Small and Micro-Business Borrowing — Question for Short Debate
Baroness Kramer (Liberal Democrat)
I very much thank the House for giving me the opportunity to bring forward a debate on small business and credit and the failure of high street banks to offer that credit and therefore the alternatives that we must look at. I warn the House beforehand that I am going to focus in the time that I have on two areas of particular interest to me, so I thank the other noble Lords who are going to participate in this debate in advance, because they will expand the conversation way beyond the range which I am capable of introducing.
There is very little dispute today that small and micro-businesses especially are struggling to access credit from the five high street banks that dominate banking in the UK, and that has been going on since the crash of 2008-and there were underlying problems before them. The Breedon report was very good; it quoted recent data that showed that 33% of SMEs applying for a loan were rejected and that the decrease in the supply of loans to SMEs in the UK has been much sharper than in other countries. We have a piece today in the FT that says that small businesses lament the shrinking pool of credit. If we needed a real illustration, the entry of Wonga into this field with potentially 2% of interest per week says in every way that there is a very serious vacuum. The truth is that the view of high street banks in this country is that "bankable" credit is a very narrow term indeed. Most lending for SMEs over past years has effectively been a form of real estate; it has not been an assessment of the business plan. It is not just that the high street banks will not do this lending-they cannot. They no longer have local knowledge; they do not have trained credit staff; they are now into a form of centralised tick-box commodity-type lending activity. The contrast is sharp with the German savings banks, the Swiss cantonal banks and the US community development banks, which are a backbone to SMEs in Germany, Switzerland and the United States. In those countries, lending has increased since the crash.
The banks that I just mentioned have a common characteristic: a social obligation as part of their mission, as well as profit-so not just a sole profit-maximisation obligation. Those banks are tied to a specific geography, so they are forced to make a success out of local businesses and to take a long-term view; they cannot diverge into other ways of earning money. Dr Thomas Keidel, who is very senior in the German savings bank association, talked to some in this House, making it clear that that local knowledge gives an intimate assessment of risk in a way that even a regional bank cannot accomplish. He said that many of the best credits in the German system are risks that would have been turned down had it not been for knowing management, understanding the order book and really being sensitive to the local issue. That is crucially different from the savings banks in Spain-they are in great trouble-which do not have that geographic link.
I argue that, frankly, this is a tier of banking that we do not have in the UK. We have some valuable community development financial institutions, credit unions, funds and banks. I have visited many, including a brilliant business enterprise fund in Bradford, but they are small and fragmented, and their geographic coverage is fairly random. I know that the Government will say that there is now an agreement with the British Bankers' Association that high street banks that turn down a credit will then refer that small business to a local CDFI. However, that is relatively meaningless unless CDFIs are coherent and comprehensive as a sector and have sufficient funding to meet demand. At present, the CDFI sector in this country is swamped. One of the banks calculated that if they were really going to meet need, they needed something like £125 million of potential lending a week, but they are nowhere near that. The irony is that plenty of investors would like to get engaged with the sector, especially social enterprises, charities and philanthropic individuals, as well as commercial players. With the additional growing capacity to raise funds through the new sector of social impact bonds, there is huge potential to support an equivalent to the local and community banking sector.
We have to remove the regulatory barriers to new entrants into the banking system in the UK, which prevents social entrepreneurs and others getting new banks started. The FSA would say that nobody applies, but look at the experience of Metro Bank, the only bank in recent history with a new banking licence. We all know the numbers-something like £25 million to get regulatory approval, in two and a half years. Consultants in the banking arena all say to anybody interested, "Don't even try. See if you can buy a banking licence, but otherwise forget it in the current climate".
Baroness Kramer (Liberal Democrat)
If I take interventions I will not get through my speech, so I am going to carry on.
I refer anybody questioning the barriers that come through the regulator to a very good piece called Street Cred by Civitas. It is a bit melodramatic, but it underscores all the difficulties that people face. I have talked with people in the US, and they reckon that it takes roughly six months and costs $2 million to get a new bank started. That is a very different situation.
The Government must develop a specialised bank licence and an appropriate set of capital requirements for small local-community banks undertaking the social impact obligation. We need off-the-shelf packages for small bank start-ups to provide economies of scale, including basic regulatory approval, working software and other forms of support. The US does it-it is called "bank-in-the-box". We need a regime to enable banks that fail to be dealt with quickly as that gives confidence, especially to the regulator, to lower entry barriers. The Banking Act 2009 failed to do that. The FDIC in the States does a far more effective job. We have to introduce such a regime. I do not see signs of it but I hope that it will come. We should also deal with the VocaLink payments system, which is owned by a cartel. There are many regulatory barriers and failures in the system. Their removal could make a fundamental difference to what we do.
I wish to make two suggestions. First, RBS is, frankly, an albatross around the Government's neck. If RBS's branch network were used to create a community banking network, we could see a massive and rapid step change in this area. Secondly, we should examine what kind of lending high street banks undertake, see where the gaps are, and whether they are genuine gaps. It seems to me that there is an argument for saying to those banks, "We are not going to make you undertake this lending but we will have you fund someone else who can through capitalising a local community bank".
