Government Assistance to Industry

Memorandum submitted by West Midlands Regional Finance Forum

We welcome the opportunity of submitting this evidence as the availability of appropriate finance is a key requirement for a healthy and flourishing economy at the local, regional and national levels. There is a wealth of evidence that there has long been a lack of appropriate finance to certain businesses at various stages of their development. This has been particularly the case for SMEs in their early stages, but also extends to more mature SMEs in certain circumstances. Government at the national and regional level has sought to address those issues through a variety of instruments, in particular the Enterprise Finance Guarantee scheme (and its predecessor the Small Firms Loan Guarantee scheme), a range of public sector backed venture capital and loan funds, Community Development Finance Institutions, fiscal incentives, support for business angel and high net worth investment activity and, on the demand side, investment readiness support to businesses seeking finance. These schemes have had varying degrees of success, but all have enabled businesses to access finance that would otherwise have been unavailable to them.

That underlying situation has been dramatically worsened by the recent recession which has led to a considerable retrenchment on the part of the financing community and a high degree of caution on the part of businesses. If not satisfactorily addressed, that combination will conspire to reduce the pace of the private sector led recovery that is our and Government’s objective.

This evidence is based on a combination of research commissioned on the advice of the Regional Finance Forum, the personal experience of the members of the Regional Finance Forum (see Annex1) in addressing the financing needs of businesses, particularly SMEs, over many years, and regular review of the impact of interventions put in place in the West Midlands during the period since 2002. The response is therefore supported by a wealth of practical experience in the business finance field.

Annex 1: MEMBERSHIP OF THE REGIONAL FINANCE FORUM

Observer

Executive Summary

a) The Banking Sector Environment

Bank relationships with customers have suffered considerably over the last two years and much work is required to repair them. Banks need to understand far more the needs of their SME customers and be more transparent in their charging structures and reasons for offering particular forms of finance. SMEs need to be better informed as to what types of finance are appropriate in what circumstances and to be prepared to explain to their banks why they prefer finance in one form rather than another. The current rigid prescribed mechanisms of large banks, including credit scoring, whilst reducing their costs and need for local skills, inevitably mean they miss some deserving investments and there is a need and opportunity for banks to be encouraged to adopt a more co-ordinated approach with other funders and business advisor/brokers to enable SMEs to be offered an appropriate funding package

b) Need to address the divergence between the banks’ reported view of "demand" and the well publicised experience of many SMEs

Definitive research needs to be carried out to resolve the question of whether banks are denying SMEs the credit facilities they need to grow and develop. Whilst the recently announced Experian review commissioned by the banks may address this issue in part, our expectation is that it will only consider rejections which occur at a formal credit committee level. It will fail to address those enquiries for borrowing which are rejected in a less formal manner before being put to credit committee or the number of businesses which are discouraged from approaching banks because of their expectation of rejection in the current climate.

c) Enterprise Finance Guarantee (EFG) scheme

The EFG is a vital tool to allow lending by banks to businesses with insufficient track record or security. It bridges the short term gap between the financial objectives of the banks and the economic objectives of the community. Such a scheme has been a key part of the UK and other financial landscapes for over 25 years. However it does not achieve maximum benefit because the manner in which it is operated generally focuses solely on security, with the result that requests for finance from start ups or for finance based on growth forecasts rather than historical performance are frequently unsuccessful. In addition there is inconsistency in the manner in which the scheme is operated within and between banks, particularly with regard to security and personal guarantees which is inbuilt on the Government guidance. The approach to requiring personal guarantees when many of the benefits fall to the community, strikes many SME directors as unfair and leads to a number of offers made being turned down because of overly onerous terms. This matter should be addressed in any further iteration of the scheme and suggestions relating to this are made within the body of this response.

i. Use of intermediaries (such as Community Development Finance Institutions - CDFIs)

Banks should support and make more use of intermediaries such as CDFIs

ii. Mezzanine Finance

Bank participation could also extend to new instruments such as mezzanine funds with higher interest rates and equity kickers. We consider that the level at which such a product is required start as low as £50,000. It is also possible that the lower level requirements of mezzanine type funding could be met by the banks using an adapted form of Enterprise Finance Guarantee.

