House of Commons - Government Assistance to Industry - Business, Innovation and Skills Committee

Government Assistance to Industry - Business, Innovation and Skills Committee Contents

3 The relationship between banks and business

Introduction

28. Notwithstanding the Department's drive for growth, the crucial factor which will determine the success or failure of the long-term economy is the extent to which business can access working capital from banks. In this section we consider the problems faced by business, and its relationship with the banking sector.

29. Responsibility for banking policy straddles the Department for Business, Innovation and Skills and HM Treasury. When he came before us at the beginning of the Parliament, the Secretary of State set out his Department's role in respect of banks. He told us that his Department oversaw agreements with the semi-nationalised banks and had responsibility for consumer protection, competition and governance. That said, the Secretary of State explained that, in practice, much of this work was carried out in conjunction with HM Treasury.[34]

30. That shared responsibility was highlighted by the joint publication in October 2010 of the Green Paper Financing business growth: The Government's response to Financing a Private Sector Recovery, which set out Government policy on banking.[35]

31. The Green Paper contained a wide number of policy initiatives including continued support for "business angels",[36] the establishment of "growth hubs"[37] to improve the "investment readiness" of small companies, and the potential for Capital for Enterprise Ltd—the Government's arms-length SME investment arm—to apply for funding from the Regional Growth Fund to establish a "business angel co-investment fund".[38]

32. It also committed an additional £200 million investment to Enterprise Capital Funds (ECF)[39] which support high-growth-potential businesses and seek to address the "equity gap" by enhancing private sector returns on investment. There are currently nine Enterprise Capital Funds operating with a Government commitment of £156 million.

33. The Department for Business, Innovation and Skills and HM Treasury have also committed to combine the Growth Capital Fund[40] with the banking industry's own Business Growth Fund—a £1.5 billion equity fund funded by UK banks. The Business Growth Fund will target firms requiring between "£2 and £10 million" a significant problem area for funding. Together with the Regional Growth Fund and the Enterprise Finance Guarantee Scheme (which we consider later in this Report), these initiatives all work towards facilitating investment for business.

34. However, the key area for the Department was highlighted by Mr Rutnam who stressed the importance of the Department's role in relation to bank lending and emphasised the fact that, together with the Treasury, both senior officials and Ministers were in regular contact with the banks on that particular matter.[41] This reflected the view of Government which was set out in the Green Paper. Financing Business Growth highlighted the importance of access to finance, acknowledged the continued problems in this area and asserted:

The Government will not stand by and let the businesses of tomorrow fail on the basis that they can't attract investment.[42]

35. The banking sector also conducted a review of its relationship with business through is Business Finance Taskforce.[43] The Taskforce's Report, published in October 2010, committed the banks to 17 actions, which are summarised below:

Improving customer relationships

Banks will:

Support a network of business mentors, improve service levels to micro enterprises, publish lending principles, establish transparent appeals processes; and initiate a pre re-financing dialogue 12 months ahead of any term loan coming to an end.

Ensuring better access to finance

Banks will:

Establish and invest in a new £1.5 billion Business Growth Fund, support the Enterprise Finance Guarantee Scheme, help mid-sized businesses access syndicated debt markets, improve access to trade finance, signpost alternative sources of finance, and help improve the supply of credit to the wider economy.

Providing better information and promote understanding

Banks will:

Fund and publish a regular independent survey, enhance the cross-industry lending dataset, hold regional outreach events, improve customer information, host a dedicated website and establish a Business Finance Round Table.[44]

36. The Government, in its Green Paper, welcomed the Report from the Taskforce and stated that it would "drive progress on the actions that the banks have committed to under Business Task Force".[45]

37. The Green Paper on banking policy contains many welcome initiatives but the key challenge is to address bank lending. All that the Department does will be of little consequence if business does not get access to sufficient levels of working capital.

Access to credit and working capital

38. Access to credit and working capital is the foundation of the private sector's ability to deliver sustained growth. Our evidence confirmed that significant problems continued to be experienced by business in accessing that finance and our witnesses from business organisations were united in their belief that there remained significant barriers to the flow of credit and access to finance. A clear indication of the current situation was provided by the Institute of Directors (IoD). A survey of its members showed that:

37% of IoD members stated that in the period Jan-June 2010 they had noticed an increase in the amount of security being requested against any lending that their organisation sought (up from 29% in the previous quarter).[46]

It also found that approximately one in five businesses which wanted additional capital in 2009-10:

Did not investigate bank loans or overdrafts because they believed they would be declined, saddled with disproportionately high costs or required to comply with requests for additional security. [47]

