SMEF0045

Written evidence submitted by National Enterprise Network

Context

National Enterprise Network (NEN) is a membership-based organisation connected to and providing

business support to the start-up, micro and SME business sector. NEN surveyed all of its members in

response to the call for evidence; SME finance as it was felt that they have

the local knowledge, have the on the ground experience, are actually living and breathing the issues

faced by their communities in self-employment, jobs and employment support. Below is their

collective responses to all questions asked.

Question 1: What are the key challenges Small Medium-sized Enterprises (SMEs) face when seeking finance?

1. The key challenges for SMEs seeking and securing finance that our members observe are: • A business may be new, have a thin credit history or limited trading track record for traditional lenders to assess lending decisions against; • A borrower may not have assets to act as security for a loan, or the value of the assets are not sufficient to act as security; • A small business may be seeking a small value loan. The loan assessment and due diligence costs the same amount for a small or big loan, so many lenders focus on larger loans where the interest repayments will be more profitable; • Loans to social enterprise SMEs in particular, which have dual objectives to achieve both purpose and profit, may not be viewed as lucrative as others for profit-driven mainstream institutions; • Mainstream banks find it difficult and costly to adequately assess the risk of SMEs with such characteristics and do not have the risk appetite to lend to them. The weight of debt some businesses have had to take on since COVID in order to survive means they are more likely to be declined by mainstream lenders due to the perceived higher risks. Many smaller businesses lack the track record, credit history or collateral required by mainstream lenders. The barriers are particularly acute for smaller businesses trying to borrow £100,000 or less. FSB research shows that the smaller the business, the less likely it is to be approved when applying for credit. BBB data demonstrates that smaller SMEs experience market trends more acutely, and therefore are likely to be disproportionately negatively impacted in terms of access to finance. The effect is exacerbated by the circumstances already noted above: many lenders focus on larger loans since their loan assessment and due diligence costs the same amount for a small or big loan, and many traditional and challenger lenders’ risk profiles automatically exclude many smaller SMEs.

Question2: Through which channels do SMEs find the most success when seeking funding and why?

Some of the SMEs that our members have worked with claim they had most success going down the Crowdfunding and Angel investment route. Smaller SMEs found success through the Start-Up Loans route stating 'we can secure some funding as this institution understands the challenges of SMEs' .

The Start Up Loan scheme has provided a good package of support to new businesses in the first 3 years of trading with an option for a second loan within five years of trading. Packages for more established businesses appear to be on a more regional basis and SME's are not always aware of them. Maybe a more national approach similar to the Start Up Loans scheme would raise awareness. Of what is available.

The overall volume of bank lending to SMEs has flatlined in real terms since 2014, despite the entry of challenger banks and fintechs into the market . Over the same period, the volume of loans made by the five big banks to SMEs has fallen by 30% in real terms . The latest available research published by the Government in 2022 shows that the ability of SMEs to access affordable finance on the right terms, is a significant barrier for 700,000 small businesses . Contraction in SME lending is partly due to fewer applications , which correlates with reduced capacity and willingness of financiers to supply “fundable” demand, contributing to subdued loan volumes for businesses that wish to invest, innovate and grow: • For businesses that apply, there is a 50% chance of being declined: since the last Treasury Committee review of SME finance in 2018, the success rate of applications for smaller bank loans has fallen from 80% to around 50% . • High perceived risk of being declined: potential applicants for bank loans are now less confident of getting approved than they were 5 years ago, falling from 50% in 2018 to just 25% in 2023 . Small businesses are less likely to apply for finance if the process is time-consuming with a low perceived likelihood of success. • Significant regional disparities in loan volumes: the poorest 35% of areas in the UK get £10bn less SME bank loans compared to the rest of the UK. • High barriers experienced by certain demographic groups: businesses led by people from minority ethnic backgrounds find it harder to get finance. Over the last 10 years 15% of all such SMEs were declined for bank loans compared to 4% of other SMEs . Women-led businesses experience double the rate of bank loan declines compared to SMEs led by men .

question 4: What role can financial innovation play in SME finance? Is there more the government and the regulators can do to improve access to finance through innovative firms?

Basic Help to SMEs to take up the simplest of electronic innovations would help so many SMEs who haven’t yet realised the opportunities presented by tech and in so doing help improve their own productivity.