iii. Supply Chain Financing

We believe this can be of use in certain circumstances and could be far more widely used by public and large private companies.

d) The role of invoice discounting and credit insurance

The disruption in business finances and subsequent company confidence that resulted from the withdrawal/reduction of credit insurance cover on sectors and individual customers and the consequent impact on the availability of invoice discounting and factoring facilities needs to be addressed by Government, businesses, asset backed lenders and credit insurers to ensure that lessons can be learned and trust in this important form of finance rebuilt.

e) Export finance

Many SMEs are concerned at the lack of readily accessible export finance instruments. This is exacerbated by a perception that bank staff dealing with SMEs frequently lack the knowledge and expertise to be able to assist in this area. To achieve an export led recovery urgent action is required in this area to enable SMEs to take full advantage of the opportunities which exist.

f) HMRC

We believe that the approach of HMRC to tax deferments was one of the most important actions of the previous government in supporting SMEs. Clearly, the deferred tax needs to be repaid but the manner in which this is done is crucial.

g) Debt capital markets

BIS should commission research to ascertain what circumstances have given rise to debt markets in the USA being more open to smaller businesses seeking smaller sums of money and how this form of finance can become more widely available in the UK.

h) Promoting greater competition

Government needs to ensure that necessary tightening in the regulatory environment doesn’t have the impact of favouring the largest players with the strongest balance sheets. In the USA government uses the banking licence procedure to encourage greater banking activity by existing institutions, particularly in disadvantaged areas. When SMEs need finance it is not possible at that point to change banks. This why codes of practice are needed and policed.

i. Research and Development

There are certain categories of activity (particularly R&D) where the nature of the activity is of such uncertain outcome that external finance may not be available. In such circumstances there is a requirement for other financing products, such as the Grant for R&D and R&D Tax Credit.

ii. Capital investment

There is also a need to encourage investment in new assets to improve the competitiveness of businesses, particularly those based in areas where productivity and historical levels of investment is below the national average. This can be stimulated by fiscal measures and financing products such as the Grant for Business Investment.

DETAILED EVIDENCE

a) Overview of the Banking Sector Environment

There is little doubt that the perceived attitudes and actions of the banks in the early stages of the credit crunch dramatically undermined the relationship between banks and their customers. More recent behaviours and the introduction of Customer Charters are going some way to restoring these relationships, but there is still much to be done. This is important for small businesses, (particularly those which do not have sufficient high growth potential to attract venture capital or business angel support), as these are dependent to a large degree on bank finance. It is therefore particularly important for the small business sector of the market that relationships between banks and their small business customers can be restored and improved.

There is a perception that banks do not really understand the nature of smaller businesses and hence look on them as "small large businesses". There is insufficient effort to understand the needs of smaller businesses and also a desire to "sell" the banks’ preferred products with insufficient consideration as to whether they are the best ways of supporting the business customer. This is particularly the case with products such as invoice discounting, where the small business perception is that something is being thrust upon them when they would prefer to have a simple overdraft facility. Therefore banks need to make far more effort to understand the needs of their business customers, to act fairly with them, and to explain fully why particular products may be appropriate and particular charging structures are required. Bank managers need to explain why products such as invoice discounting are so attractive to them, but also to recognise that the circumstances of particular businesses may render other solutions more appropriate.

There is also concern that arrangement fees and renewal fees have risen sharply and lending spreads have increased, particularly for small businesses. These factors discourage small businesses from seeking finance to grow and develop. Banks therefore need to ensure that they adopt fair charging structures and explain them well to customers. They also need to avoid the impression that they sometimes abuse a position of power, particularly in charging excessively when a business is experiencing trading difficulties, thereby restricting their ability to secure finance elsewhere.

SMEs, for their part, need to recognise that we have moved from a time when credit was cheap to one where it is more expensive and less readily available. In assessing any offers of finance they need to focus on the benefits they will generate from taking up offers of finance, rather than purely on the perceived cost of the finance being offered. Equally businesses, with their advisers, need to assess with a more open mind whether different types of finance may be appropriate in particular circumstances. If they feel their bankers are offering an inappropriate form of finance they should be prepared to argue their case and see if a more satisfactory position can be negotiated.

