Conclusions and recommendations
The SME finance market
1.It is naive to expect all business owners to possess a detailed understanding of the various financing options available to them. For many, the demands of running a business will leave little time for building financial expertise and searching the market. This points to a need for concise and easily accessible information targeted at the non-expert seeker of finance. As the centre of expertise on smaller business finance in the UK, the British Business Bank has an important role to play, and its Business Finance Guide and Finance Your Growth initiatives are to be welcomed. These tools must be maintained and promoted effectively to ensure they reach as wide an audience as possible. (Paragraph 10)
2.The Small Business Commissioner is also well placed to assist SMEs in building awareness and understanding of the financing options available to them. The Government should expand the remit of the Commissioner to provide it with a formal role in helping small businesses to access the finance they need, particularly by improving levels of awareness and understanding of financing options. (Paragraph 11)
3.Data on SME attitudes to external finance are concerning. The reluctance amongst many business owners to seek external finance is driven by a variety of factors, though it is clear that a lack of trust in lenders and an often misplaced fear of rejection are key contributors. The Economic Secretary recognised the challenges that stem from an entrenched unwillingness to apply for finance. The Treasury should conduct or commission work to identify why this attitude is commonplace amongst SMEs, and develop a strategy to ensure the UK’s small businesses have the confidence to seek the external finance that is right for them. Efforts should also be made to ensure SMEs are aware of the options available to them if they are turned down for finance; specifically the Lending Appeals Process and the Bank Referral Scheme. (Paragraph 16)
4.The Committee welcomes the Treasury’s recognition of the challenges faced by high-growth, scale-up businesses seeking investment. The Treasury should assess what can be done to improve the extent to which these companies benefit from the capital of the UK’s long-term investors. (Paragraph 19)
5.Banks are often the first port of call for business owners seeking finance, and the importance of bank lending for SMEs is clear. While the fact that bank lending remains below pre-crisis levels may be cause for concern, the Committee accepts that a bank’s risk appetite, and thus its willingness to lend to SMEs, is a legitimate commercial decision and a competitive differentiator. However, banks should keep their levels of SME lending under review to ensure they are regularly deciding whether it is optimal, rather than merely perpetuating historic trends. (Paragraph 23)
6.A lack of competition in SME banking, which has long-plagued the UK market, remains a key area of concern. While the emergence of new entrants is welcome, by the Government’s own admission, more work is needed to bring meaningful competition that will improve outcomes for SMEs. The Minister is correct to recognise the significant task faced by challenger banks seeking to break the stranglehold of the large incumbents. (Paragraph 29)
7.The previous Treasury Committee was unconvinced by the outcome of the CMA’s retail banking market investigation. Two years have passed since the publication of the CMA’s final report, yet the concerns around the level of competition persist. Given that the CMA itself noted that its measures were expected to take three to four years to have a noticeable impact, the Committee will monitor developments closely over the next two years. The Committee recommends that, in response to this report, the CMA provides an update on the implementation and impact of the measures introduced to improve competition in SME banking. (Paragraph 30)
8.Despite welcome changes to the PRA’s regime in 2017, capital requirements remain a specific source of dissatisfaction for the UK’s smaller banks. The Committee is clear that the UK’s exit from the EU should not herald a new era of laxity in capital regulation, but considers that there is an opportunity to consider how the regime can better support competition without compromising safety and soundness. The Government should provide its assessment of how this could be achieved. (Paragraph 31)
9.The Economic Secretary told the Committee that there is more that needs to be done to improve the Alternative Remedies Package. This is unfortunate, as the opportunity for the Treasury to adjust the package has long since passed. The Committee views the initiative as a rare and critically important opportunity to provide a meaningful boost to competition in the SME banking market. Both the Treasury and the independent body administering the package must take a similar view, and should not see this initiative simply as a compliance exercise to satisfy the European Commission’s State aid requirements. (Paragraph 37)
