Written evidence from Responsible Finance (ATF 30)

About Responsible Finance’s submission

Responsible finance providers extend credit to underserved markets and therefore work directly on addressing barriers to accessing to finance across the UK.  The sector has been experiencing an upward trajectory, lending more and more each year and finding innovative ways to finance the start up and growth of businesses, which are so important to the economy[1]. Last year, responsible finance providers lent £251 million, £98 million of which was to SMEs[2].  Academic research into the sector has shown that for every £1 lent, responsible finance providers generate £7 of economic value, given the businesses and jobs they create and save.  In terms of interventions, the sector is also excellent value for money; creating new jobs at 10% of the average cost of government programmes.   

For this reason, Responsible Finance welcomes the Business Innovation and Skills Committee’s inquiry into access to finance.  Enterprise lending accounts for a large portion of responsible finance providers’ loan books, so the chance to identify opportunities for the provision of finance to underserved segments of the SME market is welcomed. 

About Responsible Finance

Responsible Finance is the trade body for responsible finance providers (formerly known as community development finance institutions (CDFIs)). Responsible finance providers provide loans and support to businesses and individuals who find it difficult to access finance from commercial banks.  Responsible Finance’s mission is to support the development of a thriving and sustainable sector that provides finance for underserved communities and, as a result, contributes to the increasing economic growth and prosperity of these communities.

Evidence

The market segment that responsible finance providers primarily serve is SME lending up to £150,000.  Due to this specialisation, we have focused our responses on this segment of the market.

      How has the landscape for access to finance evolved since the end of the financial crisis?

Following the 2007-2008 financial crisis and depressed growth rates which continued until 2012, the landscape for access to finance for SMEs has changed dramatically.

First, the stock of bank lending to SMEs fell some 20%[3] between 2009 and 2013.  In the 5 years since 2011, banks have withdrawn approximately £25 billion from the SME lending market, the most drastic decline taking place between 2011 and 2013[4].  In more recent years there are signs of credit conditions improving moderately for businesses with more loan applications being approved by banks[5].

However, when this data is unpacked, it reveals trends that indicate that access to finance remains a major barrier for some businesses.  In particular, micro and small businesses report higher decline rates on new/renewed loan facilities.  For micro businesses the decline rate remains notably high – 37% for those with 0 employees and 22% for those with 1-9 employees[6].  Based on reports from our member responsible finance providers, the largest demand they see (from businesses that have been previously formally or informally declined by a bank) is micro and small businesses seeking less than £150,000 for start up or growth finance.   

This is impacting on potentially viable businesses’ futures.  Although they start small they may have ambition and potential to grow.  In addition, the proportion of “permanent non borrowing” SMEs has been increasing over time, with now nearly half of SMEs qualifying as permanent non borrowers.  A concerning development has been the growth in the proportion of micro businesses becoming permanent non borrowers – 52% in 2015 compared to 37% in 2012[7].  The SME finance monitor shows that permanent non borrowers are less likely to export than those that use external finance; and are also less likely to grow, innovate, and make a profit[8].  This contributes to the productivity challenges that the UK faces, lower overall productivity than other G7 nations, and geographical disparities in output.

Another development in the landscape for access to finance since the financial crisis is the rise of the alternative lending market.  Peer-to-peer (P2P) business lending, invoice trading, and crowdfunding have all grown exponentially since 2012.  P2Ps alone have lent £2.5 billion to SMEs since then[9].  While this is a positive development in the face of the retraction of bank lending, it should be considered whether these alternative lenders are increasing competition at the top end of the market for SMEs that can already access bank finance, or if they are unlocking finance for the segment of the market that persistently cannot access finance.

The evidence indicates that while there is certainly a mix of both, there is a skew towards the former.  For those reporting applying for alternative finance (invoice finance or 3rd party lenders), the SME finance monitor reports a decline rate of 45% - higher than banks’.  From Responsible Finance annual surveys 86% of all SME clients had previously been declined by a bank (formally or informally); only a small proportion (2%) had also applied to an alternative lender such as P2P[10].  This evidence suggests that the risk appetite of this market is similar to that of the banks, meaning that the micro, small, start up, and early stage segments of the market, seeking under £150,000 still face significant barriers when accessing finance. 