Government should ensure that its responses and comments on the banking situation are fair and reasonable – at the height of the credit crunch, for instance, it was inappropriate to draw attention to the disparity between base rate and the amounts charged to customers, as very few banks (if any) had a cost of capital anywhere near base rate. No small business would be expected to conduct its affairs at a gross loss and banks shouldn’t be asked to do so either. That said, it is a fair point that if banks retained more of their profits and paid lower bonuses they would be able to strengthen their balance sheets more quickly.

As regards actions to improve the financial readiness of businesses there needs to be better communication between finance providers, businesses and their advisors. Other areas in which improvements could be made include:

· Standardisation of documentation required to support applications for finance (e.g. standardised business plan formats and financial forecast requirements;

· Clear, like for like, cost comparisons between different forms of finance where these are being discussed with customers (e.g. between invoice discounting and a comparable overdraft facility).

· Banks can work with Businesses and their support providers to make investments applications better rather than just acting as a go/no-go operation.

b) Experience of recent years in banks’ provision of finance to SMEs

A common perception is that it was easy for SMEs to obtain credit in the run up to the finance crisis. However, for some time, probably over 10 years, there has been a growing reluctance for banks to assess SMEs on an individual basis. They reverted to credit scoring and a preference for security over any form of cash-flow based lending. This reduced their assessment costs and eventually their capabilities at branch level. As a result SMEs have not had the over generous lending that has been available to mortgages, private credit cards, or to larger companies, including those financed by private equity.

c) The divergence between the banks’ reported view of "demand" and the well publicised experience of many SMEs

There is considerable evidence that there has been a further net reduction in lending to SMEs in recent months. Much of this is attributed to businesses deferring investment decisions until the economic outlook is clearer and strengthening their balance sheets where they are able. This results in a reduction in demand. However, many businesses, particularly SMEs, are reported as having been unable to obtain the facilities they need to take their businesses forward. A recent IoD survey in the West Midlands reported that only one third of businesses seeking finance had successfully obtained the amount they were seeking. In addition SMEs report the imposition of high arrangement fees, higher interest margins and harsher security requirements, particularly for personal guarantees, even where the Enterprise Finance Guarantee is in place. These factors make SMEs reluctant to approach their banks for finance or to accept the onerous terms on which finance is offered. Even more worryingly they reduce their appetite to ‘bother to grow’. Unless these issues are addressed, future growth may be held back by an inability to obtain finance on acceptable terms. In part this requires a change in the mindset of SMEs to recognise that credit in the past has been available too cheaply; but even if they do this, it will not mean that their appetite for using credit to grow their businesses will necessarily return. However, banks too need to review their practices and ensure that they are dealing in an open, realistic and fair manner with their customers. Beyond that if they are not prepared to take a longer term economic view, rather than a short term financial one; there will still be a gap in SME finance.

Definitive research needs to be carried out to resolve the question of whether banks are denying SMEs the credit facilities they need to grow and develop. Whilst the recently announced Experian review commissioned by the banks may address this issue in part, our expectation is that it will only consider rejections which occur at a formal credit committee level. It will fail to address those enquiries for borrowing which are rejected in a less formal manner before being put to credit committee or the number of businesses which are discouraged from approaching banks because of their expectation of rejection in the current climate.

