Small firms forced to choose overdrafts over loans

A report says more SMEs are taking out overdrafts instead of loans. But do they have a choice?

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Last Updated: 31 Aug 2010

An interesting report reaches us from credit specialist CreditPal, suggesting that nearly one in three small UK firms has applied for an overdraft (or an extension of their current one) in the last two years. Since overdrafts are normally more expensive than loans, CreditPal seems to think this means small firms are missing a trick – which could be an expensive mistake. But we’re not convinced. With most of the banks in extra-cautious mode (better late than never, you might argue), arranging a loan can be a slow and painful process even for a sound business. Overdrafts may be the only way to get hold of the necessary readies in time…

About 30% of respondents to CreditPal’s study (which was carried out by YouGov) said they’d applied for a new or extended overdraft since 2007, while just 21% have applied for a loan. The trend was even more marked for firms with a turnover of £250k-£500k: nearly half had applied for an overdraft, but less than a third for a loan. So if nothing else, we can say that overdrafts do seem to have become a more popular way for small companies to get their hands on working capital.

But why? As CreditPal points out, the rates of interest on an overdraft are likely to be much higher – as much as 23.5%, in some (usurious) cases. Since the British Banking Association reckons that SMEs have about £9bn worth of overdrafts at the moment, that means small firms might be shelling out more than £2bn a year in interest payments.

CreditPal’s own theory is that borrowers ‘may feel an affinity with their current account provider’, thus making an overdraft ‘a more appealing option’. However, its argument seems to be predicated on the belief that ‘it is now clear that there is money available for [lending to] sound businesses’, if they ‘provide a reliable indication of their trading position’. And we suspect many firms would beg to differ on this point, on the basis of their experience last year.

Besides, even if banks do eventually stump up the cash, the process tends to be a big drain on time and resources. Perhaps that’s the best way for banks to curb their irresponsible lending – but that’s not much consolation if you’re a business in imminent danger of running out of cash. In which case, getting your bank manager – who already knows your business – to arrange an overdraft is usually a much quicker and simpler solution (even it does cost more). Many small firms are battling for survival; jumping through hoops to get the best lending rate may be a luxury they can’t afford.


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