As mentioned previously this gap in the access to finance landscape will ultimately affect small and new business’ ability to grow, and stifle the potential of high growth businesses. As an example, a software developer and serial entrepreneur in the West Midlands was declined by a bank loan when he tried to start his new business, Synapse, in 2014 because his business was viewed as high risk and the finance sought was too low to be profitable.  He was able to secure a £26,000 loan from ART Business Loans, a responsible finance provider, and since has grown his business from 3 employees to 28, and is generating a £1.5 million turnover[11].  SMEs like Synapse demonstrate this persistent gap in access to finance that small and early stage businesses still face, and the drag to the economy that a lack of access to appropriate finance creates.      

      What have been the most successful Government policies to assist growing companies access private finance and where is there room for improvement?

With a focus on the aforementioned gap in access to finance (micro, small, and early stage firms), there have been a number of government interventions, yielding different rates of success:

• Regional Growth Fund: The Regional Growth Fund (RGF), launched in 2010, has invested £2.7 billion in SMEs across England through six rounds[12].  In particular the Responsible Finance RGF 1 programme was a £30 million fund from BIS and leveraged in £30 million in private investment from banks (Unity Trust Bank and the Co-operative Bank). 

This £60 million fund, distributed through responsible finance providers, was targeted at the micro and small segment of the market that struggles the most to access finance, and for which this finance has a disproportionate impact, not to mention the benefit to the local economy.

To date, Responsible Finance’s RGF programme has surpassed its own targets, and outperformed other RGF schemes on a number of KPIs.  As of the end of 2015, £57 million had been disbursed to 1,850 microbusinesses and SMEs.  This has created 1,191 full time jobs, and saved a further 7,060.  The resulting cost per job to the government is £3,459, which is 7% of the total cost per job across the entire RGF programme[13]. The businesses and jobs created and saved through this programme have added £400 million to the local economies in which they are located.  90% of the fund has been disbursed to businesses outside of London: nearly 40% has been distributed to the West Midlands, and a further 35% to the Northern Powerhouse region (North East, North West, Yorkshire and the Humber), driving business investment to rebalance the economy. 

100% of the nearly 2,000 businesses supported had been previously declined by a bank, and a large proportion have been high growth, as evidenced by the number of new jobs created.  Businesses like the software developer Synapse mentioned above, were supported through the Responsible Finance RGF programme.  However, no new rounds of RGF were announced in the 2015 Spending Review.   

As evidenced by the KPIs, this was a very effective intervention by the government that was also good value for money, that improved the landscape for access to finance for those businesses that experience the greatest difficulties.

• Start Up Loans Programme: Another intervention the government has made in the micro/start up segment of the market is the Start Up Loans Programme.

The recent British Business Bank market report highlighted that demand for finance from start ups has risen in recent years (12% in 2013, 25% in 2014)[14].  The Start Up Loans programme, delivered partially through responsible finance providers, has proven an effective mechanism of reaching start ups in underserved markets with the twin approach of business advice and finance.  However, some challenges this programme has faced and should continue to consider during its evolution are:

• Credit policies and if these policies are aligned with the market it is trying to support;
• Offering a 6% product too broadly could possibly distort the market and businesses’ expectations for future borrowing;
• How the Start Up Loans programme can closely integrate with local economic growth, business, and entrepreneurship strategies. 

It was also noted in the British Business Bank report that start ups are more likely than existing businesses to be able to secure funding.  This highlights the barrier described previously of micro and small businesses, aged 2-5 years, in obtaining finance, which the Start Up Loans programme currently does not address.   

• Enterprise Finance Guarantee Scheme: This scheme has stimulated over £2 billion of lending (as of 2014 quarterly statistics have not been published)[15] into small and micro businesses that would otherwise likely find it difficult to access finance due to lack of security.  While the scheme had some instances of misuse in the past, it is a useful tool for the responsible finance sector to extend reach into underserved SME markets.   

However, the EFG scheme has been closed to new entrants for over 12 months and still not reopened as of early February.  This hiatus is preventing new lenders from using the scheme for its purpose and realising its potential, and lending to businesses that would otherwise find it difficult to access finance. 

• Funding for Lending Scheme: This scheme was launched in 2012 to incentivise banks to lend to SMEs.  In recent months there have been signs of improving credit conditions for SMEs; but there is no evidence of what segment of the market they are lending to[16]. 

      Does the UK have globally competitive markets / suppliers for financing (and debt financing) at 1) seed 2) venture and 3) growth stages? What steps could Government take to strengthen these systems?

