Memorandum submitted by the CBI




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 It is less common, but still prevalent, for a business to have new credit refused or existing credit lines reduced or withdrawn.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[1]. 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 ten 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 ten 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.




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.




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[2]. 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[3] 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[4]. 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

[1]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.

[2] 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.

[3] 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.

[4] The BBA defines small businesses as those commercial businesses with an annual bank account turnover of 1 million or less.