Beyond the Banks: Lending for growth

Simply bashing the same old banks as we have been doing since 2008 will not do, says East Surrey MP and entrepreneur Sam Gyimah. He writes that innovation and competition in banking is needed to improve SME access to finance.


Simply bashing the same old banks as we have been doing since 2008 will not do, says East Surrey MP and entrepreneur Sam Gyimah. He writes that innovation and competition in banking is needed to improve SME access to finance.

Simply bashing the same old banks as we have been doing since 2008 will not do, says East Surrey MP and entrepreneur Sam Gyimah. He writes that innovation and competition in banking needed to improve SME access to finance.

The report produced by the Independent Commission on Banking is a welcome step forward in our recovery from the financial crisis of 2008.

Ring-fencing the banks’ retail operations, appointing independent boards and demanding capital cushions of up to 20 per cent are exactly the sort of solutions we need to consider if we are to restore confidence in the banking sector.

For this reason it comes as no surprise that Sir John Vickers’ recommendations have been welcomed across the political spectrum. The report has rightly focused on the protection of the taxpayer, but on the issues of competition and innovation to get credit flowing Vickers doesn’t go far enough.

The flow of credit

As the Bank of England has reported, businesses are still struggling to secure credit. And this is a real problem as far as growth and jobs are concerned. So what are some of the problems that could be addressed to get credit flowing again?

Firstly, there is too little competition and too much concentration in the banking sector. The five largest banks have had a 90 per cent share of the market for the best part of a decade.

More than a quarter (26 per cent) of the small business banking market is controlled by RBS alone – so why would they want to increase their share in a low profitability business segment?

Given that businesses generally struggle to get loans from banks other than their primary one, this concentration and lack of competition hinders the flow of credit. A good business that has a credit facility with a bank will invariably have limits placed on the facility.

Once they hit these limits, securing additional credit becomes difficult and the consequence of this is that firms may decide not to open a new factory or take on additional staff, which are the investment decisions we needs companies to be making to drive growth.

Even if a business wanted to shop around for credit, the lack of transparency in banking services poses a significant hurdle. From arrangement fees to monitoring fees to APRs or the length of time it takes to process a loan – nothing is clear. The only thing you can be certain of in a banking relationship is the amount of time your bank manager will invest in trying to sell you insurance and other high margin services such as foreign exchange.

This may have something to do with the lack of profitability of basic banking operations as mentioned earlier (estimates for the return on equity are around 6-8 per cent), which in itself highlights why we need disruptive innovation in the banking sector – to increase competition and drive down costs. Simply bashing the same old banks as we have been doing since 2008 will not do.

So what can be done?

Selling 600-odd Lloyds branches to a new challenger, as Vickers envisages, would be a great first step to boost competition. Furthermore, the government could make it easier for new entrants like Handelsbanken. The Swedish bank offers a unique proposition to clients through a more traditional model of banking in which decisions are taken at branch level, and not left to the computer to say ‘no’.   

The question is whether demanding a greater capital requirement from retail banks as the ICB recommends will make it harder for new entrants to come into the market.

Secondly, we need to create the right environment for new, currently unregulated business models such as that of Funding Circle or Market Invoice to flourish and develop. Admittedly, these models are in their early stages, but they provide an innovative alternative that could receive greater support from the Government, in a similar manner to US President Barack Obama’s measures to boost crowdfunding in the US.

Thirdly, we need to look at diverting available pools of capital towards lending to businesses. At the moment, there are very few opportunities for retail investors to invest in unlisted, unquoted instruments.

And yet the early evidence from the likes of Funding Circle is that there are investors out there who would prefer the 8 per cent return on lending to small businesses to the 1 per cent they currently receive through savings accounts.

The logical extension of this idea is to create a bond market for SME’s. These are already active in Germany, and with a due diligence and listing process appropriate to small business there is no reason why the UK cannot profit from this example, as Anthony Hilton of the Evening Standard has argued recently.

Finally, innovation from data-mining companies, credit reference agencies, or new players like Funding Options could help standardise the process of evaluating the credit risk of a business, and help draw different players into the lending market. Simply put, the more standardised and straightforward it is to get accurate and up to date data on a business, the easier the evaluation of credit risk.

There is no silver bullet to the funding issue. The government has provided a lot of support on the equity side, by relaxing the rules around EIS, setting up the Business Growth Fund, and raising Entrepreneurs’ Relief.

I suspect there will be further measures in the Chancellor’s autumn statement, but more could be done to change the nature of the game when it comes to debt funding. We cannot be reliant upon five banks that need to recapitalise themselves to fund our growth.

This is why I have launched, in partnership with NESTA, a consultation entitled ‘Beyond the Banks: lending for growth’, to come up with proposals on alternatives for bank lending that the Treasury could implement. I would welcome any comments or suggestions.

Todd Cardy

Todd Cardy

Todd was Editor of GrowthBusiness.co.uk between 2010 and 2011 as well as being responsible for publishing our digital and printed magazines focusing on private equity and venture capital.

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