Warwick Business School

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2 Introduction Aims: Provide a broad overview of UKSMEF and related studies. Give my view of the key issues highlighted by these studies. Speculate on the benefits for policy makers of the Taskforce s quarterly business finance survey.

3 Aims of UKSMEF Provide benchmarking data on the availability and cost of finance to SMEs and the types of finance used. Collect information on the relationship between SMEs and their providers of finance. Develop a general purpose micro database for quantitative research on business finance (offering, for example, scope for comparisons with US business finances).

4 UKSMEF Surveys conducted on representative samples of 2,500 private sector SMEs (<250 employees) located in the UK. Public sector and not for profit organisations are excluded, together with the Financial Services, Mining and Quarrying, Electricity, Gas and Water Supply sectors (the latter due to the very small numbers in the population). Respondents interviewed in detail about: The characteristics of the business and its owner (risk profiles). Finances used/sought in the last 3 years. Financial relationships.

5 General structure of UKSMEF Business/Owner Characteristics (Risk Profile) Applicant Successful Amount, Terms and Conditions Rejected Amount, Reasons for Rejection Non-Applicant: Discouraged Borrower Non-Applicant: No Need for External Finance

6 Methodology One/two-stage telephone interviews carried out by IFF Research Ltd/Continental Research. Average interview length minutes. Sample structured to allow analysis by size, sector and region. Data re-weighted in analysis to the UK SME population (SME Statistics: DTI) Good response rates (67% in 2008).

7 UKSMEF General surveys conducted in 2004, 2007 (Cambridge), 2008 and Also spin-off surveys of Ethnic Minority Businesses (EMBs) and Social Enterprises in 2005/6. These data allow trends in SME finances to be examined over most of the last decade. The data and related reports are available from the UK Data Archive:

8 Main studies Finance for SMEs (2005) Ethnic Minority Businesses (2006). Social Enterprises (2007). Small Firms in the Credit Crisis (2009). Creative Industry Businesses (2011).

9 Key issues (summary) Demand side Financial delinquency/impact on access to finance. Financial discouragement/impact on growth. Supply side Rejection/credit crisis. Impact of rejection on growth (financial constraints). Financial relationships Switching.

10 Issues highlighted by UKSMEF: demand side Unauthorised overdraft borrowing and/or missed loan repayments (financial delinquency) have adverse consequences for future borrowing. Example from EMB study: 37.4% and 28.1% of Black African/Caribbean businesses which needed new finance experienced outright rejection. This is significantly higher compared to Indian (5.8%), Pakistani (13.2%) and White owned businesses (10.4%). However, these differences may be partly explained by financial delinquency: 18.2% of Black Caribbean businesses missed loan repayments compared with 2.9% of White businesses. Black African/Caribbean businesses also more likely to exceed their overdraft limit (50.5%/40.8%) than White businesses (24.7%).

11 Source: Fraser, 2009

12 Demand side In general, demand for external finance has fallen since This reflects various factors including: availability of internal finance; rising cost of borrowing; a slowing economy/increased uncertainty; and an increase in financial discouragement (since 2008). Discouraged borrowers don t apply for finance because they believe they will be rejected (Kon and Storey, 2003; Han et al, 2009). Discouragement reflects the perceived likelihood of rejection. Discouragement has increased sharply following the credit crisis reflecting business owners perceptions of the state of bank lending. Discouraged borrowers also have lower growth rates than otherwise similar non-discouraged firms. In other words, discouragement leads to lower investment and growth.

13 Demand for finance % 61.0% 57.3% 58.0% 48.7% 47.6% 30.1% 26.4% 20.4% 23.0% 16.9% 14.1% 3.3% 3.0% 3.0% Any type of finance Overdraft Term loan Leasing and hirepurchase agreements Invoice finance 3.1% 3.7% 1.9% Equity finance

14 Discouraged borrowers % 5.4% 4.3% 3.7% 3.9% 2.3% 1.5% 1.8% 1.2% 1.1% 0.4% Any type of finance Overdrafts Term loans Leasing and hirepurchase agreements 0.2% 0.3% Equity finance

15 Sales growth: DBs vs non-dbs 20.0% 10.0% 12.3% 8.0% 0.0% % % -20.0% DB -30.0% non-db -40.0% -50.0% -58.4% -60.0% -64.8% -70.0% -80.0% -72.4%

16 Issues highlighted by UKSMEF: supply side Loan rejection rates (for overdrafts especially) have increased following the credit crisis. This is due to increased borrower risk and increased risk aversion. For example, increased incidences of rejection due to lack of collateral and industry risk. Further analysis indicates that 50% of the increase in rejection rates is due to increased borrower risk (holding risk aversion/lending criteria constant) and the remaining 50% is due to increased risk aversion (holding borrower risk constant). Overdraft rejection also led to a substantial reduction in sales growth ceteris paribus. In other words, rejection led to financial constraints.