In the time I have left I wish to say a few words about the innovative online lending platforms. I am not talking about companies such as Wonga but about the platforms that have investors on the one side and borrowers on the other and offer non-exploitative lending rates. They are new in the field and have grown up in the past two years-for example, companies which offer crowd financing and peer-to-peer financing. I am sure that noble Lords find that term hilarious. This industry has significant potential but is begging for stronger regulation. There is an enormous fear in the industry that a couple of cowboys might come in and create havoc, resulting in terrible headlines, investors fleeing and the regulator intervening in an incredibly heavy-handed way. It is crucial that the Government provide a more constructive regulatory framework which is proportionate and does not stifle the industry's growth but which engenders confidence in the industry so that it can move forward.
I do not want to pretend that the Government have done nothing in this area. I am sure that the Minister will list what they have done. I acknowledge that things have been done but not on the scale that is necessary to support our SME sector. It is vital that the Government understand the limitations of the high street banks instead of constantly telling them that they should lend to these companies. They will not and cannot do that. The Government must have a coherent plan to fill this vacuum and must enhance the opportunities for local banks and quality online lenders. One of the problems is that there is no one in the structure of government at the moment who leads on this issue. It is split between BIS and the Treasury, and within the Treasury there must be five Ministers covering different parts of it. The Government should identify a champion to try to resolve this problem and take it forward. If they do not, we will not sustain our small businesses which are the backbone of our economy and we will give all the space to our competitors.
Lord Popat (Conservative)
I thank the noble Baroness, Lady Kramer, for bringing such an important and timely topic before the House. She made some important suggestions and comments, on which I would like to expand. For many years I worked as a business and corporate finance specialist, financing small and medium-sized businesses and helping them to secure bank finance either to start or to expand their businesses. We used to process their applications within the day, and many of those firms have gone on to be huge employers that contribute to our communities and our country.
The idea of small businesses securing finance in 24 hours is one that will probably amaze younger entrepreneurs. It is unfortunate that securing finance for micro-businesses in today's market is at best time-consuming and uncertain, and at worst impossible. The business-friendly climate that I encountered in Britain in the 1970s, 1980s and 1990s has unfortunately given way to uncertainty, bureaucracy and great difficulty. Nowadays, many small businesses find that it takes at least a month just to set up a bank account in the first place, let alone to get finance.
While I entirely believe and support the Government's commitment to rebalancing the economy and boosting the private sector, the climate for small and micro-businesses, particularly in regard to funding, will have to change considerably before we can make the Government's vision a reality.
I wish to muse briefly on bank borrowing. The coalition agreement makes it clear that ensuring that credit is available to SMEs is essential for supporting growth, and should be a key priority for the Government. They have announced a number of policies to support this aim, including, of course, Project Merlin, as well as the enterprise finance guarantee scheme. The intentions behind these policies are undoubtedly good, but with Project Merlin the often optimistic statistics regarding bank lending do not seem to match the experiences being felt by small businesses.
I hear every day from friends and associates in the business world that lending from banks is very difficult. With the uncertainty generated by what is happening across the eurozone, I do not anticipate that this situation will change for a considerable time. In addition, many of the schemes offered by the Government-in particular, the business department-often experience very low levels of participation. Perhaps worse, many of these schemes are unknown to many of the small businesses that could most benefit from them. As a brief aside, I wonder whether the communications strategy at BIS could be better targeted so that these schemes are heard about beyond Westminster.
We must look beyond these measures and, as this Question urges, at the alternatives. The financial avenues available to small businesses are still plentiful but require some creative thinking and a culture change. One of the difficulties we are experiencing is that FTSE 100 companies are currently holding approximately £130 billion in their bank accounts. At the same time, many small businesses and entrepreneurs are sitting at home with a fantastic idea or product, but cannot make them commercially available without significant investment. There must be a way further to encourage our largest businesses to invest in and support these micro-businesses to make their products financially viable.
We could also encourage the establishment of alternative providers of capital. In the 1970s, a large number of finance companies were licensed under the Consumer Credit Act and provided business finance to small and micro-businesses. Companies such as Forward Trust, Lombard North Central and First National Securities provided an invaluable service, particularly to leasehold corner-shop owners, as I was at the time. When I first went into business in 1977, I lent from Forward Trust, and while it was expensive it was a specialist company that was willing to take risks. Unfortunately these firms were victims of their own success, and were taken over by the banks. There is, in my opinion, a clear gap in the market for firms of this nature if we can encourage them back. In addition, I meet many high net-worth individuals who are keen to invest in small new ventures but are concerned about doing so. I would like to see the Government explore ways in which wealthy individuals can be encouraged to support start-up businesses in which they are not directly involved.
A related point is that we should encourage smaller businesses to explore new equity financing arrangements. This can help to bring in the capital needed to allow companies to grow and, if coupled with expertise or guidance, may well increase the chances of a small business succeeding, particularly if it is in the early stages.
In the UK, we are fortunate to have significant venture capital funding options for businesses. However, these are often restricted to specific geographical areas, certain specialised industries or businesses of a certain size. I should be interested to know whether the Government have any plans or incentives to help to expand the venture capital industry so that many SMEs that currently miss out can benefit from this very useful industry.
