Why do banks refuse lending to SMEs?
Although we are now almost 4 years after the beginning of the credit crunch, banks are still working hard to repay their maturing liabilities. This proves to be a challenge as the global recession means that not many institutions, perhaps except the government, have the ability to inject liquidity into the banks to keep them running. With little cash to spare, banks’ lending ability decreases, affecting their risk appetite and deterring lending to investments which banks deem as “risky”.
The credit squeeze meant that small businesses which lack the equity to back their borrowing became the first in the chain to get hit, and were forced to find alternative financing options such as [[invoice discounting]] and [[factoring]]. In fact, the invoice discounting sector has been doing counter-cyclically well. But still, it was not surprising to see that net lending contracted by 6% annually, and that the Project Merlin lending target was missed by 11%.
What are the implications?
The contraction in net lending resulted in many businesses being left undercapitalised, affecting not only the firm operations but also hindering expansion plans. The counter-cyclical performance of invoice discounting highlights the mismatch between the banks’ risk appetite and SMEs’ perceived risk profile.
The UK economy, especially SMEs are experiencing funding gaps, which negatively affects growth prospects. Businesses whose owners do not have assets to backup the early stage loans could never take off with their plans. Prior to the financial crisis banks were considerate and understanding regarding proposed business plans, however, following the credit crunch, banking institutions have ceased lending to small start-ups as they regard it as too risky.
Businesses with slow growth face another funding gap. These small firms, such as small fast food outlets or small chains of bookstores, are refused from borrowing money. Paradoxically, these are the businesses that form the backbone of our economy and are essential to our economic recovery. However, due to their slow growth profile, banks and venture capital institutions would prefer flushing cash into high growth companies that are already on a skyrocketing trajectory.
So, what now?
What banks only need to do is to be consistent with what they have been doing for decades –to support the SMEs that form the economic backbone of our very economy. The sad truth is that this Utopian scenario is simply too idealistic, given what banks are facing: balance sheet adjustments, regulatory caps, and with the looming prospect of the Eurozone crisis, it is increasingly unlikely that the situation can be resolved anytime soon.
Luckily, financial innovation has brought SMEs new financing options, such as peer-to-peer lending and [[invoice auction|invoice auctioning]]. Being Internet-based, these innovations are much cheaper than traditional high-street borrowing as each borrowing now involves multiple investors as opposed to just one creditor. MarketInvoice allows SMEs to auction their invoices to certified investors through the online [[Invoice Marketplace|marketplace]]. Typically, SMEs are able to secure 90% of the invoice face value upfront with [[Factoring service fees|discounting fees]] as low as 1% of face value. With handling charges of just 0.5% of face value, this is a cheap and transparent financing alternative.