17 Rejection rates (overdrafts) % 28.3% 22.0% 18.3% 17.5% 17.6% 13.7% 10.3% 10.0% 9.3% 8.1% 6.6% 7.1% 5.5% 1.8% All firms Minimal risk Low risk Average Risk High risk

18 Dun and Bradstreet risk ratings % 58.0% 49.3% 31.9% 23.1% 21.7% 19.4% 11.5% 8.2% 5.7% 4.4% 3.5% Minimal risk Low risk Average Risk High risk

19 Reasons for loan rejection % 28.7% 27.0% 24.5% 22.0% 20.3% 16.9% 12.5% 11.3% 11.9% 8.9% 11.6% 8.6% 11.5% 11.1% 7.4% 6.3% 6.1% 4.4% 2.1% 0.0% Lack of collateral Poor credit history No credit history Industry too risky Poor business performance No reason given Don't Know

20 Sales growth: rejected vs non-rejected businesses 20.0% 16.0% 12.5% 10.0% 0.0% -1.3% % Rejected -20.0% Non-rejected -30.0% -40.0% -50.0% -41.5% -49.4% -55.6% -60.0%

21 Issues highlighted by UKSMEF: financial relationships The importance of small business banking relationships is reflected in relationships which are typically long, monogamous and end in few divorces. The average length of relationship is over 13 years; only 5% of businesses have 3 or more finance providers; and bank switching rates are typically low. Research consistently shows that small business relationships with banks matter: longer relationships improve the availability of finance if not lending terms. Estimates from UKSMEF 2008 indicate that, ceteris paribus: longer relationships reduce the likelihood of overdraft rejection; but having multiple finance providers reduces the cost of borrowing. In this context, relationship issues can be identified by looking at bank switching and the reasons for switching.

22 Bank switching rates Loan Applicant in Loan Applicant in % 10.1% 8.5% 8.1% 6.1% 4.8% 4.2% 3.8% 4.5% 3.8% 3.3% 2.4% 2.4% 1.5% 0.4% 0.4% 0.3% 0.1% All firms 2.0% 1.5% 2.0% Minimal risk 1.3% 1.0% 0.4% 0.3% Low risk Average risk Risk Rating High risk

23 Reasons for switching Loan Applicant in Loan Applicant in % 41.3% 43.0% 36.7% 33.3% 31.4% 28.9% 26.6% 24.5% 19.6% 14.8% 14.7% 12.1% 9.0% 2.7% 3.9% 2.4% 2.6% 2.0% 1.3% 13.0% 9.4% 8.4% 8.8% 8.2% 3.0% 2.2% 0.3% 2.6% 19.2% 18.0% 4.7% 4.3% 1.5% 0.7% 4.2% 1.6% 0.7% 9.6% 7.9% 6.4% 3.5% 8.2% 7.6% 0.1%

24 Relationships/bank switching Bank switching rates have increased sharply since 2008 especially among loan applicants: The reasons for switching in the last two years reflect increased dissatisfaction with the availability of finance/bank charges. Switchers also appear unhappy with the quality of service from their previous bank: There were an increased number of divorces in 2009 due to the previous bank making too many mistakes. This points to increased issues of poor communications/lack of understanding in small business banking relationships.

25 Policy implications These findings point to the importance of: Business mentoring to help with issues such as financial delinquency and discouragement. Enterprise Finance Guarantees: helping, in particular, with access to working capital. Improving financial relationships: Taskforce banks have committed to improving their customer service: e.g., making the loan application/decision process clearer; and establishing an appeals process for businesses refused loans. Business Finance Round Table may promote better understanding between banks and businesses. Proposed quarterly survey also important by providing reliable independent data on demand/supply of finance.

26 Benefits of UKSMEF/quarterly survey Large representative samples Greater precision/confidence in estimates. Findings not limited to particular sectors or regions. Depth and breadth of financial information covered in survey. Able to pinpoint problem areas (e.g., supply of working capital; low demand/discouragement regarding term loans). Ability to track trends/developments in SME finances Particular benefit of the quarterly survey. Vital to keep track of the situation currently since policy makers are looking to the private sector to lead economic recovery.

27 Benefits of UKSMEF/quarterly survey Ability to control for risk profiles. Many headline differences in cost/availability of finance can be explained by differences in risk profiles (e.g., EMBs). Value for money. UKSMEF is relatively cheap (compared to studies such as SSBF in the US). Independence. Whilst bank-funded, the analysis is/will be conducted by independent market research agencies and academics. In this regard, it s also crucial that the data are publicly available. UKSMEF data are available on the UK Data Archive.

28 References Kon, Y. and Storey, D.J. (2003), A theory of discouraged borrowers, Small Business Economics, 21, Fraser, S (2009), Is there ethnic discrimination in the UK market for small business credit? International Small Business Journal 27, Han, L., Fraser S. and Storey D.J. (2009), Are good or bad borrowers discouraged from applying for loans? Evidence from US small business credit markets, Journal of Banking and Finance, 33,