No wonder small businesses can't get credit when the UK is the only G8 member not to have a body dealing with such finance
For some time, the calls have increased for the creation of some type of government-backed financing institution to support the UK economy. There are two areas where getting investment moving is vital for the creation of a growing economy: the financing of small and medium-sized enterprises (SME), and ensuring we have fit-for-purpose infrastructure.
The non-availability of finance to smaller businesses is long-standing, having been identified in 1931 by the Macmillan report. Market failures exist in relation to the provision of both debt and equity, often resulting from an asymmetry of information between the finance provider and the business. Financiers find it difficult to distinguish between high and low risk businesses without incurring significant costs which are judged too high in relation to the level of finance being provided, thus reducing profit margins. Banks avoid this by only financing businesses with a strong track record and/or the provision of collateral (the classic mortgaging of the family home to finance the business). There are also credit-scoring systems which mean that atypical and innovative businesses, which may be economically viable, are unduly penalised because they do not fit the mould. Added to that is the lack of competition in the mainstream SME lending market, and the trend towards short-termism in lending.
Faced with such systemic issues it is surprising, to say the least, that the UK is the only member of the G8 not to have a dedicated institution dealing with SME financing issues. There are international examples from which we can learn, notably the activities of KfW in Germany, the Small Business Administration (SBA) in the US and the Business Development Bank of Canada. The SBA provided early-stage finance to success stories such as Apple. But there is also past UK experience in the original activities of the Industrial and Commercial Finance Corporation (ICFC). It was created immediately after the second world war to address the funding gap identified by the Macmillan report and employed technical specialists, familiar with local business, operating through a regional network. That original business model gave way under pressure from external investors to increase returns more quickly. That experience needs to be borne in mind when considering how to structure any government intervention.
In the area of infrastructure investment, the coalition government's national infrastructure plan identifies the huge investment required in infrastructure over the next decade (some £250bn). We have a nascent model in the area of the green economy – the Green Investment Bank. Its activities are currently constrained by its inability to borrow until at least 2015, and then only if public sector net debt is falling as a percentage of GDP. Its role is to crowd-in private finance where it can and to demonstrate financeability by being a frontier investor, acting in a commercial manner, not as a supporter of lost causes. Finance for infrastructure investment is constrained, in part by the retreat of commercial banks from the sector and the demise of credit-enhanced bonds, but also as a result of regulatory changes which make long-term investing in infrastructure more expensive. The EU has initiatives to attempt to address these issues, but their resources are finite and have to cover the entire EU. Given our investment needs, intervention is also required by the government here in the UK.
Past and present experience points towards the creation of a British investment bank with a dual bottom-line business strategy – operating on a commercial basis and independent from government, but with an express public policy mission. Given that split and the broad range of interested parties affected by its activities, there is merit in establishing an overarching advisory council which would not have executive authority, but which would ensure that the board held to its dual strategy. Members of the advisory council could include, among others, representatives of key government departments, trade unions and business.
Funding for the bank could come from a range of sources, including channelling funds from National Savings and Investments. Something similar is done to fund comparable institutions in France and Italy. That would create an effective depositor base for the bank and give it a platform to develop further products to fund its activities – for example Green Isas, which could fund interventions by the Green Investment Bank.
Unless we learn from the experience of other countries, we will put our businesses at a permanent disadvantage, reliant on ad hoc government initiatives such as the Funding for Lending scheme, which the Bank of England has admitted could be used by banks to boost their profits instead of reducing borrowing costs. British businesses deserve and require better than that.