UK financial sector ‘failing SMEs’

The UK’s financial sector is systematically failing SMEs which could provide the greatest source of innovation, jobs and growth, according to Will Hutton of The Work Foundation.

In a paper, co-authored with Paul Nightingale from SPRU at Sussex University, he says that firms with the greatest potential for high growth are the most likely to face financial restraints on their growth. This is leading to a “discouraged economy in which innovation, investment and dynamism are stymied by a self-serving and inflexible banking sector.”

The paper calls for rigorous ring-fencing (or ideally full separation) of commercial and retail banking from high risk investment banking, along with an injection of more capital. This would change incentive structures so that supporting the UK economy, and specifically lending to innovative SMEs, becomes more attractive to the banking sector, the authors state.

They argue that higher capital ratios would lower risk premiums so that any rise in bank funding costs would be trivial and say it would create an environment where SME lending is not seen “as a consumer of scarce risk capital with a high opportunity cost of foregone investment banking opportunities”. Instead, SME lending would be a useful profit stream in its own right, competing for attention with other profit and revenue streams that all have lower returns, they say.

Will Hutton, executive vice chair of The Work Foundation, said:  “The current UK financial services sector has grown bank assets to more than four times British GDP – of which lending to UK Corporates constitutes a mere 5% of lending. Despite, or because of this growth, a key sector of the economy – the innovative British “Mittlestand” – has been under-supported. This lack of support to SMEs encourages perception among firms which should qualify for lending that they will not get credit, leading to significant numbers of discouraged borrowers, who thus don’t seek out loans. This lack of investment leads to reduced levels of innovation in the economy, creating a self-reinforcing cycle of less innovation, less investment and less dynamism. Such a discouraged economy is particularly problematic at a time when the UK needs to do all it can both to grow and rebalance its economy. ”

The paper draws on academic research and the interim findings of a survey of small firms undertaken by the Federation of Small Business (FSB) which shows that while the bulk of firms had not applied for loans, of those that did only 41% received all the funds they sought. Some 37% of the firms were turned down.

John Walker, national chairman, Federation of Small Businesses, said: “The UK’s small businesses are the country’s main source of innovation and the main route to strengthening the recovery. As experience has shown, this recovery will only happen with the help of the banks when they stop focussing on their balance sheets and start to see small businesses as a good investment.”

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