It’s time to replace the failed Project Merlin with a more radical solution to the UK’s business finance freeze, argues Barclay Lamont, who puts the case for a microfinance-based model.
Everyone realises that small and medium-sized enterprises (SMEs) form an important engine for growth in the UK. Everyone also realises that it is difficult for these enterprises to raise finance. Project Merlin was announced by Chancellor George Osborne in February 2011 with the primary objective of increasing lending to SMEs. It has been far from successful.
The main reason for this is that retail bankers don’t like lending money to small businesses: it is expensive and unprofitable. The truth is they never lent money to small business in the first place, but to the entrepreneurs themselves, taking some sort of primary security like their house. As a result most retail bankers cannot now tell a good business from a bad one.
So is the UK really open for business, or are those trying to survive in the corporate jungle constantly thwarted by the institutions that have been established to help them?
It’s no secret that for many new UK entrepreneurs, the most difficult finance to raise is the first tranche – the £5,000 to £20,000 that lets someone get a concept off the ground or rejuvenate an existing small business. The main causes are that banks are not interested and ‘friends and family’ may not have the resources.
The underlying reason that banks are not interested is the cost of due diligence. Essentially, it costs as much to vet a loan for £10,000 as it does a loan for £100,000, and the potential return on the former is tiny. This is one of the reasons Project Merlin is unfulfilled.
There is a solution to this tricky problem, however: microcredit.
The received wisdom is that microcredit doesn’t work too well in industrialised economies, though in the third world there are examples of it becoming an asset class and Mohammad Yunus won a Nobel Prize for reinvigorating the business economy in Bangladesh through microfinance. The model has two major advantages over Merlin. It costs next to nothing to administer and it makes no value judgements.
Let us propose that any respectable customer of a high street bank should have the right, without any further conditions, to take out a loan on standard terms for between £5,000 to £20,000, depending on the stage of their business (for example, start-up or mature). The customer would need to be in good standing with that bank and meet a modest set of objective criteria, but this would not be contingent on any project-related due diligence.
The bank’s loan officer would have no discretion; if the customer met the criteria, he or she would have an absolute right to a loan on standard terms. The criteria would be fact-based – say, a current account for X years, an Experian credit rating, a mortgage, whatever… The details can be worked out.
There is, however, one catch.
In return for the loan, the borrower would agree to list his or her details on a publically accessible website that would be managed jointly by the UK clearing banks. This website entry would include: the borrower’s details, email, web site and address of the business; the amount and purpose of the loan; a summary of the borrower’s performance under the loan and perhaps updates on the progress of the business provided by the borrower.
In other words, every interest or principal payment made by the borrower would get a tick; every payment missed would get a cross. There would also be clear criteria for increasing interest costs or accelerating repayment if the loan went into default or became otherwise impaired – which means there would also have to be a way for a delinquent borrower to extinguish his or her website entry by refinancing the loan on commercial terms.
The important point, in this solution, is that the website would be open and accessible to everyone. Provided that the initial criteria chosen by the bank do actually sift out the chancers and the charlatans from the upright citizens, the threat of one’s public credit rating being damaged would mean that a borrower will prioritise the service of his or her loan.
The beauty of the system for the lending bank is that the costs associated with making the loan would be trivial, meaning that the deal could be profitable even with a low interest rate.
Ultimately the site could become the basis for a more proactive business community, adopting the models established by Facebook or LinkedIn. In any event, it would serve as a modern substitute for the local knowledge bank managers used to have when they worked in communities and knew their clients. The cost of maintaining it would be negligible – it might even make money if commercial advertising were introduced.
And who knows, perhaps the Treasury could be persuaded to throw something into the pot to encourage the growth they seem so keen to engender?
Barclay Lamont is a former investment banker and has advised the government on investment matters. He is the author of the investment dictionary Lamont’s Glossary and runs several small businesses.