Responsible Finance works closely with its CDFI members and stakeholders to improve access to finance for small businesses which are viable, but have been declined by other lenders. By funding businesses with unmet needs, CDFIs create high levels of economic and social impact additionality. Over the past 5 years the CDFI sector has generated significant economic and social impact in the following ways: • Loans to previously declined businesses: CDFIs have lent over £1bn to small enterprises across the UK, many located in deprived areas or led by excluded groups, with the overwhelming majority having been previously declined by mainstream finance. Over 90% of CDFI borrowers go on to successfully repay their loans and grow their businesses, delivering additional economic growth, productivity gains and reducing inequalities. • Loans to businesses located in areas of high deprivation: around 50% of our CDFIs lending is to areas in the 35% most deprived regions. In comparison, only 25% of bank lending is to the 35% most deprived regions.

Question 5:  How accessible is finance for SMEs of different sizes?

Loans are difficult to access regardless of the size of SMEs, and the process is lengthy and complicated. It’s very splintered so needs a lot of prior knowledge of the landscape process. The smaller businesses often do not have the in-house resource in terms of time and expertise to pursue the different finance for small businesses.

The Bank of England has estimated the annual unmet funding need for all SMEs at £22bn . Our members, CDFIs, focus on providing SME term loans of less than £100k where over 97% of unmet funding need occurs. Drawing on data from BEIS Longitudinal Surveys, the SME Finance Monitor and the ONS, Responsible Finance provides the following high-level estimates of the unmet need for viable businesses applying for loans of less than £100k : • 130,000 SMEs apply for about £3.4bn of loans each year . Most of these are smaller businesses (99%) with less than 10 employees. • 65,000 of these applications are successful, leaving 65,000 with unmet funding needs. • An estimated further 130,000 SMEs are discouraged from applying for bank loans for a variety of reasons. • Therefore, only 25-30% of SME funding needs are met for loans of less than £100k, based on numbers of declined and discouraged borrowers. • This leaves around 195,000 SMEs with unmet funding needs each year, amounting to between £4bn and £6bn. • Of those SMEs with unmet needs, our statistical credit modelling predicts that an additional 50,000 SMEs looking for between £1.4bn and £1.6bn could be fundable at loan interest rates of between 10% and 15% each year. • For those that are not fundable, access to business advice and support as well as signposting to grant schemes offer a route to help them become investment ready and able to secure investment in the future.

NEA was a great stimulus to those individuals who were unemployed who often had little security or access to funding - this has now been withdrawn.

Is finance available to allow SMEs to scale up from venture capital funding?

Yes but it is hard to build up track record. Finance is usually not available or hard to get to scale up from venture capital funding. In our experience where there is venture capital funding available it often requires a lengthy and complex process which is off-putting.

In our experience Venture capital is not available to SME's without trading history which can be a challenge.

Question 7: How successful has the Bank of England’s Term Funding Scheme with additional incentives for SMEs (TFSME) been at encouraging banks to lend to SMEs?

Not successful at all and the details of the scheme have not been distributed widely enough.

Question 8: What role do credit reference agencies play in supporting SME finance?

Credit reference agencies need to hold the most accurate and up to date data in supporting SME's. Sometimes different CRA's present a different picture of the same business. SME's need to check credit reports regularly for accuracy and completeness.

Question9: What impact has the RBS bailout state aid Alternative Remedies Package and its various funds for SMEs (implemented by Banking Competition Remedies Ltd) had on SME access to finance?

The remedies Packages seem to help the SMEs to be on a better footing, especially with the rising costs.

Question 10: Is securing access to SME finance particularly challenging for women, people from ethnic minorities, people from certain social classes, or any other group? Is so, what should be done about it?