It is worth taking a moment to consider two other points. This Question is clear about looking for alternatives to high-street banks. It is my personal view that, if we were to reduce the barriers to entry for the banking industry and encourage competition, our SMEs would benefit most. By encouraging new banks-particularly local, regional and community banks-new sources of capital will become available to SMEs. In addition, by granting full banking licences to other international banks, such as those from India and China which do not currently do large amounts of business in the UK, or by supporting the creation of new banks, small businesses across the country will feel the benefits and have access to new sources of credit.
My final point is that, while I fully support the need to find new sources of capital for micro-businesses and SMEs, we should not decouple this from ways in which we can reduce the costs that these businesses incur. I know that this week's publication of the Beecroft report has created some debate about the best way forward, but the Government have a duty to do all they can to reduce the considerable regulatory and fiscal burden on small businesses.
We need a radical new approach to small businesses generally, not just to how they find alternative sources of finance. I would appreciate my noble friend's comments, especially on the areas that I have suggested: the speed at which we can raise finance; the need for BIS's communication strategy for small businesses to be well targeted; whether we can make effective use of the £130 billion of deposits held by the FTSE 100 companies to help small businesses; whether we can do something about high net-worth individuals; and whether we can do more about our venture capital funding. As the noble Baroness, Lady Kramer, said, there are many barriers to starting a new bank. How about issuing a full banking licence to some of the foreign banks that have cash liquidity?
Lord Myners (Labour)
My Lords, I, too, congratulate the noble Baroness, Lady Kramer, on securing this debate. It is a pleasure to follow the noble Lord, Lord Popat, who brings a great deal of relevant business experience to our debate. I also look forward to hearing the reply from the Minister, the noble Lord, Lord De Mauley, who also has a very impressive career record in banking and financial services. Although the number of speakers in the debate may be small, with the single exception of me the quality of contribution will no doubt be exceedingly high.
It may be helpful to set some context for this issue. First, lending by UK banks to corporate borrowers, excluding financial institutions and real estate, represents less than 5% of the assets of the UK banking sector. Secondly, small businesses, and in particular the smallest of small businesses, tend on average to be net lenders to banks rather than net borrowers: that is, they run working capital cash surpluses and do not rely on debt from any source to support their business. They do of course rely on the banks for services, particularly for payment processing.
Chart B on page 7 of the Bank of England's Trends in Lending, published in April 2012, shows that net lending to SMEs continues to contract at a rate of about 5% per annum. In fact, this has been the case since 2009 and it is not limited to the UK alone; it is a global phenomenon. It is observable in the United States and in the euro countries that lending to small companies is contracting.
Despite the fact that lending is contracting, terms are widening. An economist might say that that suggests prima facie evidence that if banks can charge more in a market of contracting demand, there must be inadequate supply so that the banks can charge more generous-some would say penal-terms. I am not at all persuaded of that. As a Treasury Minister I wrestled with the issue of whether declining commercial lending was a function of banks not lending or of borrowers not wanting to borrow. I certainly did not find a convincing answer to that question and I do not think that the current Government have either. I suspect that we will never be able to find the answer. I remind noble Lords that this is not a distinctly UK phenomenon. It appears to be happening elsewhere in the world.
I think that the widening of terms is a consequence of effective competition among market leaders. The noble Baroness, Lady Kramer, referred to the dominance of our five major lenders. Indeed, the report of the Independent Commission on Banking highlighted on page 167 that the concentration and absence of effective competition was at its most acute in the SME sector. Personally, I think that the Royal Bank of Scotland should never have been allowed to acquire NatWest. I declare an interest. I was a director of NatWest at that time and have no doubt that it needed remedial treatment, but the economic consequences of the concentration in SME lending was damaging to the economy.
We must, of course, await the White Paper, due to be published on
The noble Lord, Lord Popat, referred to Project Merlin. It did not deliver the gross lending target that was set for it, but it was not the right target. Again, I wrestled with this in government. Mr Vince Cable was very clear. In an interview in the Daily Mail before Merlin, he said that the introduction of a gross lending target as opposed to a net lending target would,
"be completely letting the banks off the hook. It's perfectly possible for banks to achieve a gross lending target while withdrawing capital from small to medium-sized businesses".
I think that the right honourable Vince Cable was correct and that the Treasury's approach to defining the objectives of Project Merlin were right. Indeed, it is to the Government's credit that they did not renew Project Merlin because the banks were quite frankly running circles around them in achieving those gross lending objectives.
We shall see how the new programme of credit easing operates. It does not involve direct lending to small businesses; it involves reducing the funding costs paid by the banks. We have heard very little about credit easing and have seen very few cases of small businesses claiming that they have been rescued or significantly supported by credit easing. I am very sceptical about whether it will work in practice. I hear that one of the major banks is offering cashbacks to SMEs through credit easing-in other words, not reducing the level of debt at all. The Government need to look very carefully at whether that initiative will work.