The UK’s SME finance market is relatively competitive, but still faces challenges in terms of creating a diverse market at every stage of a businesses’ funding needs.  There are also significant geographic disparities and inconsistencies; for example Wales, Scotland, and Northern Ireland often do not have access to access to finance programmes in England.

In terms of the seed stage, we received feedback from members that the landscape for seed funding is fragmented across the country; with a need for grants/low-cost loans and advice available for businesses at that stage. 

In terms of the venture stage, we have greatest insight into the small scale investment end of the market (sub £150,000), where there has historically been support through Regional Growth Funds and Start Up Loans delivered through responsible finance providers that targets this end of the market.  However, with no new RGF programmes planned, continued access for businesses to small scale venture investment is uncertain.

Finally, in the growth stage, there is a particular gap in the small, sub £150,000 end of the market, with few providers providing this investment, given that it is perceived as having high transaction costs and unprofitable.  However, as demonstrated in the response to the first question above, there is considerable demand in this segment of the market, and the gap in funding has adverse effects on the businesses’ growth, expansion, potential to export, and productivity.  The discontinuation of the RGF programme, which was largely targeted at this segment of the market could potentially widen this gap if there are no replacements.  The structure of regional funds such as JEREMIE 2 typically cannot reach venture and growth stage small businesses in this segment; and in reality only a small proportion of the total fund is allocated to micro/SME venture and growth, so it is important that Local Growth Funds or another replacement are allocated to this segment to be distributed through local intermediaries such as responsible finance providers.

      Are alternative methods of raising finance (such as crowd-funding and peer-to-peer) sufficiently well-regulated and monitored for companies to be confident in utilising them?

This question is generally outside of our scope, but we will comment that alternative methods of raising finance (such as crowdfunding and peer-to-peer) are not currently regulated in a customer-facing way.  These types of platforms lend only to limited companies (an unregulated market), and are regulated for holding and managing client money, but are not regulated in the way they treat or protect customers in the way that consumer credit firms are regulated by the Financial Conduct Authority (FCA).  Therefore businesses using them to raise finance would not have any means of gaining confidence outside of that they are being monitored for prudential risk.

      What are the main improvements or interventions, in terms of finance, that the Government should make to achieve the objective of increasing the number of successful and high-growth businesses in the private sector?

The lending data available indicates that despite improved economic conditions, the micro, small, and early stage segment of the SME market seeking below £150,000 finds the landscape for accessing finance particularly challenging.  This is also a segment of the market that has potential to grow, but because of its vulnerability, does not consistently have the opportunity to realise this potential.

Some government interventions have been particularly effective at stimulating investment into this segment of the market, enabling it to grow.  These interventions have namely been going through local funds such as responsible finance providers, which already have local reach and trust, and are well networked with other local institutions. 

Given this existing reach, interventions that enable the scaling of local funds such as responsible finance providers, will help to achieve the objective of increasing the number of successful and high growth businesses able to access finance. 

Improvements to existing programmes can offer a good value for money intervention:

• In particular, improvements to existing guarantee mechanisms, such as the Enterprise Finance Guarantee scheme targeted at the responsible finance sector, would unlock significant commercial investment, which in turn would increase access to finance to this segment of the SME market.  On behalf of the sector, Responsible Finance would welcome the opportunity to engage with the relevant departments to explore how guarantee schemes can be used nationally and regionally, to unlock this commercial investment and therefore support the development of more successful and high growth businesses.

• Second, improvements to the Community Investment Tax Relief (CITR), could also yield significant investment into the responsible finance sector to reach the micro and small businesses that face the biggest access to finance gap.  CITR is an important tool for responsible finance providers to attract new private investment for onward lending.  To date over £100 million has been raised through CITR, which has facilitated more than £100 million of onward lending.  CITR is over a decade old, and new reliefs have been launched in the meantime, so it is important the CITR remains appropriate and competitive as a key mechanism for growing investment into the sector, and therefore the sector’s economic impact.  We propose aligning the benefits of CITR with those of SITR, relaxing the requirements for accreditation so more responsible finance providers can access CITR, and make a marketing push for CITR and SITR together to develop the market for investors.  The proposed changes would generate an additional £140 million in economic benefit annually through more businesses backed, and more entrepreneurs helped to realise their growth potential.  

10 February 2016

Responsible Finance    2016

1