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The bigger, the better. That seems to have been the message coming from the banks in recent years as they assess corporate customers for credit. While companies of all shapes and sizes have found it harder and more expensive to obtain loans than before the financial crisis, it is the small business market where problems have been most severe.
Larger businesses have hardly avoided the credit squeeze – the most recent data from the Bank of England show that overall business lending fell by 3 per cent in February compared with a year earlier. But industry experts say mid-cap companies – those with annual revenues of up to £500m – have not had such a torrid time.
“The sharp pullback from lending has been less acute for medium-sized companies,” says Matthew Fell, director for competitive markets at the Confederation of British Industry, the business lobby group. “Banks do not view them as such a credit risk, although there are still constraints.” Generally, banks see bigger companies as a safer bet as they tend to have more established track records, reliable profit streams and larger pools of assets that can be used as collateral.
Nevertheless, groups such as the CBI stress that more needs to be done to stimulate the growth of these companies, which they say are crucial to finding a route out of recession.
“The government could act as a change agent here – it needs to look at how it can do more,” adds Mr Fell. “Compared with [small and mid-sized enterprises] the solutions could be a bit different – making some forms of equity finance more attractive, and increasing access to capital markets. To get growth going they need to be unlocking new forms of finance.”
Research from the CBI estimates that medium-sized businesses with turnover up to £100m could contribute up to £50bn to the British economy by 2020. While they only account for 1 per cent of UK-based firms, they generate 22 per cent of revenue and 16 per cent of employment, it says.
However, compared with similarly sized companies in other markets, UK mid-caps make a smaller contribution to the economy. In Germany, they provide twice the number of jobs, according to the research, while those in the US and France also yield a higher share of employment.
Experts warn that efforts by the UK government and policy makers to bolster lending to smaller companies, while also creating an attractive trading environment for larger FTSE-listed businesses, has meant that those in the middle have often been overlooked.
Part of the reason for the fall in lending is increasingly onerous financial regulations hitting UK institutions. Banks now have to hold far higher levels of capital and liquidity on all loans – although the rules are most strict for lending to smaller companies. They argue this in turn makes it harder and more expensive to lend.
Also, analysts say relations between lenders and their customers have broken down, as banks have moved to centralise decision making, taking it away from local branches in an attempt to make the application process more efficient.
This trend did not have much of an impact in the years leading up to the financial crisis, when most customers would have their loans approved.
But since the crisis, this model has compounded banks’ reluctance to lend as it makes it harder for them to gauge the risk posed by a particular business. Handelsbanken, the Swedish bank that has more than 100 branches in the UK, allows its local managers to make about 95 per cent of lending decisions, but this model is rare. Typically banks make such decisions at head office, prompting criticism that those involved do not have a good understanding of their customers.
BoE figures show that net lending to businesses in the UK has been negative since 2009. In February this year it was at its lowest in almost two years. This fall is generally pinned on a combination of lower supply, as banks rein in risk and rebuild capital buffers, and a fall in demand from businesses jittery about the economic outlook in the UK and eurozone.
“Medium-sized firms are no different to others in terms of uncertainty in the economic outlook being the biggest brake on demand,” says the CBI’s Mr Fell. “The number of companies deciding not to apply for loans is creeping up.”
Banks stress that acceptance levels on business loans are similar – if not slightly higher – to those before the crisis. They say fewer businesses are requesting finance as they move to take a cautious stance, by repaying debt and hoarding cash, given the uncertainties in the market.
However, critics say this reluctance is largely down to higher costs and the tougher terms and loan conditions that banks are imposing in some cases. Borrowing costs are under pressure from both the eurozone crisis, which is making funding more expensive for banks, and structural changes such as tougher regulatory requirements. Consultants say that, as a result, it is more crucial than ever that companies who do apply for loans ensure they have a strong and viable business case.
“It is easier for mid-cap companies to get credit as they should have a large enough balance sheet so banks can lend against their assets,” says David Sayer, a partner at KPMG, the accountancy firm. “But they have got to make sure the banks understand their business and are kept informed of their plans.”
Mr Sayer says that to have the best chance of securing finance, businesses should produce clear cash flow forecasts and explain to banks what the key swing factors are.
“They must deliver on promises,” he stresses. “Businesses endlessly overpromise and under-deliver. They should think through exactly what their borrowing requirements are and explain the key assumptions they are making. If funds don’t come in, banks can then understand why.”
The government has taken some steps to boost lending to mid-cap companies. It set lending targets for the five largest banks last year. These targets covered total business lending, which the banks met, as well as lending to smaller companies specifically, which they did not.
The Business Finance Partnership, a scheme announced last year, is aimed at boosting the supply of credit to medium-sized companies. Through this the government plans to invest £1.2bn alongside a number of selected partners from a shortlist that includes M&G Investment Management, the fund manager, Cairn Capital, the hedge fund, and some smaller debt specialists. It will essentially match the funding of these investors. This will then be lent directly to businesses with a turnover of up to £500m. The aim is to help companies that are too large to qualify for other credit schemes but too small to have easy access to capital markets.
Experts say any real improvement in lending must be rooted in a change in the supply of bank credit. This will require a significant return of confidence to the broader economy, which few are forecasting any time soon.
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