The noble Baroness, Lady Kramer, referred to the case for new banks, and I think that the noble Lord, Lord Popat, did as well. We have seen two banks sold recently-at least one, Northern Rock, was sold; and Lloyds Banking Group is still trying to sell the business under the code name Project Verde, which has to be disposed of under the state-aid remediations. It was interesting that these banks sold not at book value but well below it. That is quite telling when we consider the attractiveness of being involved in banking. Mr Stephen Hester, the chief executive of the Royal Bank of Scotland, said in a recent interview that many people thought that one had to be dumb to invest in banking at the moment. I suspect that those who hope for the creation of new banks will find themselves waiting a long time. At the moment, if you put £1 of capital into a new bank, its de facto value will rapidly fall to 70p or 80p because-I do not wish to be too technical-the ROE generated with an appropriate leverage ratio is simply not capable of matching the cost of capital. In other words, the banks are not producing a return that is consistent with the risk, as the equity provider would expect.
We heard comments about alternatives such as pay-day and peer-to-peer lending. We need to keep them in perspective; they are very marginal and will not have a transformational impact on the UK economy. They might be of some benefit to individual borrowers but they are not the solution to the problem of generating economic recovery. Similarly, the proposals from Mr Tim Breedon-worthy, well argued and thoughtful as they are-must again be seen as marginal, at least in the short term. Reducing the dependence on banks as a source of credit and encouraging bond markets, as one sees for instance in America, is a good and laudable objective, but it will not help us out of the current mire of the double-dip recession. For that, we need to see fundamental economic adjustments.
The core issue is not that our banks are not willing to lend, or that they are constrained by capital, but that people do not want to borrow any more than they need in a climate where the business and economic outlook is highly uncertain. The absence of confidence, to which the Government's economic policies have been a contributory factor, is leading to a lack of appetite for borrowing, investing and growing businesses. While we may look for fault on the banking and credit availability side, the real issue is whether we can articulate coherent and credible strategies that will get the economy moving again. To date, the Government have not shown evidence that they can do that. They and the Bank of England seem to be following policies of financial repression. However, I am hopeful that circumstances are changing and that there will be a greater appetite on the part of the Government for taking positive measures to stimulate and promote economic growth without going back to aggressive deficit-growth strategies.
Lord Smith of Clifton (Liberal Democrat)
My Lords, I, too, thank my noble friend Lady Kramer for securing this very timely debate. It is humbling to follow such a great expert as the noble Lord, Lord Myners. I cannot begin to compete with him but I, too, will attempt to put the issue in context.
It looks likely that some of the institutional giants in the world of banking may go the way of the dinosaurs. Nothing lasts for ever, and they resemble nothing so much as the cruise liner "Costa Concordia", wallowing in the shallows of the Mediterranean and waiting to hit the rocks. Mindful of that, we must read the runes and suggest alternatives. It is a banal truism to say that financial services are vital to the health of the nation's economy-and equally vital, as my noble friend suggested, to the prosperity of both community and region.
Project Merlin, which was referred to, was meant to increase the flow of bank loans to businesses, particularly small and medium-sized enterprises. Although the banks agreed to this, in practice little was achieved; there was no magic. Project Merlin would have been named more aptly, Project Tommy Cooper. The failure was symptomatic of how the banks are not serving the needs of the economy. We need to raise our sights and contemplate alternatives.
As the noble Lords, Lord Myners and Lord Popat, said, much of the western world, including the UK, are in for a protracted period of zero growth at best, or negative growth at worst. The UK will experience a society and economy similar-although, I hope, not with the same magnitudes-to that of the 19th century. The Victorian age, Dickensian and ghastly though it was for so many, nevertheless inspired the creation of a whole range of remedial initiatives. These included the rise of the co-operative movement, the formation of building societies, credit unions, mechanics institutes and the like. Self-help and mutuality constituted the operating principles of the time, with the main emphasis being on the local and communal. As my noble friend Lady Kramer said, the banks in those times were much more focused on serving the local and regional areas and were by no means all centred on London.
Globalisation has, of course, brought many economic benefits but also costs, including the recent disasters within the financial services industry. We need to recreate the local to offset the worst excesses of globalisation. We should learn from our Victorian predecessors. The Victorians, of course, inhabited an era of increasing economic growth, whereas for us it will be the reverse. That makes it all the more important. It would be sheer folly to think that existing arrangements and institutions will be able to adapt themselves. Already commentators are adding to the "too big to fail" character of banks a "too big to manage" dimension. It is interesting that in today's FT there is a report which states that,
"pressure mounts for the break-up of US banks".
This is why other options must be explored.
If history may be a guide, so, too, can comparative experience. I refer to the extraordinary example of Mondragon in Spain. Starting in 1956, a range of industrial co-operatives have developed. Central to their growth has been their own bank, to which they subscribe and from which they borrow capital. As co-ops, they are owned and controlled by their employees. They are also restrained in the size of their labour force, and above a defined limit the individual co-op has to split up and divide into two. There are now over 250 constituent co-ops in the Mondragon federation, employing nearly 84,000 people. It is the seventh largest enterprise in Spain.
Co-ownership, of course, has long been a much cherished Liberal Party and Liberal Democrat party policy. The late Lady Seear was an ardent advocate of co-ownership on these Benches. In the mid-19th century there was a good deal of cross-party support for wider share ownership. Now there has been a revival of interest, with talk of enterprises being created on the lines of the John Lewis Partnership model. It has been mooted, for example, for the re-organised Post Office.