10.It is disappointing to hear that the industry is expressing concerns about the package’s design and implementation. Delays to implementation are not without cost, and given those witnessed to date, it is all the more important for Banking Competition Remedies Ltd to administer the Alternative Remedies Package in as timely a manner as possible. (Paragraph 38)
11.The UK’s alternative finance sector has demonstrated impressive growth in recent years. This is beneficial for SMEs seeking funding, and is in part down to measures introduced by the Government to encourage the sector’s development. However, it still accounts for a relatively small portion of the overall SME finance market, and it is likely that potential for further growth still exists. The Government must not rest on its laurels; further work will be required to ensure the UK’s alternative finance sector fully realises its potential while maintaining appropriate standards of protection for consumers. (Paragraph 49)
12.Open Banking has the potential to bring significant benefits for SMEs seeking finance. Its impact on the market to date, however, has been muted. As an initiative based fundamentally on the sharing of private financial information with third parties, its success will depend heavily on the willingness of consumers and SMEs to trust those firms. Perhaps understandably, given the frequency of high-profile IT failures and data breaches, that trust appears to be seriously lacking. The Treasury told the Committee that it expected the impact of Open Banking to be slow to materialise, but the Committee urges it to take a more ambitious stance. Working with the Competition and Markets Authority, the Treasury should provide an assessment of the initiative’s effect on the market to date. The authorities should also set clear and challenging milestones for the industry in relation to the timely development of Open Banking services, and deliver a comprehensive strategy for combatting the clear public trust issues that threaten to undermine the initiative. (Paragraph 50)
Misconduct and regulation in SME banking
13.The treatment of vast numbers of SME customers placed in RBS’s Global Restructuring Group was nothing short of scandalous. The actions of GRG staff heaped untold misery on hard working business owners, recklessly destroying livelihoods in pursuit of profit. The “Just Hit Budget!” memo typified the toxic and unscrupulous culture entrenched within the organisation; a culture that has been rightly highlighted as a key driver of events at GRG. (Paragraph 56)
14.It is widely acknowledged that an organisation’s culture is strongly guided by the “tone from the top”; the standards of ethics and integrity demonstrated by those in senior positions. The overwhelming majority of those responsible for cultivating GRG’s patently unprincipled culture remain employed in RBS’s new restructuring division. This threatens to seriously undermine RBS’s claim that the bank’s culture has changed fundamentally in recent years, and raises concerns that the bank has merely undertaken a rebranding exercise. (Paragraph 57)
15.The length of time taken by the FCA to investigate events at RBS’s Global Restructuring Group has left those who saw their livelihoods destroyed understandably incensed. The Committee shares their concerns. (Paragraph 82)
16.The FCA is not taking enforcement action against the perpetrators of the misconduct at GRG, but this must not be interpreted as a “not guilty” verdict. SME customers were treated appallingly, and because of shortcomings in regulation this mistreatment is likely to go unpunished. The Committee views this inaction as a damning indictment of the regulatory regime and a sad reflection of its inadequacies. GRG exemplifies a regulatory framework that is failing the UK’s small businesses. (Paragraph 83)
17.The FCA itself concedes that the failures at GRG might ordinarily have triggered disciplinary action had they occurred in a regulated business. That we have a regime in place that allows this sort of behaviour to take place with impunity is simply unacceptable. The victims of misconduct—who have seen those that destroyed their businesses go unpunished—rightly expect change. (Paragraph 84)
18.Experience has shown that the justification for leaving commercial lending outside the regulatory perimeter is feeble, and it is unclear whether this issue was subject to sufficient public debate when the regulatory perimeter was first established. Many small business owners are no more financially sophisticated than everyday consumers, yet they will often be required to engage with relatively complex financial products. They may also lack the resources to purchase the appropriate advice or expertise externally. To deprive them of regulatory protection because of an assumed universal sophistication is wrong, and this unfairness is compounded by the fact that most SMEs are unaware of the regulatory position. In addition, the interconnection between personal finances and business finances can mean that the potential for personal catastrophe due to SME banking misconduct is significant. The Treasury and the FCA should introduce a regulatory regime that protects SMEs. The scope of the regime must be based on an appreciation of the varying levels of financial sophistication within the SME community. This will require analysis of the financial sophistication of the UK’s SMEs that goes beyond blunt metrics covering headcount and turnover. (Paragraph 85)