39. The Forum of Private Business told us that lending to small businesses remained a problem and that in 2010 there had been "no increase in the availability of finance for smaller firms, despite the economy coming out of recession".[48] Furthermore, it was of the opinion that rates of lending to small business had probably declined.[49] Our representatives from business also made the point that loan approval rates did not give a clear picture of lending as many businesses were no longer attempting to apply for finance (as shown in the IoD survey) and therefore did not appear in the figures.[50] Roger Bibby, speaking for the Federation of Small Businesses told us that he had wide experience of assisting his members in sourcing finance and that "a lot get thrown out at [an early] stage, so they do not appear in the statistics".[51]

40. In addition to the problems with overall lending rates, our witnesses believed that the cost of finance and the application process were also barriers to accessing funds from banks. The broad position was described by the Federation of Master Builders in the following terms:

While banks were not commonly removing all access to credit, they were increasing its cost in a variety of ways for both new and existing services, and frequently turning down requests for new credit facilities.[52]

41. Matthew Fell of the CBI told us that the relationship between banks and businesses had been badly damaged at the height of the financial crisis and that even businesses with a well established relationship found that previous good relations with banks "seemed to count for very little at the height of the crisis when credit lines were pulled unilaterally".[53] He believed that what was needed was "a much stronger and sustained engagement on the ground from the banking community in among their business customer base", because "lending decisions are all too often punted up to central credit control and there is less autonomy now in terms of local decision making".[54] The Black Country Chamber of Commerce agreed that there was a disconnect between the policies of banks at the local and national level. The Chamber cited anecdotal evidence of "lending being agreed at the local level, but then being withdrawn when the decision is looked at nationally".[55]

42. The Manufacturing Technologies Association highlighted problems with communication between the two sides and characterised the relationship as a "dialogue of the deaf" with the banking sector insisting that low rates of lending were due to a "paucity of demand" at the same time as the manufacturing sector consistently reports "a pattern of banks unwilling to lend in support of projects [...] which make good economic sense".[56] Both the Federation of Master Builders and the SMMT complained of an almost blanket refusal by the banks to lend to their members because their sectors were deemed too much of a risk.[57]

43. We took evidence from representatives from the British Banking Association, RBS and Lloyds Banking Group to hear for ourselves the support that banks gave to business. What we heard was in marked contrast to the evidence given by business.

44. Peter Ibbetson, representing RBS, agreed that banks had a "big role"[58] to play in supporting businesses within the UK and asserted that RBS had:

Very adequate liquidity to lend to the SME customer base. Our capital position is sufficiently secure to be able to be confident to continue lending to the SME customer base.[59]

He also claimed that within the first nine months of 2010 RBS lent £35 billion to the business marketplace and that it was providing "5,000 new overdrafts and loans every week".[60]

45. John Maltby gave a similar view from Lloyds Banking Group. He asserted that Lloyds Banking Group had "continued to grow our lending throughout this whole period"[61] and that it had "sufficient liquidity and sufficient capital to support [...] small and medium-sized businesses".[62] Furthermore, he told us that Lloyds was being "encouraged internally as well as externally to lend to small and medium-sized businesses".[63]

46. Peter Ibbetson denied that criteria for approving applications had increased, but he conceded that banks were now "more forensic" in their questioning of businesses than they were before the recession. That said, he argued that his bank continued to approve credit at "the same percentage of applications that we receive that we would in an up cycle".[64] The British Bankers' Association also argued that reductions in the LIBOR and the Bank of England base rate had resulted in "the vast majority" of SMEs paying substantially less to borrow money.[65]

47. Peter Ibbetson asserted that the problem was not a lack of any desire to lend but was one of demand.[66] To back up this position, he cited a recent Report from the Institute of Chartered Accountants which suggested that "only 5% [of businesses] didn't get the funding that they were after, but 27% didn't actually return to the banks for a renewal of their funding".[67]

48. The Department was alive to the differing views of business and banks over access to business finance and we were told that it was now collecting data on the demand for, and availability of, bank credit. Emma Squire, the Deputy Director, SME Finance, Enterprise Directorate, at the Department for Business, Innovation and Skills, explained that the data received so far had indicated that "over two thirds of the smallest firms who seek a loan receive one, and upwards of 85% of mid-sized, small firms".[68] However, she acknowledged that the data did not "resonate with what we're hearing from the FSB and from businesses".[69]

49. Mr Ibbetson was aware of this divergence of views and acknowledged that there was "an issue of perception" which clouded the debate over lending rates. He accepted that banks had to "continue working hard to get over that".[70] Matthew Fell believed that Government had a role to play in breaking down barriers between the two sides:

