year. This is clearly
at odds with the experiences reported by SMEs and our survey data.
While helpful, case studies and survey data cannot demonstrate
how credit constraints differ from sector to sector and with different
types of credit. The forthcoming data from the banks will play
a vital part in assessing credit constraints and developing the
appropriate solutions.
30. The CBI also welcomes the recent announcement
of RBS, LloydsTSB, and HSBC in relation to their small business
lending. These announcements will provide much needed certainty
to their small business customers about their banking relationships
going forward.
31. The CBI is also taking a lead role in
bringing together banks and SMEs. Later in December we will host,
jointly with the BBA, a roundtable to discuss current lending
conditions.
Action by the government
32. At this stage the CBI would not recommend
any regulatory action against the banks, with respect to their
small business customers. It is yet to be seen how the voluntary
actions taken by the banks and the implementation of the finance
announcements made in the pre-budget report will affect SME lending
and banking relationships.
33. In addition, the forthcoming granular
data from the individual banks will allow us to pinpoint the precise
problems which are causing credit constraints and therefore create
a solution to these problems. Any further action taken by the
government needs to be based on this evidence.
34. The government should urgently assess
the trade credit insurance market and, in consultation with businesses,
take appropriate action. In addition the government should consider
further measures to boost the supply of equity finance for SMEs,
where this type of finance would be appropriate.
December 2008
32 An SME is defined here as businesses with less than
500 employees. Note that the banks do not use employee numbers
to define the size of their business customers. Back
33
In October both Nationwide and Halifax reported a year-on-year
fall in house prices of over 14%. IPD have reported falls in commercial
property prices every month since the beginning of 2008. Back
34
Defined by the Bank Of England in its Financial Stability Report
as customer lending less customer funding, where customer refers
to all non-bank borrowers and depositors. Back
35
The BBA defines small businesses as those commercial businesses
with an annual bank account turnover of £1 million or less. Back
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