19.The Committee recognises that bringing commercial lending within the regulatory perimeter will not be a ‘silver bullet’. But doing so would afford the FCA a significant amount of discretion as to how to design and implement a regulatory regime. This regime would need to be proportionate—taking account of the potential impact on the supply of credit to SMEs—and targeted at those SMEs that show the greatest need for additional protection. (Paragraph 86)
20.The FCA’s plans to drive up conduct standards in the SME lending market by using industry codes of conduct will not provide SMEs with the protection they need. The idea is untested and, as Andrew Bailey acknowledges, industry codes do not have a track record of success. Firms cannot be compelled to sign up to voluntary codes of conduct, and the FCA’s initiative may lead to these codes being watered down if they are drafted in the knowledge that they may be enforced against in future. (Paragraph 87)
21.Mr Bailey told the Committee that if the initiative does not work, the regulatory perimeter will need to be reconsidered. The Committee considers it unwise to take a ‘wait and see’ approach; the authorities should get on the front foot by taking action that they know will provide adequate protection to SMEs. It is clear that extending the regulatory perimeter is now necessary. Waiting for another high-profile misconduct scandal before pursuing it would be irresponsible. This episode has raised wider questions about the perimeter of regulation, which the Committee continues to consider. (Paragraph 88)
Redress
22.Providing more small businesses with access to the Financial Ombudsman Service is a sensible step. However the Committee was concerned by the timeline for the change originally proposed by the FCA, and was unconvinced that the necessary due diligence regarding the Ombudsman’s readiness and capability had been undertaken. (Paragraph 131)
23.The FCA has extended the timeline, with widened SME access to the FOS now expected to take effect from April 2019. Nevertheless, this leaves less than six months for the FOS to build the specialist unit that will be responsible for handling SME complaints, and to establish, from scratch, a wide range of proposed auxiliary tools and resources that will support that unit. By his own admission, Simon Walker’s proposals to build this new capability within the FOS by the second half of 2019 are “extremely ambitious”. This, coupled with concerns raised by many stakeholders regarding the Ombudsman’s effectiveness in dealing with its current remit, threatens to undermine the proposal. Providing wider access to an Ombudsman that is under-prepared and under-resourced will yield little benefit. (Paragraph 132)
24.Larger SME disputes are likely to be more complex and of higher value, and thus more challenging to resolve. Building the necessary capability at the FOS will be a significant task necessitating extensive training and recruitment, as well as the development of procedures more suited to this kind of case. Lessons must be learned from the serious problems caused by previous large-scale organisational change at the FOS, and both the FCA and the FOS must take ownership of this initiative. The Committee will continue to hold both to account throughout the implementation process. (Paragraph 133)
25.The FCA should set out, as a matter of urgency, how it has satisfied itself that the FOS will be appropriately resourced to handle larger SME disputes from April 2019 as proposed. It should not hesitate to extend the timescale for implementation if it has any concerns surrounding the FOS’s preparedness. If the timeline for implementation is pushed back, the FCA should ensure that complaints made on or after the original implementation date of 1 April 2019 are eligible for consideration when the changes do take effect. The FCA should also take this opportunity to reconsider the FOS’s funding structure in light of the concerns raised by Richard Lloyd. (Paragraph 134)
26.Expanding the remit of the FOS, as proposed by both the FCA and Simon Walker, will still leave a gap in the market for dispute resolution. Larger, more complex SME disputes will be either ineligible or unsuitable for the Ombudsman, yet those bringing these disputes may lack the resources required for litigation. The Committee believes that a Financial Services Tribunal is required to handle these disputes, and that such a body would usefully complement the expansion to the FOS’s remit proposed by the FCA. (Paragraph 135)