The ground is becoming more fertile for the planting of the seeds of a new thinking. Some fruitful new signs have emerged. For example, there is the issuing of local currencies in Lewes, Brixton, Totnes and elsewhere; and the facilitating by Mr Ivan Massow's "Business Angels", whose peer-to-peer lending encourages companies with more than adequate cash reserves to make loans to credit-strapped companies. I am sorry that the noble Lord, Lord Myners, thinks this is small beer. I hope it will become catching and grow.
However, much more needs to be done. We need a champion along the lines of the late Lord Young of Dartington. Michael Young pioneered the rise of the consumer movement in the last half of the 20th century that unleashed a social and economic revolution. That is what we need here. Someone with that kind of vision, lateral thinking and organising flair is sorely needed now to address the pressing problems we face, none more so than in the area of the local provision of banking credit. There are, alas, too few Michael Youngs, which is why I suggest a co-operative of intelligent, like-minded pioneers to think up and bring about the radical changes that must be wrought.
We must not drift or sleep-walk into the future. As a response to the continuing crisis, mass protest, though wholly understandable, is not the answer. That answer will come only from radical and new ideas. The focus must be on the small scale and communal. If the Prime Minister's advocacy of the big society is to have any chance of becoming a big deal, small and communal enterprises will form its essential components.
I have one question for the Minister: what evidence can he adduce that the necessary thinking and effort is being applied by the coalition to address this issue?
Lord Berkeley (Labour)
My Lords, I, too, welcome this debate and the success of the noble Baroness, Lady Kramer, in achieving it. It has been a very interesting debate so far and I would like to discuss, if you like, the other end of the telescope: the needs of small businesses that have contracts with large companies.
Due to the way that the large companies have set their terms, these SMEs seem to need more and more finance in order to create enough working capital to keep going. It is very sad that some of these major companies are taking action to make it more difficult for SMEs to continue. They do not seem to realise that if they do not have the SMEs, their own businesses are not going to succeed. I will describe two case studies-one good, one bad-and I certainly am not blaming banks for the situation, I am blaming the companies. It is an issue that needs some action.
First, the good company is Network Rail-it may surprise your Lordships to hear me cite Network Rail as a good company, but actually in the past five years, from being a pretty bad customer, it has turned out to be a very good one. In November, it launched a fair payment charter for its suppliers, which it signed with 30 of the biggest construction and engineering companies. Network Rail says that the charter helps to,
"increase liquidity through the supply chain",
and there is about £7 billion a year of expenditure at stake. I believe that some 80% of its suppliers are in the SME category, so it is quite important.
The key thing is that Network Rail has taken a decision,
"to shorten the time it takes to pay suppliers from 56 days to 21 days".
Equally importantly, the fair payment charter also,
"commits Network Rail's suppliers to make payment to their first-tier subcontractors within seven days of receiving payment. This means that the time from the submission of a main contractor's application to receipt of payment by the first-tier supplier is now 28 days",
which really helps to,
"increase the liquidity of the supply chain and provide greater certainty for suppliers in terms of business planning".
The other thing Network Rail has done is to,
"phase out the practice of retention in contracts-where a portion of payment is withheld until after completion of work".
This is very common in the civil engineering industry as well. The charter also requires suppliers,
"to mirror the retention regime agreed with Network Rail for the ... subcontractors. So, where the main contract retention is zero, this will be replicated down the supply chain".
This is a major achievement.
In March, Network Rail signed up to British Standard 11000-Collaborative Business Relationship Management Systems-with its five major suppliers through the Institute for Collaborative Working. I declare an interest in that I am on the board of the institute. It really is a major step forward. I talk to a lot of contractors and suppliers of Network Rail and they welcome it. It is not often that suppliers to any big organisation welcome the payment terms, and this is really a positive step forward. Let us hope that it continues-I have every reason to believe that it will-as it will help getting value for money on a £7 billion programme.
Now for the bad case, and it is pretty bad. I refer to National Grid, which is a company that is probably of a similar size to Network Rail. It is a pretty strong company. It made a profit of £644 million in the year to
National Grid pays an average of 24 days beyond the terms in its contract. It also has very tough procurement processes for small suppliers, which it forces to accept these non-standard terms. It has 42 days as a standard for payment of invoices and is actually paying suppliers, on average, 66 days after it receives the invoice for the work done. This hides the fact that over 34% of the suppliers have to wait 91 days to be paid by National Grid. According to Dun & Bradstreet, this company has one of the worst payment records in the UK. Only 7% of all UK businesses have a worse delinquency score, as I would call it. Of every 10,000 National Grid payments, 5,683 are significantly late. At one time last year its payment terms were 60 days over standard, which means that it is taking over 100 days to pay its suppliers. I suggest that the company is using its monopoly position to force suppliers into lending it millions of pounds-which then forces the banks into lending to the smaller suppliers, through what are probably expensive overdraft facilities, to keep them solvent.