The overall volume of bank lending to SMEs has flatlined in real terms since 2014, despite the entry of challenger banks and fintechs into the market . Over the same period, the volume of loans made by the five big banks to SMEs has fallen by 30% in real terms . The latest available research published by the Government in 2022 shows that the ability of SMEs to access affordable finance on the right terms, is a significant barrier for 700,000 small businesses . Contraction in SME lending is partly due to fewer applications , which correlates with reduced capacity and willingness of financiers to supply “fundable” demand, contributing to subdued loan volumes for businesses that wish to invest, innovate and grow: • For businesses that apply, there is a 50% chance of being declined: since the last Treasury Committee review of SME finance in 2018, the success rate of applications for smaller bank loans has fallen from 80% to around 50% . • High perceived risk of being declined: potential applicants for bank loans are now less confident of getting approved than they were 5 years ago, falling from 50% in 2018 to just 25% in 2023 . Small businesses are less likely to apply for finance if the process is time-consuming with a low perceived likelihood of success. • Significant regional disparities in loan volumes: the poorest 35% of areas in the UK get £10bn less SME bank loans compared to the rest of the UK. • High barriers experienced by certain demographic groups: businesses led by people from minority ethnic backgrounds find it harder to get finance. Over the last 10 years 15% of all such SMEs were declined for bank loans compared to 4% of other SMEs . Women-led businesses experience double the rate of bank loan declines compared to SMEs led by men .

Question 11: Do SMEs have adequate and appropriate access to a complaints procedure when in dispute with their bank or lender?

Banks and lenders are required to publicise a complaints procedure which should be available to SME's.

Question 12: How effective has the Lending Standards Board’s Standards of Lending Practice been?

The board has been effective as SMEs benefited from the loans which helped the companies to thrive.

Question 13: How well does the Financial Ombudsman Service (FOS) work for small business complaints?

Based on experience the FOS has worked well for small business complaints responding within the relevant timescale and with clear explanations of the next steps.

Question 14: Is the FOS’s existing role in SME finance appropriate? If not, how should it change?

FOS's existing role in SME finance appears to be appropriate providing FOS can cope with the volume of small business complaints.

Question 15: How effective has the Business Banking Resolution Service been, and what lessons can be learnt from it?

The service has been accessible for clients. It has highlighted the need for someone to speak to rather than an email system.

Question 16: Should SMEs have the same level of consumer protection and deposit insurance limits as retail consumers?

Would agree that SME's should have the same level of consumer protection and deposit insurance limits as retail customers.

17. Should commercial lending to SMEs be brought into the regulatory perimeter?

Ideally no, this will make it costlier to lend and will drive providers out of the market, as we have already seen with the recent consumer duty regulations. What may seem a well-intended action will lead to reduced options and increased market failure

18. What impact will the PRA’s proposed Basel 3.1 capital requirements framework, and in particular the proposed removal of the SME support factor, have on SMEs in the context of the PRA’s objectives?

We understand that this comes into force in January 2025 for regulatory bodies and will impact on credit, credit valuation and operational risk and address weaknesses in banks internal models and reinforce the quality and consistency of capital measures. Impact on SME's is most likely in the retail sector but in mitigation a new lower risk weight will be introduced for this class of exposure.

