Monthly Archives: February 2012

Merlin’s spells need more work – sector specfic bank lending

Project Merlin has hit the headlines again in the past few days. Despite news that all the large players (bar one) reached or exceeded their SME lending commitments under this Government deal, there still seems to be ample anecdotal evidence of unmet company need.

What’s really going on…?

One set of data that was released by the Office of National Statistics in October 2011, and referenced in the Chancellor’s Autumn Statement, is quite enlightening. It contains evidence from a Europe-wide survey comparing the financing experiences of a large sample of businesses, across a range of sectors, in 2007 and in 2010.

The headline is that demand is up and approvals are down. This is no particular surprise (though the increased demand shown in the ONS data seems a little at odds with bank surveys, which consistently suggest that companies overall are choosing to repay existing debt rather than request more). However, the scale of the change in loan approval rates for certain sectors is quite striking.

Reflecting the shape of the UK economy, the majority of the companies in the sample were service businesses. 32% of these sought finance in 2007, which grew to 37% in 2010. Of those seeking finance, the main source was bank lending. Again, so far, so unsurprising. But approval rates for bank loans to these businesses were running at 84% in 2007: in 2010 the approval rate fell to 61%.

The position for ICT businesses is worse, where demand for finance has grown more strongly (28% to 36%), and bank loan approval rates have fallen more sharply, from 85% to just 45%. And this is puzzling, when 70% of construction industry applications were still approved in 2010.

The same picture emerges on less formal lending via overdraft. 2010 approval rate for construction companies, 73%: for ICT firms, 63%. And if you are unlucky enough to be a service business looking for an overdraft, the ONS data shows that your chances of getting one in 2010 fell to a barely credible 26%.

So your prospects of bank funding seem to vary markedly by sector. Which suggests that the underlying issue may be a process problem as much as any overall lack of appetite.

After all, at the same time as banks are being told to take more risk by increasing their lending, they are also being required to strengthen their capital adequacy ratios, a message strongly backed by the Bank of England. The Basel III regulations undoubtedly encourage, and arguably compel, banks to do more of their lending to lower risk, better secured customers.

The largest single reason obtained by ONS for loan declinations in 2007, and in 2010, is lack of collateral. And what is the key difference that separates the manufacturing and construction sectors from the service and ICT sectors…?

Virtually all businesses, including manufacturing ones, have valuable intangibles which generally do not feature on the balance sheet. There are solid accounting reasons why they don’t, but the omission has the effect of making these assets not only intangible, but invisible. Trouble is, wherever these intangibles do appear in a company’s accounts, credit teams tend to attribute a nil value to them. This is a bit of a problem, considering that intangibles are the main source of corporate value and the main focus for company investment.

The ONS data seems to point to a pretty fundamental disconnect between the access to funding needed to build a successful, competitive, knowledge-based economy and the steps that have to be taken to reduce the risk of further financial shocks. It’s a dilemma that must be resolved, because as nearly all commentators agree, growth is essential if structural debt is to be reduced.

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