Winkling out the shy money

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The Independent Online
Is there a financing gap? The financial services industry has been criticised for at least 100 years for failing to provide sufficient funds for industrial investment. Writing in 1880 of the railway boom earlier that century, Benjamin Disraeli pointed out: 'What is remarkable in this vast movement is that the great leaders of the financial world took no part in it.' So in a way the identification by Stephen Dorrell, Financial Secretary to the Treasury, of five areas of weakness is one more example of politicians worrying that finance was not somehow doing a proper job. The railways, after all, were built.

But it would be wrong to dismiss the concerns. Mr Dorrell's points, made in a speech on Wednesday to the CBI, are derived from a wide-ranging Treasury review which has been looking into the provision of finance for business. The five points are: manufacturing's small share of the economy; an underdeveloped medium- sized business sector; difficulty in raising capital for high-technology start-ups; high dividend pay-outs; and little 'relationship finance'.

The point about manufacturing should be set on one side, for whatever view one takes on the pace of deindustrialisation, this is a process that is taking place in all the Group of Seven economies - in fact it is now probably happening faster in Germany and Japan than it is in Britain or America. High dividend pay-outs, too, can be set aside, for there has been considerable criticism of dividend policy in the City itself and there are now signs that companies are adjusting their policy simply because the investment community can see through inflated payments.

The other three points need further discussion: the shortage of middling-sized firms first. We are certainly unusual in the dearth. We have a large number of giant corporations and many business start-ups, but not so much in the middle. Whether this is the result of some deficiency in financial services, though, is not so clear.

There are several questions. In the case of family-owned businesses, why do the families sell out? Maybe, given taxation, this is the only way of releasing capital. But other countries' tax systems are not so different.

In the case of public companies, it may partly be that takeovers are too easy, or that the high proportion of company shares that are controlled by large financial institutions encourages concentration in industry too. Maybe we need more medium-sized financial institutions if we want more medium- sized companies.

Evaluation problem

Difficulty in getting finance for high-technology start-ups is a commonly voiced criticism. We have a lot of start-ups, but few high-tech ones. But this criticism always runs into the response: the risk/reward ratio in high-tech start-ups is very unattractive. A pat explanation would be that people interested in high-technology are not usually very interested in making money, while people interested in making money are not usually very interested in technology. But there is also surely a problem of evaluation. UK financial institutions are brilliant at judging issues like country risk, but not good at evaluating high-technology.

Finally, 'relationship finance'. One issue here is whether companies really want it. They want relationships when things are going badly, but when business is going well many prefer to split their business among several banks, making them compete on price. In fact, the banks have probably been better at nursing the casualties of this recession through their intensive-care units than they have in previous recessions. But that is not an argument for encouraging bankers and their customers to seek a longer- term relationship, simply because it makes good banking sense.

The report card on these three areas of concern, then, is: should try harder. But there are surely other weaknesses in our financial system which Mr Dorrell did not mention and which deserve at least as much attention as the ones he did. Here is one in particular: the 'granny gap'.

This is the difficulty many small businesses have in finding equity finance. These are companies seeking perhaps pounds 50,000 or so of risk capital - the sort of sum that might in an earlier generation have been supplied by family funds, and is supplied by family funds in some of the immigrant communities and in the developing economies of East Asia.

Plenty of businesses need this sort of money, and there are plenty of individuals would would like to risk it. The problem is that administrative costs make it impossible for conventional financial institutions to act as intermediaries. The BES schemes might have done the job, but became a tax loophole.

One partial solution has been suggested privately by Peter Burt, chief general manager of Bank of Scotland. This would be a Small Business Equity Scheme, which would allow people to invest a relatively modest sum, say pounds 5,000 a year, in a business. There would be tax incentives to do so, but the modest amount of the subscription would limit tax avoidance.

That is not necessarily the right formula, but it is one ingredient for the stock pot. There is some kind of financing gap. We do not really know what will best fill it, so we ought to try lots of solutions.

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