d) The impact of invoice discounting and factoring on the market for SME finance

The Government’s Green Paper on Financing a Private Sector Recovery (the ‘Green Paper’) suggests at Paragraph 3.30 that "There do not currently appear to be constraints on these markets", "these markets" being taken to include Asset based finance such as invoice discounting and stock financing. The experience of many businesses during the recession has been that the availability of invoice discounting facilities changed dramatically overnight, with credit limits being slashed and some customer limits being reduced to zero. The position was exacerbated (and, in many cases, caused) by credit insurers cutting levels of cover on certain customers and removing cover altogether in some sectors, such as retail, construction and automotive. This led to many businesses suffering financial distress as their financing facilities were cut dramatically. A high proportion of the customers of the Advantage Transition Bridge Fund (the region’s Transition Loan Fund which made loans of between £50,000 and £250,000 to viable businesses which could not secure mainstream funding between November 2008 and 2009) had experienced these problems and had therefore had to seek finance from other sources. The impact of this experience is that many SMEs are now highly sceptical of invoice discounting as a source of finance as its shortcomings have been so dramatically highlighted. Reduced turnover leads to lower facilities, but in difficult economic times that mathematical impact can be compounded by a reduction or removal of credit limits. Whilst we believe that invoice discounting will be a valuable source of finance as businesses recover and turnover increases, banks and other providers of this sort of finance will need to address the concerns of SMEs in this respect and explain why they consider such forms of finance more appropriate than the loan and overdraft finance which SMEs have typically used. In addition to the issues discussed above, many SMEs have found invoice discounting unavailable to them as regards export customers, and the availability of stock financing in the SME sector is much lower than the throwaway line in the Green Paper suggests. Indeed our experience is that stock financing is largely unavailable to SMEs. Some large companies, including in the public sector, refuse to let SME suppliers use invoice discounting; it appears on a whim/prejudice!

In our view there is a clear need to research the role of credit insurers and invoice discounting generally and, in particular, in difficult economic times when conditions in these areas can change overnight.

e) The apparent divergence of view between the manner in which Government believes the Enterprise Finance Guarantee is being operated and the reality on the ground

The Green Paper states in paragraphs 3.8 and 4.15 that the Small Firms Loan Guarantee Scheme and the Enterprise Finance Guarantee Scheme were intended to address situations where the lender found it difficult to assess the credit worthiness of a particular proposition because of a lack of track record or security. Our experience is that banks use the EFG almost exclusively to address issues of security rather than track record, and that this reluctance to use the Scheme in the absence of a track record also extends to a reluctance to use it where forecasts are based on growth rather than a continuation of the status quo. This issue needs to be addressed if businesses forecasting growth are to be adequately financed as the economy recovers.

In terms of what options the Government might consider to support increased lending to business our view is that the objective of Government actions to support increased lending to businesses is to increase the availability of finance to businesses which would not otherwise be available. It is not merely to see a significant take up of the particular initiative implemented, particularly if this leads to increasing take up of the scheme by banks for lending which they should be doing in any case (e.g. by extending coverage of the scheme to some mid-sized businesses…which may have a lower credit risk than SMEs").

In assessing options for further Government actions there needs to be a focus on what currently makes it unattractive for banks to lend to businesses, particularly SMEs. In our view the factors which make lending to SMEs unattractive in certain circumstances are:

· The risk of default;

· The relatively low levels of income which banks can achieve from smaller business customers relative to the higher risk of lending.

The risk of default is addressed to some degree by the EFG, but the 25% exposure is still significant in the context of the relatively low levels of income achieved from lending to smaller businesses, particularly when allied to the 9.75% cap on claims. This leads banks to excessive caution in assessing small business lending propositions which exacerbates the cost: benefit ratio. Accordingly we would suggest that the level of guarantee is raised to 90% for smaller businesses and start ups. This was a position allowed by the EU under state aid at the time of the credit problems but was not taken up when the EFG was introduced as a replacement for the SFLG.

A further incentive to lend to smaller businesses could be provided through the fiscal system, for instance by applying a lower level of Corporation Tax to profits on business carried out with smaller customers or, if transaction taxes are introduced, they should be alleviated for SME lending. An alternative could be for SMEs to be allowed higher levels of tax relief on interest charges and other costs related to raising finance, thus allowing banks to charge what they regard as the commercial rate whilst bringing the net cost suffered by the SME down to more acceptable levels.