19. Should the Government do more to enhance SME access to finance? And, if so, what

Yes 1. Encourage mainstream finance to provide more financial support to community lenders. Rationing the supply of loans to small businesses is a commercial decision for lenders, but it has a direct impact on local economic activity and inequalities. There have been widespread calls for mainstream lenders to support the community lending sector, which can provide loans and support to small businesses that mainstream finance cannot. This would not only lead to a more diverse SME finance sector, but also create banks’ customers of the future. The Community Reinvestment Act in the US has stimulated many billions of dollars of investment from banks into community lenders. Support is growing in the UK for a similar policy in the UK. The UK lacks a working partnership between better resourced retail banks and under-resourced purpose-driven institutions: “A Fair Banking Act would provide this structure by establishing a financial inclusion framework and a corresponding ratings system that assesses retail banking institutions on their performance at tackling financial exclusion. Positive ratings would reflect strong performance under the categories of lending, service and partnerships with purpose-driven providers.” The APPG on Fair Business Banking has also urged the government to go further: “A mandated portion of bank lending should come through CDFIs in order to allow them to scale their offerings further” 2. Establish a scheme dedicated for funding community lenders, run by the British Business Bank (BBB). Via the programmes noted above, the BBB does provide support for CDFI lending. These programmes are integral to the success the CDFI sector has had to date, however some underserved and underrepresented business still don’t yet benefit. A scheme dedicated specifically for community lenders to enable on-lending could be catalytic, high impact and enable on-lending to an even wider scope of businesses across loan sizes, demographics, and geographies. A joint report published by Big Society Capital and Citibank made a compelling case for such a targeted programme, concluding that: “The British Business Bank’s initiatives, and the work of alternative online providers, have made more small business finance available. Yet there is still an opportunity to improve and scale this provision for small businesses that are either unable to access mainstream finance or are not reached by existing programmes.” 3. Use dormant assets to provide first-loss concessionary capital. Using new dormant assets channelled through social investment wholesalers to make enterprise an engine of social and regional renewal. Dormant assets can provide concessionary capital for community lenders. This can be used in conjunction with other measures such as loan guarantees and tax reliefs to leverage in 3rd party capital up to 4x . The key to making this a success is to keep the cost of capital as low as possible, allowing investors to on-lend at affordable rates and provide valuable business support. This requires different mandate for social investment wholesalers like Big Society Capital who have previously operated a market pricing approach to capital. A recommendation in a key report endorsed by Big Society Capital is to: “Use new [dormant assets] to develop a dedicated lending source for enterprise lending CDFIs. This dedicated funding source could use concessionary capital to: • Provide a revolving first loss program to attract commercial capital. • Provide equity or concessionary capital to enterprise lending CDFIs to strengthen their balance sheets and enable them to leverage in other finance. • Provide grants so CDFIs can invest in their organisations to scale up activity” We encourage policymakers in DCMS and wider government to support this proposal. 4. Unlock legacy funds for CDFIs. Historic schemes such as the Regional Growth Fund (RGF) continue to provide capital for the sector, but they could do much more and at a lower cost to the government. If the remaining £15mn of RGF legacy funds – which have already surpassed their targets and are now being lent out by the CDFIs – were endowed to the sector, then an additional £75m of lending capacity would be unlocked. We recommend that government should accelerate this process. 5. Improving the effectiveness of the bank referral programme to direct more declined and discouraged borrowers to lenders such CDFIs. Many loan declines are not formalised, or SMEs do not follow through with the referral. As few as 8% of “declines” are referred on using the current platforms. In an average year around £25mn of loans are funded through the scheme. As one CDFI stated: “Although the vast majority of our loans are made to businesses previously turned down by mainstream finance, less than 2% of our customers are coming through referral platforms. We know there are a lot smaller businesses being declined but we are not seeing them. Somehow the system needs to be improved.” 6. Support awareness raising of CDFIs. The community lending sector does not have the resources to market itself in the way that the private sector does. This has led to a low level of awareness by both potential investors and fundable businesses with unmet needs. Responsible Finance calls on the government to help raise the profile of CDFIs through speeches, visits, meetings, media opportunities and social media.

20. What has the impact of the Covid Bounceback Loan Scheme (BBLS) which was followed by the Recovery Loan Scheme, been on SME finance?

BBLS appears to have been well received by SME's as it delivered at a critical time when intervention was necessary and kept businesses going through a difficult time. Some negative feedback around some providers taking longer than anticipated to complete applications

However, this has worsened the situation for some business in the long term as trading has fallen and cost of living has risen making it difficult for some SME’s to pay their loan and continue to trade. Banks are aggressive in chasing loan repayments which put more pressure on already struggling business

21. In the US the Treasury approved a fund, (State Small Business Credit Initiative (SSBCI)) for incentivising and supporting underserved businesses. Does the UK need similar provisions?

Yes The Community Reinvestment Act in the US has stimulated many billions of dollars of investment from banks into community lenders. Support is growing in the UK for a similar policy in the UK. The UK lacks a working partnership between better resourced retail banks and under-resourced purpose-driven institutions: “A Fair Banking Act would provide this structure by establishing a financial inclusion framework and a corresponding ratings system that assesses retail banking institutions on their performance at tackling financial exclusion. Positive ratings would reflect strong performance under the categories of lending, service and partnerships with purpose-driven providers.” The APPG on Fair Business Banking has also urged the government to go further: “A mandated portion of bank lending should come through CDFIs in order to allow them to scale their offerings further”

22. How useful is the British Business Bank? Does its finance hub improve SME access to finance?

Yes. It enables businesses to thrive through loans that are greatly needed especially in difficult times like the Covid pandemic era. The finance also boosts the cash flow as well.

There needs to be more awareness raising of the BBB and the finance hub to get the message out to SME's. The finance hub needs to include access to finance for different sizes of SME's including micros.

September 2023