What they can do is help to understand the different drivers on each side of the equations. So for the banks to be hearing what the perceptions and issues from the small business community are and equally for small businesses to be understanding what the lending criteria are from banks and what the capital requirements are that are placed upon them, so that they can understand and make sure that their business plans and business proposals are as user friendly as possible in the eyes of the banks.[71]

50. Phil Orford returned to the central issue of lending rates and argued that Government needed to continue to push the banks to increase lending to business as it was clear to him that "they can lend more".[72] Roger Bibby from the Federation of Small Businesses said that while he wanted the dialogue between the two to be more than just "bashing". He believed that the need to "push them" remained important.[73] The Forum of Private Business acknowledged that tougher regulation of banks would be "popular" amongst its members, but was of the view that more important factors would be for:

The new Bank of England regulator to set specific timelines for decisions to be made on lending, written feedback on loan rejection and [...] internal escalation within the bank to be made transparent.[74]

51. That said, some of our witnesses were sceptical about the impact of regulatory action. The EEF, the manufacturers' organisation argued that "it is not evident that the use of lending targets has or will lead to improvements in accessing finance".[75] Matthew Fell also offered a note of caution in that he did not consider "top down directed lending" to be the long-term answer. Rather, he argued that lending decisions needed to be "pushed back down to on the ground" and returned to the branch level.[76]

52. When we took evidence from the Minister he was keenly aware that bank lending rates remained a problem and that there was "conflicting information and opinion" arising from the available data.[77] He believed that there was "some element of truth in what the banks are saying and there is some element of truth in what small business is saying",[78] and reiterated the Government's position that resolving this problem was a priority for the Government.[79] He assured us that he was pressing the banks to make sure there was "clearer information, clearer commitments and action both in terms of the lending and the information [banks] provide".[80] The Minister was also adamant that:

where there is unreasonable behaviour by the banks—whether it is in terms of their willingness to lend, or indeed the terms and conditions that underpin that—we will act on that where we find evidence of unreasonable behaviour.[81]

53. Ms Squire told us that the British Banking Association and banks had committed themselves to producing more transparent data in relation to lending which the Department would receive "on a consistent basis over time at regional and sectoral level, so it will be easier to hold banks to account". She also confirmed that the industry had committed to undertake and fund a quarterly survey, which she hoped would identify the problems faced by businesses when trying to access finance from banks.[82]

54. On Wednesday 9 February the Chancellor of the Exchequer announced to the House, the outcome of the agreement the Government had made with the banks, commonly known as Project Merlin. He said that in relation to SMEs the banks had agreed to:

commit to lend £76 billion this year. That is £10 billion more gross new lending to small and medium-sized businesses, a massive 15% increase, materially higher than they had been planning to lend this year and materially higher than anyone who has followed these discussions would have expected.[83]

55. The formal statement from the banks declared that this lending would be "subject to its normal commercial objectives, credit standards and processes and regulatory obligations, as well as the availability of the required funding".[84]

56. While the commitment to increase lending is a positive development, the Federation of Small Businesses was not convinced that the agreement would deliver significant change. Andrew Cave, representing the FSB said that "the vast majority of businesses are not going to the banks and seeking finance at the moment" and argued that "the cost of borrowing—both existing and new borrowing—is increasing and those issues are not going to go away with today's announcement."[85] Furthermore, John Varley, the former head of Barclays bank was reported as describing the deal as more of a signal of banks' "capacity and willingness" than a firm commitment.[86]

57. The statement from the banks also stated that their collective gross new lending results "will be tracked, on a quarterly basis, and the data will be made available to the Bank of England so that they may publicly report it".[87]

58. Working capital is the life-blood of business. If it is not available then the economic recovery will wither on the vine. We believe that the Government has had sufficient time to debate with banks the need to provide sufficient finance and come to an agreement on appropriate levels of bank lending. We expect the Government to deliver on its claim that it "will not stand by and let the businesses of tomorrow fail on the basis that they can't attract investment". The agreement between the Government and the banks to increase levels of bank lending represents a step in the right direction. The only reliable assessment of the banks' delivery on commitment, however, will be the level of take-up of that additional finance. We are aware that the terms and conditions currently applied to loans can be onerous and far too often drive businesses to use inappropriate forms of alternative finance. Furthermore, the cost of that finance can also hinder access. If either of these factors are not addressed the agreement reached by the Government will have been of little, if any, benefit to small and medium-sized businesses.

