Where has the money gone?

If official figures are right, lending by major banks rose by almost £1bn in the third quarter. So why are small firms still struggling to raise credit? Sean Farrell reports
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The Independent Online

If Britain’s banks are to be believed, then they have never done better by their small business customers – rate cuts are passed on in full, lending is up, advice seminars are planned. Yet small and medium enterprises (SMEs) complain of draconian actions by their lenders while the Government blames the banks and piles on the pressure to make them support small companies. How can this be?

HBOS yesterday became the latest bank to announce measures to support its 180,000 SME customers, promising to maintain the link between small business overdrafts and base rate rather than inter-bank lending costs. Customers will benefit immediately from base rate cuts, the bank said, following similar announcements from Lloyds TSB and Royal Bank of Scotland, the other banks receiving capital injections from the Government.

And British Bankers’ Association figures show that lending by the major banks was up by almost £1bn in the third quarter. Yet industry group surveys show small firms struggling to raise credit or paying higher rates to refinance loans.

The Government has kept up the pressure on banks to stand by SMEs because of concern that a squeeze on the sector that makes up the majority

of the economy could force healthy firms out of business. More than 99 per cent of companies employ fewer than 49 people and SMEs account for £1.4trn of turnover, or 51 per cent of UK gross domestic product.

The Business Secretary Lord Mandelson has been particularly vocal, saying last week: “It is completely unacceptable to the Government and to business in this country for banks indefinitely to stop functioning as banks.”

The Government is frustrated because its forced recapitalisation of the banking sector – which is set to part-nationalise RBS, Lloyds and HBOS – was meant to give lenders a big enough buffer to absorb future losses and keep them lending.

The Governor of the Bank of England, Mervyn King, has voiced doubts about official lending figures and clearly believes the banks are not making enough credit available. He told the House of Commons Treasury Committee that the Bank’s agents around the country were reporting cases of businesses under pressure from their lenders. Mr King said he thought banks were still hoarding capital because financial market jitters were pressurising them to remain over-capitalised. “The single most pressing challenge to domestic economic policy is to get the banking system to resume lending in any normal sense,” the |Governor told the committee.

The Bank’s own figures in its credit trends report show that credit lines to medium-sized companies fell in the third quarter and were expected to keep dropping as the economy worsens. But Lloyds TSB says its SME lending is up 18 per cent this year, while Barclays claims loans and overdrafts to smaller companies were up 5.3 per cent for September from a year earlier. HSBC says this year’s small business lending is at similar levels to last year.

Banks do say that if the riskiness of a borrower has increased then they will insist on changing lending terms. That could mean cutting the credit available because the business is no longer viable and needs to be scaled back, or increasing the interest rate to reflect the increased chance of default.

A senior SME banking source at one of the major lenders says that what is going on is no different to what happened in previous downturns. Though companies have been dipping into their savings, the sector still has more deposits than borrowings and there is plenty of money available to lend, the source says.

“What is happening in the small business market is a textbook recession,” the source says. “The lobby groups’ members are saying, ‘The banks won’t lend to me at all’ and the banks are telling them either they can’t afford to repay and must restructure their business or they will have to pay a higher price. We are not short of capital but there are issues of pricing and the ability to repay.”

What is different this time is that many companies went outside the mainstream banking sector for finance during the long boom in easy credit. Larger SMEs and smaller corporates, turning over £15m-£20m, were sucked in to financing themselves with new debt or semi-debt financial instruments from markets that have dried up. These companies have now turned to the mainstream banks for funding but cannot fund themselves on similar terms.

Owners of smaller enterprises have taken advantage of the booming property market to release equity from their homes or borrow against their property. Small independent finance companies grew up during the debt boom, lending money to SMEs against their properties and selling the loans on in the market but their business model has gone bust. Business owners have also used their personal credit cards to finance their businesses.

“All this has gone on in a long boom and we are not in that situation now,” the senior SME banker says. If equity release remains dead when the economy starts to turn around that will be bad news because it has been an important source of funding for the start-up businesses that will emerge then.

Small businesses’ anger and the banks’ claims that they are lending more may also be explained partly by customers using more of their overdraft facilities. This adds to total borrowing but banks may also reduce the facility to reflect riskier conditions, leaving businesses short of credit they thought they would be able to use.

Michael Thommes, a corporate loan broker, believes the banks are not telling the full story and that they are happy to lend because, with competition reduced, they are able to make fatter margins, just as they are rebuilding mortgage profitability with Northern Rock and others out of the market.

“If I was a bank I would be charging a top rate as well,” he says.

Banks report a big increase in business for factoring and cashflow management services as companies find themselves short of working capital. Lloyds TSB this week highlighted the squeeze faced by SMEs as suppliers demand payment quicker and customers – including many big corporations – take longer to pay.

The Government recently pledged to pay its SME suppliers within 10 days and banking sources suggest that after weeks of bank-bashing it might be the turn of the bosses of Britain’s big corporates to be hauled into Downing Street and told to do likewise.

The Chancellor, Alistair Darling, has demanded figures to show what is really going on with SME banking. The picture is complex but with the recession only just beginning the pressure for banks to support Britain’s all-important small businesses will not go away.