Finance for growth
Since the financial crisis and subsequent economic downturn, one refrain has been persistent in political and popular discourse: economic recovery would speed up if only banks lent more money to small businesses.
In fact, as a new Demos Finance report shows today, this argument is not only wrong, but it is also sucking up valuable political energy – not to mention funds – that could far more valuably be directed at initiatives that could really ignite growth.
Our report – Finance for Growth – challenges the claim that businesses are being starved by a lack of bank lending by looking in detail at the small and medium sized business (SME) sector, at the loan application process, and at the companies that drive growth. We found that almost half of small businesses do not – and never plan – to borrow, while those who do seek credit are approved.
The report shows that just 40 per cent of all UK SMEs made a credit application in the past year, while only 1 in 25 businesses (2.4 per cent) applied and were refused. The research also finds that most refusals were because borrowers were judged to be incapable of repaying debt, highlighting the dilemma banks face over contradictory calls for them to simultaneously lend more and reduce their overall risk. As the latest figures from the Bank of England show, the government’s Funding for Lending scheme is helping people to fund mortgages, but not being used for small business investment.
Indeed, if the roots of the financial crisis lay in banks’ lending to borrowers who could not repay, it is clearly absurd to encourage anyone to take more risk by taking or providing loans that won’t be repaid. Debt is not, and should not be, the only way for companies to finance themselves – but by focusing almost exclusively on bank borrowing as the holy grail of business funding, public policy risks stifling growth itself – or of driving illusory growth by creating another housing bubble.
Instead, our report argues, we need a ‘growth-focused approach’ for business that targets companies who want to grow, and incentivises other forms of finance, such as equity investment, alongside debt.
The prevalence of ‘easy credit’ in the years leading up to the financial crash in 2008 created a culture of small businesses reluctant to seek alternative forms of equity finance. The government should act on calls by small business for fiscal and legislative reform to help create new equity markets, to address the lack of equity culture in the UK, and seek ways to encourage businesses to access other sources of investment through everything from angel investment and venture capital funds to peer-to-peer lenders and crowdfunders.
Furthermore, treating small businesses as a homogeneous group is inaccurate and unhelpful for promoting growth. The report therefore strongly urges the government to copy the Canadian model – not too tough an ask given the new Bank of England Governor – and instruct either the Bank or the Office of National Statistics to develop a reliable SME registry to plug data gaps on the number of SMEs, and establish which businesses are pursuing a growth strategy.
This would allow banks to make the most of their substantial branch networks and investor contacts to address knowledge and skills gaps in businesses. Investment would be better spent on mentoring and training for businesses, and helping them secure alternative forms of finance.
Banks have a clear role and responsibility to support the economy. But, as our report shows, we should not be bulldozed into thinking that the best way to do this is by insisting on a one-track approach that focuses on banks lending more money into a sector that neither wants nor needs additional debt. We need to encourage a different way of thinking about business finance, and work to ensure banks play their role in delivering this vital finance for genuine growth.