27.Simon Walker’s review concluded against the creation of such a Tribunal. Instead, Mr Walker favours increasing the voluntary jurisdiction of the FOS such that businesses with turnover up to £10 million would be eligible. Mr Walker also proposed, in time, increasing this threshold to something considerably higher. The Committee does not believe that the Ombudsman is the appropriate forum for the resolution of disputes of this nature. The Committee has well documented reservations about the FOS’s current effectiveness and capabilities, and is of the view that broadening its remit well beyond what the FCA is already proposing would be unwise and potentially damaging. Separately, the Ombudsman’s powers and procedures are unlikely to be appropriate for the resolution of large and complex cases. The Ombudsman lacks the power to take evidence under oath, compel the attendance of witnesses, or test evidence by cross-examination. (Paragraph 136)
28.One of Mr Walker’s arguments against the establishment of a Financial Services Tribunal is that its creation would require primary legislation, and that getting legislation through Parliament during and immediately after the UK’s withdrawal from the European Union will be difficult. The Committee does not accept this. Parliament must always make time for initiatives of such discernible importance. There is strong cross-party support for the creation of a Financial Services Tribunal and the Government must not be hesitant when it comes to bringing forward the appropriate legislation, even at a time when there may be other significant demands on parliamentary time. (Paragraph 137)
29.The Committee therefore recommends that the Treasury brings forward proposals for the creation of a Financial Services Tribunal. This must be accompanied by an amendment to s138D of the Financial Services and Markets Act 2000 to enhance the legal rights of SMEs. The Treasury should also consider drawing upon the expertise of the Law Commission to aid its consideration of this issue. Taken together, these changes will ensure that the UK’s small businesses will no longer be denied justice, as so many have been in the past. We must introduce a system for dispute resolution and redress that gives the UK’s SMEs the confidence to engage with financial services providers, safe in the knowledge that they are not vulnerable to exploitation and mistreatment. (Paragraph 138)
30.In response to previous instances of mistreatment of SMEs, the FCA has worked with banks to establish ‘ad hoc’ voluntary complaints and redress schemes. It is very hard for the Committee and the wider public to have confidence in such schemes, when their design and operation is ultimately at the discretion of the banks responsible for mistreating their customers. The Committee agrees with Andrew Bailey, Chief Executive of the FCA, that the deficiencies of voluntary redress schemes serve to highlight the need for standing complaints and compensation arrangements for SMEs. (Paragraph 139)
31.The Committee recognises that the formal powers of the FCA to secure compensation for SMEs are limited, even when regulatory requirements have been breached. However, it considers that the FCA could in some cases have taken a more robust approach to the design and operation of redress schemes. In particular, it is disappointing that Mr Bailey defended RBS’s decision not to submit consequential loss claims in the GRG complaints process to independent oversight. RBS took great comfort from the Mr Bailey’s endorsement of its stance; and it was only following sustained pressure from the Committee and from the Economic Secretary that it finally reversed its position. It would have been preferable had Mr Bailey used the opportunity created by the Committee’s interest in GRG to get a better deal for SMEs. (Paragraph 140)
32.More generally, it is concerning that, under existing law, the FCA cannot respond to a breach of its regulatory requirements by establishing an industry-wide redress scheme for SMEs. This inability to act in response to demonstrable misconduct has damaged trust and confidence in the regulator. At the next opportunity, the Financial Services and Markets Act 2000 should be amended to allow the FCA to establish industry-wide redress schemes for incorporated businesses that have been affected by a breach of regulatory requirements. (Paragraph 141)
33.The Committee has little confidence that Clydesdale’s review of Tailored Business Loans provided appropriate compensation to all those who were mis-sold these products. It is surprised that the FCA appears to have had such little involvement in the design and operation of this scheme, given that the concerns around poor sales practices were acknowledged to be analogous to those that existed in respect of ‘standalone’ IRHPs. (Paragraph 142)
Published: 26 October 2018