Memorandum submitted by
Confederation of British Industry (
the turmoil in the financial markets began in September, the
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
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.
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.
13. More worryingly, the
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.
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
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. 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 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
Pre-budget report announcements
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
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. 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.
Action by the government
32. At this stage the
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.
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.
 In October both Nationwide and
 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.
 The BBA defines small businesses as those commercial businesses with an annual bank account turnover of £1 million or less.