59. The data on lending rates which the banks will provide to the Department and the Bank of England should go some way to demonstrating whether or not the banks have delivered on their commitment to increase lending. We note the banks' undertaking to provide lending data to the Government and the Bank of England. All of this data will need to be made public so that it can be examined by us and the wider business community. We will expect it to be published as soon as practicable after it has been received. We also recommend that the Department include in its assessment of that data, any survey information received from business organisations on the costs of that finance and the level of loan applications which are turned down before formal applications are made.

Small Business Economic Forum

60. There was a more positive appraisal of bank/business engagement through the Small Business Finance Forum. The Forum was an informal body set up under the previous Government in November 2008 and comprised UK banks,[88] the Bank of England, the British Bankers' Association (BBA), key business representative bodies[89] as well as individual entrepreneurs and small businesses.[90] The Forum acted as an intermediary between the banks and business owners. The banks viewed the Small Business Finance Forum (SBFF) in a largely positive light. RBS considered it a welcome opportunity for all parties to understand each other's positions and was of particular use during the recession. It described it as:

The only forum where the banks, the trade bodies and the Government regularly met together, discussed the key issues in a confidential environment, defined solutions and set timelines for their delivery.[91]

61. Lloyds also supported the forum as a "useful interaction between business representatives, industry and other key stakeholders to shape policy addressing and remedying SME concerns; including improving access to finance and customer confidence".[92]

62. Roger Bibby from the Federation of Small Businesses agreed that the dialogue with the banks was useful, in particular in improving access to the Enterprise Finance Guarantee Scheme.[93] Matthew Fell agreed with that view:

Those forums did play an important role in getting that message back to the banks, who then pushed the awareness and the training out through the branch networks.[94]

63. The Forum has subsequently been replaced with the Small Business Economic Forum. The Department hopes that the new Forum will provide "an opportunity for businesses representatives and small businesses to share their views with Ministers on enterprise issues, in particular economic issues facing small firms".[95] The only major change between the two is that bank representatives will only attend this body "when finance matters are on the agenda".[96]

64. The first meeting was held in October with both the Secretary of State and Mark Prisk MP, the Minister of State for Business and Enterprise, in attendance.[97]

65. Matthew Fell from the CBI believed that the Small Business Economic Forum had been designed to address the "broader economic climate that supports small business"[98] and therefore had the potential to widen the debate from one that focused explicitly on banking relationships. He believed that continued dialogue with the banks was to be welcomed but he cautioned that the Forum would not be "a silver bullet" and the new Forum would not be "the vehicle that changes lending flows by a factor of 10".[99]

66. Peter Ibbetson, from RBS, welcomed the establishment of the new forum but argued that banks should be represented at all meetings rather than having attendance restricted to finance matters because the role of banks was not limited to funding.[100] He argued that banks "collectively represent all businesses in this country, so being there for all the issues that are being discussed is quite important".[101] Roger Bibby agreed that dialogue between the two was important and that the Small Business Economic Forum together with the Business Finance Taskforce had the potential to be more effective in addressing wider support to business.[102]

67. It is clear that all sides value the opportunity for dialogue offered by a forum which brings together banks, business and Government to both discuss the needs of business and to improve the relationship between banks and business. The widening of the remit of the new Small Business Economic Forum has the potential to deliver that. But the Forum should not be seen as an alternative to direct action to address shortfalls in lending. Quarterly meetings, while welcome, will not deliver on this in time.

68. We note the view of the banks that they would prefer to be full time participants rather than invitees when finance is discussed. This is a positive approach and we recommend that Government and business take a flexible approach to membership of the Forum and consider extending full membership to the banks.

THE RELATIONSHIP BETWEEN BANKS AND BUSINESS AT THE LOCAL LEVEL

69. The British Bankers' Association's Banking Finance Taskforce also saw the need to improve communication and understanding between banks and business. Its Report undertook to "facilitate an army of mentors to local businesses, with the aim of increasing the probability of success for business credit applications".[103] The BBA expects many of those mentors to be current or former banks employees:

Banks will assist in recruiting mentors by encouraging current or former bank employees to become business mentors. We will also work with accountants and other finance professionals to encourage their participation in the mentoring network.[104]

70. Many of our witnesses complained that the banks continued to hold an overly risk-averse position when it came to lending. The Forum of Private Business argued that despite the economy coming out of recession "banks continue to be risk averse and are not providing enough credit to allow business to make the most of the improved conditions.[105] EEF, the manufacturers' organisation, saw the pricing of risk by banks as one of its main concerns"[106] and argued that this resulted not just in higher interest rates but also in additional costs and conditions attached to a loan.[107]

