The alternative finance sector has made leaps and bounds of progress in the last few years. It is encouraging to see that the role of SME finance in the economy has come to the forefront of political debate. At this time it would be interesting to see how the Government is helping small businesses. Yet first we must discuss why this is the case in the first place.
Why do SMEs require help?
Although the extent is highly debated, small and medium sized enterprises have complained that they struggle to access the funding they need from traditional sources such as bank loans. Project Merlin figures released in February seems to corroborate this fact.The statistics revealed that banks had collectively undershot the agreed target when the Government launched the scheme by just over £1 billion. The target was £76.4 billion to be lent to SMEs over 12 months.That said UK banks still lent £74.5billion to SMEs last year, which is still a very good figure.
What has further compounded the perceived current lending problem for SMEs is the Basel III agreement. The 2008 financial crisis unleashed a swathe of new regulations on the financial sector, most of which will rank far down the list of concerns of the average small business owner or the accountants who advise them. The aim of these regulations is to shield the economy from similar global crises in the future.
Of all the new regulations that emerged,Basel III in particular poses a threat to SMEs. The directives require an increase in the size of the equity a bank holds relative to the value of the loans they issue, and a much more formalised assessment of any risks. In short banks are encouraged to hold more capital (increasing the minimum loan to equity ratio to around 4.5%) and therefore lend less. Loaning to SMEs is weighted as relatively high risk; and thus, when combined with rising capital requirements and turbulent capital markets, may result in a disproportionately high cost of capital for banks when lending to such small businesses and a gradual shift of their entire business models away from SME lending. Unfortunately this is quite the reverse of what SMEs need to grow and expand.
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The Eurozone crisis has not helped business confidence in the UK particularly either. The IMF’s recent analysis of Europe’s largest banks has shown that these institutions are looking to shrink their balance sheets by $2.6 trillion over the next 18 months. Balance sheets need to shrink but what is not good is a synchronised and extensive deleveraging that could lead to further financial instability and weaker growth in Europe.
So what does this mean for small and medium sized businesses? The bulk of the deleveraging it is assumed will occur through asset sales, rather than a drop off in lending. Although this does mean that the credit supply is still shrinking and thus limiting lending for UK businesses.The report by the International Monetary Fund highlights that SMEs who rely too much on bank lending may be badly affected by bank deleveraging. This begs the question that maybe traditional bank finance is not really the most appropriate method for start-ups and early stage companies to use.
It would be unfair to blame the banks for problems across the whole macroeconomic plain. It must be understood that banks are in a period of retrenchment; ‘bashing the banks’ is counter-productive when talking of SME lending. There is no silver bullet to SME finance.
How is the Government helping small businesses?
The Government has pinpointed the need for a strong small and medium sized business sector, to help the economy grow. Commentators have described SMEs as the ‘lifeblood of the economy,’ which is certainly a good sound bite. Small businesses account for nearly half the country’s GDP and employs 60% of the workforce.
One announcement that thrilled us here at Market Invoice is that the Government has committed to allocating £100 million to invest through non-traditional channels and platforms.The fact that alternative financing options were even mentioned in the Budget is really encouraging and shows that a significant proportion of British businesses want to grow and create jobs, but are not being satisfied by the current range of traditional banking products.
The Chancellor also used the Budget to launch the National Loan Guarantee Scheme. The NLGS will guarantee £20 billion through bank loans to small and medium businesses. The scheme will help businesses access cheaper finance, by reducing the cost of borrowing. This is a step in the right direction for small businesses as it looks like the Government are trying to get banks to start lending to more SMEs, however this is not much help if the majority of small businesses can’t get the bank loan approved. The minimum loan value is £25,000, a ceiling that has alienated many small and medium sized enterprises.
The Enterprise Finance Guarantee (EFG) is a loan guarantee scheme intended to facilitate additional bank lending to viable SMEs lacking adequate security for a normal commercial loans. The reforms to the EFG announced by the Chancellor will make it easier for SMEs to access guarantees. The reform sees the Government acting as guarantor for bank lending and thus giving credibility to small business loan applications. The EFG is designed to help lend to viable businesses with an annual turnover of up to £41million and seeking loans of between £1,000 and £1million.
Is alternative finance the key?
It was announced at the end of May that a number of alternative funding platforms including Market Invoice will be competing for the afore mentioned Government investment of up to £100 million. We ourselves are applying for £30 million of this inviting bounty in order to improve our alternative invoice finance solution platform.
The biggest barrier for small business owners embracing alternatives is awareness, so while this investment is fantastic, the industry receiving acknowledgement from the Government will lead to huge returns in the future. We are looking to reset the funding landscape –there is plenty of market share to go around. One cannot be over critical of the banks it is detrimental to the financial lending cause and more than that it is important that there is a link between new and traditional lending models – a good dialogue to ensure business owners can find the right type and source of finance for their individual needs.
The Next Generation Finance Consortium was also established to create a link between new and traditional lending models to ensure business owners can find the right type and source of finance for their individual needs. The Next Generation Finance Consortium also aims to liaise with Government bodies and other organisations to lobby for support on key issues relating to SME finance. As quoted in the Breedon Report for alternative methods of business funding, there is no silver bullet to solve the SME liquidity problem, even in the sphere of alternative finance there are so many options that a start-up may want to consider. From P2P lending, to debt-for-equity and, of course, invoice finance, SMEs will need to look at their business model and see how they can work with non-traditional bank lending.
There is definitely a clear role for Government in helping to educate business owners to the new emerging alternatives across the financing spectrum.The Government cannot be relied on all the time however and the onus is on bodies like the Next Generation Finance Consortium to give advice and provide insight into the best course of action that a small and medium sized enterprise can take when it comes to traditional and alternative finance.