As regards the detail of the EFG, firstly, we must emphasise that the existence of a government backed loan guarantee scheme is an absolutely fundamental need for SMEs, no matter what its exact faults. It has been in existence since 1981 at a rate of over £250m per year and has arguably not kept pace with inflation recently and is prevalent in some form or other in most of our international competitors. To deny its importance and legitimacy, as some free market economists have sought to do, is to fly in the face of all the evidence of its benefits. The justification for the EFG and its structure is not purely a question of financial cost but of economic value. It is generally used only when traditional lending is not available and therefore by definition is short term incremental investment in the business with additional economic benefits for the nation. The general criticism that the default rate is higher than normal lending is spurious. If that was not the case then our banks would truly be seen as totally incompetent, which is clearly not the case. It is the bridge between financial and economic benefit for our current complex state systems.

Detailed areas in which we would like to see the EFG improved are:

· Enforce the use of the scheme for circumstances where there is insufficient track record (including with regard to prospective growth), rather than the current situation in which banks largely use the scheme to meet shortcomings in security; this will probably require an increase in the banks’ assessment capability at a local level;

· Greater clarity and guidance about the extent to which personal guarantees and other security should be sought. There is a perception amongst SMEs that the banks seek a "no risk" situation in which the Government covers 75% of the risk and the balance is covered by personal guarantees, frequently for 100% of the borrowing (and never less than 25%). This strikes SME directors as unfair and an inappropriate position only for them, and fundamentally a repudiation of the Companies Act position which separates personal assets from those of the business. This position is a government responsibility and they cannot hide behind the banks;

· Greater clarity of the extent to which EFG can be used for a business with a significant level of export activity (as opposed to specifically for export finance);

· Relaxation of the overall 9.75% cap on claims which banks can make in respect of their EFG lending which was never present in the SFLG which this EFG replaced.

We would not like to see the cost to the borrower increased, particularly whilst there is a perception that excessive personal guarantees are being sought by some banks. There is already a perception that EFG money is relatively expensive and we know that perceived high rates can act as a disincentive to businesses accepting offers of finance. We would not suggest any attempt to increase the cost to the borrower until such time as the impact on defaults of the bank being allowed (under EFG) to take personal guarantees can be assessed.

As regards the effectiveness of the EFG in addressing the financing needs of businesses, we have calculated that EFG has accounted for approximately 2% of SME lending since its implementation. Given the claims of SMEs that banks are not lending to them, this seems a relatively small proportion of total SME lending. We believe that this is a result of two factors, firstly the banks’ focus on EFG as a means of covering a lack of security (rather than track record or other risk characteristics) and secondly the perceived unfairness of some of the conditions imposed by the banks (e.g. excessive arrangement fees, excessive pursuit of personal guarantees, etc). As indicated above, we suggest these issues should be addressed by Government reinforcing positive guidelines to banks as regards the manner in which the scheme should be operated.

f) Securitisation

The lessons of the credit crunch indicate that a key issue in making securitisation more attractive to investors is to increase the transparency of what assets are actually being securitised and to ensure that credit ratings given to securitised vehicles are robust and well founded. This implies that the chain between the investor and the underlying assets being securitised should have few links and that the underlying assets should be identifiable and verifiable. Securitisation of sound assets as a route to raise growth finance can accelerate growth (as the Northern Rock experience demonstrates): however, Northern Rock also demonstrates the difficulties that arise if the securitisation is of assets which are worth less and of greater risk than investors originally appreciate.

i) Supply Chain Financing

We believe this can be of use in certain circumstances. We know of its use by one local authority and believe that it could be far more widely used by public and large private companies. It is a mechanism of introducing more secure assets into the whole financial system. It is possible, that large and secure purchasers could act as guarantors for goods and invoices from their suppliers which would be particularly helpful to SMEs and help them to grow and provide more competitive supply to both the public and the private sector. It might be possible for this to be done on a combined national or regional basis through some major banks. Santander is a leader in this field following some of its successful Spanish experience. However, Supply Chain Financing may suffer from some of the same issues as Invoice Discounting, particularly where certain sectors go out of favour (as is still the case with much of the automotive sector).

j) Use of intermediaries (such as Community Development Finance Institutions)

A fundamentally different way for banks to get involved in lending to SMEs is by using/supporting intermediaries. Already this has happened in the support of CDFIs where banking finance can be protected to a degree by the use of public grants (sometimes part financed through ERDF). The CDFIs can take a more portfolio based approach to lending whilst still providing sufficient security for the banks to have an appetite to lend to them. During the credit crunch lending by CDFIs in the region doubled and ongoing demand indicates that viable business propositions are not being funded from mainstream sources.