71. The Forum of Private Business welcomed mentoring schemes or "shared training schemes" through which "banks, accountants and business owners have the option of understanding the basics of how banks assess risk".[108] The FPB also believed that this would facilitate an improvement in communication "at a more local level".[109] This was also the view of the CBI. When he gave evidence Martin Fell argued that the only way forward was to establish:

A much stronger and sustained engagement on the ground from the banking community in among their business customer base, because I think there is a perception at least, if not a reality, that lending decisions are all too often punted up to central credit control and there is less autonomy now in terms of local decision making, branch networks.[110]

72. At present, the relationship between banks and businesses can be characterised as distant and lacking in trust. As a result, banks have become far too risk-averse with decision-making based on formulas rather than local knowledge. The banking sector's proposals for banking mentors to assist businesses has the potential to develop a two-way process of understanding. Key to their success will be a change in bank culture with banks at the local level making lending decisions based on the merits of individual applications and not merely acting as an intermediary between businesses and banks central offices. If they are to achieve this, banks need to develop a new approach to risk management with process which are sufficiently sophisticated to balance local decision-making with the need for strategic risk assessment.

Business Growth Fund

73. The Government's Green Paper on banking policy takes into account the banks' proposals to establish a Business Growth Fund, which would provide:

A substantial investment portfolio over a number of years which is expected to reach a total of £1.5 billion; subject to rolling review as the initiative progresses.[111]

The Fund will work to support established companies with strong growth potential and offer between £2 million and £10 million to those companies, in return for an equity stake in the business. The investment provided would be in the form of equity capital.[112]

74. In its Comprehensive Spending Review, the Government welcomed the banks' Business Growth Fund[113] and subsequently announced plans to divert support for its Growth Capital Fund to the British Bankers' Association initiative.[114] This has been welcomed by the banking industry, but it has led to a level of confusion over what representation, if any, the Government should have on the board of the Fund. Angela Knight, from the British Bankers' Association, agreed that the Department should have a role in the Fund but was not convinced of the need to have ministerial representation:

We wouldn't have thought a Government Minister, no, but we would have thought a representative through one of the officials would be a good idea, because the board is of course an independent board. It's not the board that will decide the lending decisions; the board will do the policy and so forth.[115]

75. Emma Squire told us that the Department was considering how best to influence the Business Growth Fund and explained that a number of options were being considered:

Potentially that would be through representation on the board, through nominating a nonexecutive director from outside Government to represent our interests on the board, or just through more informal channels. What is clear is that new fund will explicitly target the market failure that we identified in the independent Rowlands Review last year, which is for growth capital for established SMEs. So as long as the fund will target that gap, I think we will be content.[116]

76. The Business Growth Fund has the potential to deliver significant investment to British industry. We believe that Government should be represented on the board of the Fund, but whether this is through a Government Minister or an official is open to question. However, we strongly believe that Government representation in whatever form it takes should have, at its heart, the promotion of businesses and business need. We recommend that Government representation on the board of the Business Growth Fund be founded in the Department of Business, Innovation and Skills. Relinquishing that role to HM Treasury will not give business the appropriate levels of expertise and support they require.

34 HC (2010-11)543-i, Q67 Back

35 www.bis.gov.uk/assets/biscore/corporate/docs/f/10-1242-financing-business-growth-response.pdf Back

36 Business Angels are high net worth individuals who invest on their own, or as part of a syndicate, in high growth businesses. In addition to money, Business Angels often make their own skills, experience and contacts available to the company.(For more information see the British Business Angels Association: bbaa.org.uk). Back

37 Growth hubs are intended to provide strategic advice and coaching to SMEs at a local level. Back

38 www.bis.gov.uk/assets/biscore/corporate/docs/f/10-1242-financing-business-growth-response.pdf Back

39 www.bis.gov.uk/policies/enterprise-and-business-support/access-to-finance/enterprise-capital-funds Back

40 www.bis.gov.uk/policies/enterprise-and-business-support/access-to-finance/growth-capital-fund Back

41 Q 21 Back

42 www.bis.gov.uk/assets/biscore/corporate/docs/f/financing-business-growth-response.pdf Back

43 The Taskforce was made up of the CEOs and senior representatives of the six largest UK banks: Barclays; HSBC; Lloyds Banking Group; Royal Bank of Scotland; Santander; and Standard Chartered. Back

44 www.bba.org.uk/media/article/business-finance-taskforce/press-releases/ Back

45 www.bis.gov.uk/assets/biscore/corporate/docs/f/financing-business-growth-response.pdf Back