Network Rail and National Grid are both regulated monopolies, as the House will know, but Network Rail has this code of practice while National Grid sits on what I believe is a pretty fat profit and thinks that it is reasonable to delay payment to SMEs for over 100 days, thereby putting some of those businesses into financial difficulties. My question to the Minister is: what is Ofgem doing about it? Has it got any teeth, or has National Grid achieved what I call regulatory capture? The Government want to encourage SMEs and investment, as do we all. They also want to encourage growth-as the noble Lord, Lord Taylor of Holbeach, said in winding up the last debate. Will the Minister therefore ask Ofgem to require National Grid and the other companies in this sector to adopt a fair code of practice on the lines that Network Rail has so successfully operated in the rail infrastructure industry?
Lord Young of Norwood Green (Labour)
My Lords, I thank the noble Baroness, Lady Kramer, for providing the opportunity for what might be a micro-debate in terms of numbers but a macro-debate in terms of the issue. I start with what my noble friend Lord Myners referred to as the core issue-if we do not get some growth and confidence back into the economy, we face a situation where potential borrowers and small businesses see borrowing as the very last resort because they do not have confidence in the current financial situation.
I am also glad that we are having a debate on an issue which something like 28% of SMEs said was one of the key issues that they face. I am afraid I did not agree with much of what the noble Lord, Lord Popat, said except when he got on to the Beecroft report. I do not think that that is going to encourage small businesses to take on more employees. Confidence and the ability to borrow if they feel confident are much higher up their agenda. If we had to give a message on how they should treat their employees, it would not be on the ability to fire them without giving them a reason for dismissal. It might be on recognising the need to invest in their employees and have decent HR policies. They might find that they would get a much better return in productivity and retention. That has been my experience over the years.
I must admit that, listening to the noble Baroness, Lady Kramer, I found myself in agreement with much of what she said. She talked about the different developments in the US, Switzerland and Germany and the social obligation and local nature of their banking. That is a view about which the Federation of Small Businesses, if one looks at its report, was asking the Government. I look forward to the noble Lord, Lord De Mauley, commenting on whether the Government intend to pick up on any of the recommendations of that report from the Federation of Small Businesses.
There seems to be some disagreement, as some have suggested, including, I think, the noble Baroness, Lady Kramer, in relation to innovative, online peer-to-peer lending. I do not feel confident about saying who is right. The noble Lord, Lord Smith, referred to that as something that would be of value, although my noble friend Lord Myners did not necessarily agree with that. I must admit that I was fascinated to hear the comments of the noble Lord, Lord Smith, about Mondragon-I do not know whether I have pronounced that right-and the expansion of Co-ops. That was an interesting point.
Whatever Merlin did, it certainly was not a magic bullet. It did not deliver. My noble friend Lord Myners delivered a far more comprehensive analysis of the failure of Merlin. What is the Government's strategy, given that Merlin has failed and credit easing does not yet seem to have emerged to solve the serious problems that we face? The plain fact of the matter is that the Government are failing to get the banks lending to SMEs and that is one of the contributory factors to holding back growth and job creation. Credit easing has failed to get banks lending to more small businesses. If we were in government, we would have established a British investment bank to support SMEs-an infrastructure that was backed by the British Chambers of Commerce and by Adam Posen from the Bank of England.
In relation to other measures that the Government could take that might assist small firms to take on extra workers, a national insurance tax break might well provide some relief and encourage companies to consider taking on extra workers. In our view, it would reverse the Government's damaging VAT rise. Interestingly, the Bank of England's lending report of April 2012 said:
"The stock of lending to businesses decreased by around £9 billion in the three months to February ... The net monthly flow of lending in February was at its lowest in almost two years".
It went on to say:
"Spreads over reference rates on lending to small and medium-sized businesses widened in 2012".
That is not a good picture at all of the Government's attempts to get banks to lend to small businesses.
"Nobody ever argued that the credit easing scheme would solve the problem of small business lending. We argued that it would cheapen the cost, and that will happen. All the major banks are now engaged in arranging packages to enable those lower costs to be passed through".
He said that we were going to be,
"pleasantly surprised by the take-up within a few months".-[Hansard, Commons, 14/5/12; col. 289.]
That sounds different from what the Chancellor told us in October in his description of the credit-easing scheme. I would welcome the Minister's opinion on whether the Government feel that that scheme is having any effect.
In the other place, Labour's shadow Small Business Minister, Toby Perkins, said that the Bank of England survey showed that many businesses are seeing the cost of finance rise and that small and medium-size businesses are finding it hard to get finance at all. He said that we are looking to the private sector to grow our economy, but 50 businesses are going under every day and too many are struggling to get the finance that they need to grow and take on extra employees. He said that Ministers promised that the credit-easing scheme would help firms unable to get finance, but the report shows that the scheme is failing to make a difference. He went to say that the Government continue to let down small firms under pressure because of the recession made in Downing Street. Labour is planning a British investment bank to help small businesses get the finance that they need to grow. Our five-point plan for jobs and growth will provide real help, including a one-year national insurance tax break for small firms hiring extra workers.
I was interested in the comments made by my noble friend Lord Berkeley when he gave us the idea of the good guy and the bad guy. This is a serious problem for SMEs. I would be interested to hear what the Minister has to say about what he described as a fair payment charter. It seems a worthwhile proposal for industries which are regulated.
