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Berry, Grant and Jarvis, 2003

Executive summary

The problems experienced by small and medium-sized enterprises (SMEs) in accessing finance form a continuing saga that has fuelled the debate on constraints on the growth, and threats to the survival, of enterprises of these sizes in the UK. The importance of this debate is reflected in the periodic government commissions that stretch back as far as 1930. The term commonly used to describe this funding problem is the 'finance gap'.

The finance gap for SMEs is complex because it relates partly to a lack of equity investment and partly to a mismatch between the debt finance available, the conditions attached to the supply of the finance and the requirements of the SME market. In terms of debt finance, the main sources in the UK are the four main clearing banks.

There are numerous European banks operating in the UK. These banks tend to adopt a different approach to lending that, it is argued, favours the SME. In particular, in assessing the loan application, these banks tend to look forward to future earnings as a source of repayment of the loan and interest. In the banking literature this approach is referred to as the 'going concern approach' and contrasts with that of the UK banks, which have tended to take a security-based lending approach, referred to as the 'gone concern approach'.

The objective of the research, detailed in this report, is to determine the extent to which European banks are involved in the UK SME lending market and the nature of their involvement. In addition, the research also identifies the approaches these banks adopt and compares them with those of the UK clearing banks.

To identify those European banks operating in the UK SME market, a telephone survey was initially carried out. This was followed by interviews with the corporate lending managers of each of these banks. The interviews were taped, transcribed and analysed against a template drawn from the literature on bank lending in the UK and Europe.

THE MAIN FINDINGS OF THE RESEARCH

• Despite the deregulation of the financial markets, evidence of dissatisfaction with services offered by the clearers and the fact that excess profits are being made in the market for lending to SMEs (Cruickshank, 2000) only ten European banks were identified as being active in the UK SME lending market.
  
  
• Cruickshank (2000) estimated that the big four UK clearers have 89% of the market. This dominance is unlikely to face any real challenge from other European banks.
  
  
• Those European banks active in the SME market deal with medium-sized companies, typically with a turnover in excess of £5m and ranging up to £250m.
  
  
• The European banks are interested in providing much larger loans, in millions rather than in thousands. Thus they do not provide the answer to the finance gap, identified by Cruickshank (2000), of loans of between £100,000 and £500,000.
  
  
• For medium-sized enterprises in the UK that wish to raise relatively large loans, the adoption of the going concern approach by the European banks could be advantageous when they have insufficient security to underwrite their borrowing requirement.
  
  
• There is no evidence among the European banks of the short-termism that British banks are often accused of. Among European banks, there was evidence of a greater degree of knowledge of the business sectors, as a result of specialisation, than is typical in the UK.
  
  
• The majority of European banks lending in the UK SME market displayed clear home country effects. These effects included expediency, whereby subsidiaries of existing clients are afforded different treatment as a result of their parent companies¿ relationships with the head office of the bank.
  
  
• There are a number of factors that appear to restrict the expansion of European and other overseas banks¿ activities in the UK SME lending market. These include the types of services offered and the lack of a strong branch network.
  

IMPLICATIONS AND RECOMMENDATIONS

At present, European banks compete effectively in the UK lending market in terms of lending to large companies. This research indicates that this is not the case in the UK SME lending market. Although there are a large number of European banks present in the UK, it is recognised that a number of constraints discourage these banks from participating in the SME market.

The UK government has recognised the lack of competition in the UK SME lending market, as reported by the Competition Commission, which has resulted in the UK banks making undertakings with regard to their relationship with SMEs. The effective entry of European banks into this market would further enhance the competition. In particular, the approach taken by these banks in looking forward to future earnings generation, as compared with the conservative approach based on secured lending, is likely to encourage UK banks to move in this direction. This should have a positive effect in bridging the finance gap.

The UK government should therefore actively encourage the numerous European banks operating in the UK to extend their services into the SME markets. This means considering the constraints on European banks moving into this market and helping to create a level playing field in which these banks can compete effectively. This may mean, for cost/benefit reasons, that their target clients will be medium-sized companies. It is companies like this that have been identified as having problems raising finance.

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