k) Mezzanine Finance

Bank participation could also extend to new instruments such as mezzanine funds with higher interest rates and equity kickers (such as were adopted by the original ICFC). We have had some indication of an appetite for such bank participation in our attempt to introduce a mezzanine fund in the West Midlands. Our expectation is that the proposed Growth Capital Fund will effectively provide a mezzanine product, although we consider that the level at which such a product is required starts well below £2 million. In fact we would suggest that it could start as low as £50,000. This is borne out by research carried out at the Regional Finance Forum’s request by West Midlands Enterprise Consultants. This report concluded that the: "findings demonstrated an area of market failure due to the lack of provision of unsecured loans of between £50,000 and £1 million and adequate business support alongside the finance". We have some doubts as to whether the mezzanine gap really extends as high as £10 million: if it does so then we would regard that as a function of the current economic circumstances rather than a consistent, long term issue.

It is possible that the lower level requirements of mezzanine type funding could be met by the banks using an adapted form of Enterprise Finance Guarantee. However, for that to happen there would need to be a significant change in the way the banks applied the scheme to put greater emphasis on the extent to which the scheme could be used to support lending to businesses with insufficient track record, or a growth forecast which the bank found hard to validate. The original ICFC was supported by the clearing banks and the Bank of England and was very successful for them and the economy in the mezzanine space. However, in the absence of such an approach, some form of publicly backed mezzanine provision is required from £50,000 upwards.

l) International Trade

It is particularly important that trade finance for UK exporters is readily available if we are to experience an export led recovery. However, recent evidence suggests that trade finance for export activity is a difficult area for SMEs in particular:

· Credit insurance is available on an at best patchy basis;

· Invoice discounting of export debt is often difficult to achieve at a suitable level;

· Government support with such as EFG has been refused by banks as against government guidelines;

· More exotic destinations which are helped by ECGD for larger companies and contracts are not available for SMEs;

· Banks and invoice discounters have during the recent credit problems often adopted a sectoral exclusion approach even on existing contracts.

International banks should be well placed to address this issue, with their broad international coverage. We understand that some banks such as RBS/Nat West have adopted their own portfolio approach to some exporting, excluding the need for third party insurance. We believe that international banks with no UK presence, particularly in the fast developing markets, may be encouraged to support this activity. In addition, banks may be able to put in place improved documentary credit arrangements which make export finance more readily available. Our perception is that banks’ own staff have limited exposure to export finance arrangements and that standards and processes within and between banks vary significantly.

A further frustration is the restrictive attitude many banks exhibit to the prohibition on using EFG for export credit activity. Our reading of the EFG rules is that as long as EFG is not used explicitly as an export credit line, EFG can be used to support investment (including in working capital) by a business a significant part of whose activity is in export markets. The application of this rule therefore needs clarification.

m) HMRC

The HMRC Business Payment Support Service/Time to Pay scheme has been a valuable lifeline to many businesses during the recession. However, there have been issues with it which should be addressed. In the first instance the scheme seems to have been offered too readily, with the result that a number of businesses availed themselves of the scheme when in practice they did not need it. Conversely, as time went by it became progressively more difficult to access the scheme, particularly if initial repayment forecasts were not achieved. Whilst recognising that the main job of HMRC is not to assess credit risks, it is important that propositions are considered on a case by case basis and handled appropriately. In some instances a determination to put businesses into administration may have acted to the detriment of both HMRC and the business concerned.

How this now unwinds is a key concern and maybe an opportunity for fresh private sector involvement. A proposal has been made that the banks should take over the debts (subject to them being indemnified, maybe using the EFGS). This would bring them back into the SME market and replace Government debt with bank debt. There have also been suggestions about them being developed into a series of Bonds sold on the market which could create a new credit instrument as suggested earlier.

n) Debt capital markets

Our perception is that larger businesses can access debt capital markets appropriately but the Green Paper implies that debt markets in the United States of America are more open to smaller businesses seeking smaller sums of money. We would therefore suggest that BIS commission research to ascertain what circumstances have given rise to this situation and how this form of finance can become more widely available in the UK.