I conclude by coming back to small and medium-size businesses. When I speak to them, they tell me that they see this as an issue of high importance. They do not tell me that the ability to hire and fire is their number one concern. Given that Project Merlin has failed, what positive steps are the Government intending to take? Are they going to pick up recommendations made by the Federation of Small Businesses? I look forward to the Minister's response.
Lord de Mauley (Whip, House of Lords; Conservative)
My Lords, I thank my noble friend Lady Kramer for initiating this debate, and all noble Lords who have participated. This is a vital issue and has been for a long time; it is not a recent phenomenon, although it is even more acute in the current environment.
The Government are committed to rebalancing the economy, encouraging private sector investment and creating the conditions for confidence to return, small companies to thrive and growth to revive. Ensuring that small businesses and micro-businesses can access the finance most appropriate for them is a core priority. While we want to ensure that there are alternatives to high-street banks for businesses, the majority will remain reliant on banks. It is vital that SMEs are able to access bank finance. I will explain what we are doing in that area before dealing with alternatives.
First, the Government provide guarantees to viable SMEs lacking sufficient collateral to secure commercial finance. The enterprise finance guarantee scheme plays an important role in facilitating credit to viable small businesses and micro-businesses. Over 12,800 businesses with a turnover of under £1 million have been offered EFG loans. That equates to 70% of all the loan offers under the scheme. The enterprise finance guarantee is delivered by lenders directly. They include banks, and alternative finance providers such as community development finance institutions.
Secondly, in the Budget the Government launched the national loan guarantee scheme, which reduces the cost of bank lending to smaller businesses by up to 1%. This is achieved by the Government providing guarantees on unsecured borrowing by participating banks to enable them to borrow at a cheaper rate, and therefore to pass on the entire benefit they receive to small businesses through cheaper loans. The Government will provide up to £20 billion of such guarantees. Thousands of businesses have already benefited from LGS loans and the scheme is proving popular. Ulster Bank formally launched the scheme in Northern Ireland last Monday.
Thirdly, to improve relationships between banks and small businesses, we are working with the BBA on the delivery of a range of bank commitments. As a result-and this is very significant-the banks have put in place: first, an independent appeals process to deal with situations where businesses have been declined loans; secondly, an online mentoring portal for SMEs to find sources of advice; and, thirdly, a lending code that makes it clear what standards businesses should expect from their banks.
It is also important that we do what we can to encourage the development of diverse sources of finance for SMEs beyond just the banks, which is the gist of my noble friend's Question. Increased competition not only between banks but between forms of finance will improve outcomes for businesses. The Business Secretary recently commissioned a report, which has been referred to in this debate, from Tim Breedon that explored alternative finance options such as supply chain finance, mezzanine finance, peer-to-peer lending, retail bonds and so on. All these should be fostered and encouraged, to create a more resilient business finance environment. The Government have a role to play but so do financial institutions and, crucially, businesses themselves.
To diversify the sources of finance available to smaller businesses further, BIS has received £100 million from the business finance partnership. This funding will focus on alternative lending channels which aim to lend specifically to smaller businesses. The key aims of this scheme are to stimulate the development of non-bank lending channels and to increase the supply of capital to smaller businesses. In support of these objectives, we are considering investing business finance partnership money through peer-to-peer lending platforms, mezzanine loans and supply chain finance products.
For businesses seeking other forms of debt finance, community development finance institutions offer an alternative to the banks. They provide microfinance and small loans to enterprises that banks consider too costly or too risky to serve. Such businesses can nevertheless be viable and tend to have a positive impact on their local community. The Government support the CDFI sector in a number of ways. A key aspect of this community investment is tax relief. This encourages investment in CDFIs by providing a tax relief worth up to 25% of the value of the investment over five years. The funds so invested are then on-lent by the CDFIs to small businesses and social enterprises. We are currently looking at ways to simplify the rules to encourage more usage and make it more effective. This is because public investment of this type has been shown to be an effective method of generating and protecting economic output. Our evaluation has demonstrated that every £1 of tax incentives generates an additional £1.89 of net gross value added. We also support CDFIs through the regional growth fund by contributing £30 million to the sector to facilitate £77 million of lending through small loans-around 4,500 loans-to small and micro-businesses.
In addition, we are about to launch a pilot scheme at the end of this month to help young entrepreneurs set up their business and access finance when doing so. Aimed at 18 to 24 year-olds, the start-up loans scheme will provide microfinance and mentoring support to enable young people to start and grow a business.
I have focused so far on debt finance. The Government are also committed to supporting equity funding. We have committed £200 million over four years to the enterprise capital funds programme, bringing our investment to more than £300 million for SMEs with the highest growth potential. We are also working to stimulate business angel investment through the establishment of a £50 million business angel co-investment fund. This partly addresses my noble friend Lord Popat's point. Through this, we co-invest with business angels in high-growth-potential early-stage SMEs, particularly in areas most affected by public spending cuts. My colleague Mark Prisk announced the first deals under this scheme earlier this month.
However, we are not limiting our support to finance itself. To help businesses navigate the various support programmes, we have launched the "Business in You" website to help businesses access support and mentoring and determine which financial support package suits them best. The growth accelerator programme will also provide intensive management and training support to high-growth-potential SMEs.
