William Tebbit, Co-Founder and Commercial Director of Trade Finance Partners
On 2nd December the Bank of England announced a further extension to its Funding for Lending Scheme (“FLS”) taking it through to January 2016; the focus is lending to SMEs. FLS, launched in July 2012 was a flagship scheme targeted at getting liquidity into the economy to assist with driving the recovery by providing cheap funds to banks for onward lending to business.
Whilst we should all support efforts to assist the SME sector in particular as it employs over 40% of the UK work force I find it very hard to fully support such an ill thought through scheme. FLS is a scheme designed to address a political problem and not to provide a workable solution for the real world. FLS is the Government’s way of shifting the responsibility for funding for businesses into the banking system. By providing cheap money to banks you do not ensure this gets delivered to where it is needed; however what you actually do, is shift the responsibility and achieve your political objectives. You can see the thought process: “We the Government have provided cheap money to banks to ensure that if they can’t get the money to businesses, it is their entire fault”. Sadly this has become a tactic of Government of whichever political persuasion since the early 1990’s. Nobody likes to take responsibility for delivering real solutions; a sound bite is quicker and easier to Tweet.
The key problem with FLS is that there is an assumption that lending is the answer to businesses and in particular SME’s problems. This is a gross simplification of the problem; businesses need working capital which may or may not be provided by debt. It can also be through equity or cash generated by business activity. Fundamentally debt is secured against assets; equity is provided in return for a share of the profits. It follows therefore that if a business doesn’t have any assets it is unlikely to be able to borrow debt. This fundamental point seems to have been overlooked or misunderstood by the designers of FLS.
Banks understand the criteria for lending. If you look at the websites of the various banks that participate in FLS you will find that in the terms and conditions it says (basically) that “our usual lending conditions apply”. That means if you don’t have assets and or security we won’t lend to you. So the banks take cheap money from The Treasury and lend it to businesses that they would have lent to anyway; not the smartest use of our tax receipts!
This has the effect that businesses that have either used all available security or do not have security can’t borrow money from banks; however cheap it is. The problem is that growing businesses tend to have future earnings which haven’t turned into profits and therefore flowed through to the balance sheet. What that means is that new young and growing businesses tend not to be suitable for lending. These are exactly the businesses that have the potential to drive the economy out of recession. Don’t forget 40% of all those employed in the UK work for a business with less than £25m revenue. So what on earth possessed somebody to think that FLS was ever going to address the needs of growing businesses?
It is always easy to pick holes in other people’s ideas; it is less than helpful however to leave it at that. Businesses that require additional funding cannot expect a single source to satisfy all their needs. Smart business owners need to act smart; they need to understand the multiple sources of funding that are available to them. This will include the participants in the “New” Alternative Finance market place and also traditional and under used sources of working capital finance such as Trade Finance. Trade Finance in particular when offered in a traditional way can be very useful. Rather than lending it is offered as funding for confirmed orders. It is off balance sheet and can therefore fund future orders prior to the creation of a receivable. Invoice discounting and factoring whilst a huge market really only advances payment for goods already invoiced; it does not fund the purchase of those goods prior to delivery. Many businesses believe that they should be able to access debt; however they are frequently failing to price the risk. All funding has a cost which should reflect the risk of the transaction. One of the issues facing business people is that debt, if accessible, is priced at historically record low rates. However this price often does not reflect the level of risk that a lender is being asked to take. It is therefore essential for the business owner to understand the risk and be able to price that risk. Unsecured lending will be considerably more expensive but is more likely to be available as its pricing is more likely to reflect the risk. Again business owners must do more to understand the sources of funding available and not solely seek to rely on the banks to lend into situations where they simply can’t do so.
The creators of FLS should in my opinion have looked further into how businesses fund themselves right through the supply chain. If they had done so they would have understood the importance of credit insurance to SMEs. They would also have realised that the market had contracted and that the lack of availability of credit insurance has had a huge impact on risk for SME’s. It would appear that had some of the cheap money offered to banks been made available for credit insurance then it is highly likely this would have had a more immediate beneficial effect on economic activity. This perhaps goes to root problem with FLS; it was designed to solve a political problem rather than address the real issues in business.