In the past there has been discussion with intermediary institutions about the provision of grouped bonds which are then available to individual SMEs. This could be good way of introducing new capital into the market place and again is worth a trial. Later we talk about the possibility of using the outstanding HMRC loans as a start to new debt capital markets.

o) Promoting greater competition

Greater competition will appear when business demand for finance and business prospects improves. This has been demonstrated in successive banking cycles and is borne out by the recent trends in the impact of lending from overseas sources to UK businesses. At the moment overseas providers have largely withdrawn from the market to sort out their balance sheets and stabilise themselves.

A limited amount of splitting up of UK banks will help re-introduce competition (e.g. the divestment of certain activities by RBS and Lloyds Banking Group). Government needs to be cautious, however, that Government backed initiatives aimed at stimulating competition do not, in fact, crowd out the private sector.

Government also needs to ensure that necessary tightening in the regulatory environment doesn’t have the impact of favouring the largest players with the strongest balance sheets. Such an approach would clearly reduce, rather than increase, competition.

Visits to the USA have demonstrated there that the government uses the banking licence procedure to encourage greater banking activity by existing institutions, particularly in disadvantaged areas.

Generally the concept of competition between banks is flawed for SMEs who need finance. It is not possible at that point to change banks and therefore any company is totally dependent on the arbitrary power of their bank. This is a major reason why codes of practice are needed and policed.

The current modest level of return from mainstream investments also gives rise to an opportunity to encourage Business Angels to enter the debt finance market as well as the equity market. We are aware of Funding Circle (see www.fundingcircle.com ) which seeks to mobilise investors to lend to businesses seeking up to £50,000, although this will not provide access to finance for start ups or those with less than two years trading history. We are also aware of other new organisations looking to encourage lending by Business Angels at a higher level, one of which is a West Midlands based VC/angel organisation. This activity could be encouraged further, if the scope of the Enterprise Investment Scheme was extended to enable lending instruments to benefit from reliefs as well as equity investment. Also, the higher the quality the propositions, helped by intensive investment readiness programmes, the greater will be the competition to supply finance.

p) Future Risks

Our principal concerns are that banks’ appetite to lend to businesses will recover more slowly than businesses’ requirements for additional resources to support growth, that businesses will perceive the cost at and terms on which they are offered growth finance to be such they would prefer to lower their growth aspirations and turn down the finance offered and that with more demanding capital requirements there is a danger that the cost of finance will increase and availability of finance will reduce further. Part of these concerns relates to transitional issues brought about by the financial crisis, However, it is likely that the ongoing landscape of business finance will reflect a generally more prudent attitude to lending and with a higher risk premium factored in. It should also be recognised that the finance supply from the private sector for SMEs has been inadequate for at least the last 30 years and needs public interventions. It is not just a feature of the recent credit issues. It is a fundamental structural issue in that, at least in the short term, the economic benefits for the nation are not coincident with the financial returns desired by the banks and other lenders, which consequently prefer to invest in other areas. Instruments which can help address these concerns are:

· Continuation of improvements in the way the Enterprise Finance Guarantee scheme works;

· Ensuring a suitable array of public sector backed venture capital and loan funds;

· Making it more attractive for Business Angels and mainstream finance to invest using different instruments (e.g. loan and mezzanine funds );

· Thoughtful and comprehensive, positive tax incentives for investors;

· Increased financial awareness amongst businesses, particularly smaller ones;

· Ensure availability of skilled brokers and market places by public support.

q) Other issues

i. Research and Development

There are certain categories of activity (particularly R&D) where the nature of the activity is of such uncertain outcome that external finance may not be available. In such circumstances there is a requirement for other financing products, such as the Grant for R&D and R&D Tax Credit.

ii. Capital investment

There is also a need to encourage investment in new assets to improve the competitiveness of businesses, particularly those based in areas where productivity and historical levels of investment is below the national average. This can be stimulated by fiscal measures and financing products such as the Grant for Business Investment.

September 2010