Noble Lords asked a number of questions. I will address as many of them as I can. My noble friend Lady Kramer compared the German, US and Swiss local banks and their emphasis on localness favourably against our branch networks; my noble friend Lord Smith made a similar point. We recognise the value of the bank branch network and relationship banking for SMEs, where the manager knows the area and understands the business. Indeed, these values are still present in the UK banking sector. In particular, some of our smaller banks have chosen to adopt more traditional banking models, with an emphasis on good customer service, personal relationships with customers and local focus to operations. The larger banks, too, recognise the importance of having managers with a clear understanding of businesses and the local area.
However, my noble friend makes an important point, and the Government remain committed to ensuring that viable businesses can access the finance that they need at an affordable rate. My noble friend suggested that RBS's network should be used as the basis of a regional banking network. The Government's shareholding in the Royal Bank of Scotland is managed on a commercial and arm's-length basis by UKFI, whose overarching objective is to protect and create value for the taxpayer as shareholder, with due regard to financial stability and acting in a way that promotes competition. Splitting it up into a regional banking network might be a considerable undertaking and would take a fair while. It is uncertain whether it would improve lending conditions for small and micro-businesses. However, UKFI continues to work closely with the bank's management to assure itself of the bank's approach to strategy and to hold it rigorously to account for performance.
My noble friend suggested that credit unions and CDFIs are too fragmented and small. That chimes with something that the noble Lord, Lord Myners, said; he was basically sceptical of alternative forms of finance in general. The Government recognise the important role that CDFIs play, but are aware that the sector needs to operate on a greater scale to widen their coverage across the United Kingdom. The Government's regional growth fund award of £30 million will help to address this issue, as it will facilitate £77 million of lending. It will also allow the Community Development Finance Association, which developed the fund, to build its capacity and capability to act as a wholesaler to the sector. This will allow it to look to private sector funders and European institutions. This, combined with the community investment tax relief and enterprise finance guarantee scheme, will enhance the sector's capacity to grow.
My noble friend was critical of the barriers to entry to the banking industry; a number of noble Lords referred to that. All prospective new banks must apply for and receive a banking licence from the FSA. This is an essential step to ensure that all banks in the UK operate to the required standard and that consumers are protected. It is right that standards are robust. The FSA has, however, recently implemented a number of improvements to the banking licence process which will make it easier for potential new entrants to navigate. These include holding pre-application meetings with the applicants and the introduction of a modular approach to assessing deposit-taking applications.
My noble friend suggests a less onerous licence for small, local banks with a community obligation. We are clear that prudential standards for capital and liquidity should not act to dampen the effective competition and that new banks should not be treated disproportionately subject to the level of risk. That is why we have supported the Independent Commission on Banking's recommendation that the OFT should work closely with the Prudential Regulation Authority to review the application of prudential standards, to ensure that they do not pose excessive barriers to entry and expansion from new entrants.
My noble friend was concerned that the new online lenders should be regulated under the Consumer Credit Act and by the OFT, and about the feeling that the responsible players are bracketed with the cowboys. The Government have noted the online peer-to-peer lenders' concerns and are keeping the case for further regulation under review. Any decision to regulate would need to balance the needs of borrowers and lenders and the possible impact on new market entrants.
I am afraid that I am running out of time, so I will write to noble Lords whose questions I am unable to address. My noble friend Lord Popat had several. He was concerned about low participation in government lending schemes and the poor publicising of schemes available. We recognise the lack of awareness of government schemes and, following the Breedon review earlier this year, we have already committed to consider how best to improve awareness of such schemes. We are working to raise understanding of the support available to SMEs, including through a new online finance finder tool at www.businesslink.gov.uk.
The noble Lord, Lord Myners, referred to the Vickers report. I enjoyed his thought-provoking speech. Let me just answer his point. The Government welcome the work of Vickers and further analysis is ongoing to confirm the detail. As the noble Lord said, a White Paper and formal consultation will be launched next month.
The noble Lord, Lord Berkeley, raised a very important point. May I say, rather rudely, that most of it was slightly outside the scope of this debate? However, I can see exactly where he is coming from. He addresses the finance that is available to suppliers-for example, to National Grid. The Government acknowledge that this is an important issue. Many SMEs report that working capital and late payment are obstacles as great as access to external finance. Mark Prisk has convened a working group with business representative bodies to explore how to tackle this issue, which also relies on SMEs agreeing payment terms in advance.
Several noble Lords referred to Project Merlin, through which the banks have lent £215 billion to businesses in the United Kingdom, including £75 billion to SMEs against a target of £76 billion. I acknowledge that they have not hit the target by £1 billion in £76 billion, but this none the less represents a 13% increase in gross lending on 2010 and Project Merlin has clearly focused the minds of senior bank officials on SME lending.
Lord de Mauley (Whip, House of Lords; Conservative)
My Lords, I am sorry-I am out of time and I cannot allow interventions. I have to conclude.
As I hope noble Lords can see, we have a large menu of measures to support the provision of diverse sources of finance. We will carefully assess the impact of these policies to ensure that businesses of all types are able to access the finance that they need.