Small and Medium-sized Businesses: Access to Finance

Viscount Hanworth Excerpts

Thursday 30th January 2014 Lords Chamber

[Viscount Hanworth (Lab)]

My Lords, small and medium-sized enterprises, SMEs, depend mainly on commercial banks to provide finance via loans, overdrafts and credit cards. According to the evidence from a National Audit Office report, lending to SMEs was negative in almost every month from June 2011 to August 2013, which is to say that, during the period, adequate finance was not forthcoming from the banks. We are told that 37% of SMEs use no external finance. More of them use credit cards or overdrafts than loans. Loan rejection rates in the UK are around twice those of France and Germany and, of those SMEs whose loan applications are rejected, 70% can find no alternative sources of finance.

The present dearth of financial support is undoubtedly a consequence of the need of our large banks to reduce their leverage—they have been endeavouring to improve their reserve ratios by limiting their lending. The manner in which they are doing this has caused acute distress among many small enterprises. A recent edition of the BBC’s “File on Four” radio programme, “Default by Design?”, bore witness to this. The programme focused its attention on the practices of RBS, the Royal Bank of Scotland, 80% of which has been in public ownership since it was rescued from insolvency. The Tomlinson inquiry, which was briefed by Vince Cable to investigate the practices of the bank, has alleged that it has been sinking good businesses so that it can profit from their demise. The BBC programme provided evidence to substantiate this allegation, and some startling malfeasance was revealed. A subsidiary agency of the bank was able to acquire the assets of businesses that had been driven into financial difficulties by the effect of the interest rate swaps that the bank itself had foisted on the businesses.

Modern bankers deal with small businesses in a manner that differs markedly from traditional practices. Banks have become increasingly remote from local industry and commerce. In the past, a bank manager would be expected to have an intimate knowledge of his business clients and of their enterprises. Within our lifetimes, the number of private clients of banks has increased dramatically, but nowadays they are dealt with, not on a personal basis, but on a statistical or algorithmic basis, and the same methods are applied to small businesses. The algorithms of banking have two aspects. On the one hand, there is the matter of global resource allocation, which determines the size of the funds that are available for lending, as well as the threshold of creditworthiness. The second aspect is the assessment of the creditworthiness of the potential borrowers, which is also described as their default risk.

A callow young manager can nowadays handle the essential decision in respect of a loan application by a small business in a seemingly objective manner that requires no expert knowledge on his part. The decision depends on a credit score that is formed from an additive combination of measured attributes, both numerical and categorical, that are recorded in a computerised database. The aggregate score is compared to a threshold value, and the request for a loan is granted only if the threshold is surpassed. The typical basis for such decisions is a statistical analysis that covers a large sample of cases. This is a decidedly obtuse way of going about the business.

It is an undoubted statistical fact that a large proportion of start-up businesses are bound to fail. On the other hand, it is among such businesses that the most dynamic elements of a developing economy will be found. It used to be the task of a bank manager to exercise his judgment in discriminating between the businesses that would be viable and those that were bound to fail. The effect of the algorithmic approach is to deny funding to the majority of start-up enterprises on the grounds of the high rate of mortality of the group as a whole. This is profoundly injurious to our future prosperity and to the prospects for employment.

Another dire consequence of the modern approach can arise when, on account of a need to reduce its leverage ratio, a bank such as RBS decides to heighten the threshold that is applied to credit ratings. A group of businesses will then become liable to have their loan facilities withdrawn. It seems that RBS is far more adept at driving its decisions to foreclose on such businesses than it is in assessing their true prospects.

A hit squad called the Global Restructuring Group resides within the bank. The group is intended ostensibly to get businesses back in shape by providing helpful advice and, possibly, by restructuring the loans. Its true purpose seems to be to foreclose on those businesses in a manner that will be most profitable to the bank. This is the kind of abuse that the Labour Party has in mind when it calls for the restructuring of banks and the establishment of new banks to compete with the existing ones.