UK: CAPITAL WAYS - BANKS. - Finance - Tight-fistedness, short-sightedness and a lack caution and parsimony of the banks. Fears are voiced about the met. The sources of support are there, though, for those willing.

Last Updated: 31 Aug 2010

Finance - Tight-fistedness, short-sightedness and a lack caution and parsimony of the banks. Fears are voiced about the met. The sources of support are there, though, for those willing.

Banks are notorious for the generosity with which they hand out umbrellas when the sun shines. They were, however, uncharacteristically slow to withdraw them this time when the recessionary rains started to fall. So the brollies that got soaked in the early '90s took a long time to dry out, and there is a notable reluctance to distribute them again, even now that quite large patches of blue sky have started to reappear.

The truth is that the UK financial sector - particularly the high-street end of it on which most small and medium-sized businesses still predominantly depend - has been going through a terrible time, and its attempts to recover, though perfectly understandable, are making life extremely uncomfortable all round.

It was all so different as the Lawson boom shrugged off the impact of 1987's stockmarket collapse and moved towards its final feverish peaks. In those heady days there was barely a deal, a takeover or an expansion scheme that could not be readily funded. Indeed there was often a queue of lenders falling over themselves to offer the money. After Big Bang an army of hungry, foreign invaders moved in, from Frankfurt, Paris and Milan - and above all from Wall Street - and many of them identified smaller companies as a relatively soft target. Several set up ambitious branch networks embracing regional centres like Cardiff, Bristol and Leeds and for the finance directors of even quite modest enterprises it was as if Christmas was happening all year round. Traditional relationships went for nothing, as the newcomers offered ever-keener rates and fancier services, and the Barclays, NatWests and Midlands of this world were forced in many cases to match them or see their own customer-base cut to ribbons.

Unfortunately this short-term bonanza swiftly turned into longer-term misery - and for many, terminal disaster. Unemployment and interest rates soared. Consumer confidence plummeted. Loan-service commitments, which had looked easy to meet on the day the agreements were signed, soon turned difficult and then impossible. Barclays reported bad debts piling up at the rate of £10 million a week. NatWest, with well over £1 billion set aside in 'provisions', revealed that half of this related to advances of less than £50,000 apiece. And in 1992 no fewer than 63,000 corporate names vanished from the registers at Companies House - the largest number of annual failures recorded since the General Strike year of 1926.

The upshot has been wholIy predictable. The overseas bankers, sucking their burnt fingers, have either sought more promising outlets (like Eastern Europe or the Pacific Rim) or now talk only to the largest and best-entrenched corporate borrowers, while the household-name locals have re-established all - perhaps even more than all - of the dominance they previously enjoyed. The important difference, though, is that they are now much tougher, both in the pricing of the services they are prepared to provide and the identification of risks they are no longer willing to undertake. Hence the stream of complaints, at their tight-fistedness, short-sightedness and lack of sympathy, which on several occasions has reached Parliament and caused ministers like the president of the Board of Trade, Michael Heseltine, (and certainly his opposite numbers on the Labour front bench) to wonder aloud whether all this caution and parsimony is not in danger of damaging the economy as a whole.

In practical terms, the most significant official response so far has been to set up a Whitehall investigation chaired by the Treasury minister, Anthony Nelson. Its remit is to seek out 'market imperfections which may impede the flows of finance' and suggest ways in which they might sensibly be repaired - especially as far as they affect the allegedly unmet needs of Britain's small-to-medium firms. He is due to publish his findings and recommendations some time later this year.

It is far from being the first such enquiry. Complaints that banks are too mean and stock markets too myopic and greedy have been common since the beginning of business history, and every political generation sees new efforts to define and resolve the supposed problem. Harold Macmillan produced one ponderous report in 1931, and shamed the high-street clearing banks into setting up the institution which became today's 3i, now Europe's biggest single source of venture capital. After the war Harold Wilson came back to the subject and prodded the Stock Exchange into launching an Unlisted Securities Market, so that equity funding could be made more easily available to fledgling entrepreneurs.

Now there is yet another drive on to discover why the UK is so pushed to sustain the local equivalent of Germany's famous Mittelstand - a flourishing core of small-to-medium-sized enterprises which are still able to create jobs, generate exports and establish themselves as world leaders in their various specialist fields. Nelson, however, will need to be extremely careful. He is bound to find himself assailed by the usual whingeing chorus which assembles on these occasions, demanding tax breaks, special subsidies and further heroic cuts in interest rates. Yet it is far from clear that these are the remedies really required.

On the contrary, it could easily be argued that the best way to help the great mass of British corporate enterprise might well involve encouraging it to sharpen up its own often less-than-optimal standards of financial management. Responsibility for the over-trading, over-gearing, over-borrowing and over-acquisition that contributed so much to the county's recent economic miseries cannot be laid wholly at the door of the clearers - they merely provided the wherewithal which others then put to dubiously-desirable use.

It is certainly not true that the UK's industrial and commercial small fry are always starved of support. For most of the deregulated '80s the reverse applied. Banks beefed up their small-business units and energetically fostered new sources of long-term risk capital, while the venture capitalists, stuffed with institutional investment, were ready to back almost any proposition in the sure knowledge that a USM flotation would safely and profitably take it off their hands.

It is from the many hangovers generated during that heady period that most of today's difficulties arise. These include not only the bad-debt experience which has contributed so largely to the banks' current mood of steely-eyed suspicion, but a number of other unhelpful side-effects. The badly-singed venture capitalists, with a stack of bust or unsaleable participations still cluttering their books, have drawn in their horns a long way and are now only really interested in sure-fire projects like the larger type of management buy-out. The biggest of them all, 3i, which has sunk £2.7 billion in some 3,700 companies during its 50-year life span, reluctantly decided, after months of preparation, that this was no time to offer itself to the investing public. And the USM, after suffering a string of failures and disappointments - many of them from among the defunct rockets of the Lawson years - is gradually being phased down, which will leave most of the corporate tiddlers cut off from any practicable access to equity funds.

There are some welcome signs of improvement. Venture capital is scenting recovery and once more flexing its muscle. All the main groups are busy raising new capital and the mighty Prudential has announced that it is doubling its 'new enterprise' commitment to £500 million. Even the mezzanine finance sector, which provides second-tier, less fully secured funding for the more elaborate deals, is coming back to life. Indeed the Intermediate Capital Group, which is the biggest specialist provider of this particular service, is exuding confidence.

So far the Stock Exchange authorities, despite pressure from brokers like Brian Winterflood, of Winterflood Securities, who has always specialised in the trading of small-capitalisation shares, have been unable to agree any workable plans. Now a new pressure group, Cisco (The City Group for Smaller Companies) is calling for a separate and independent exchange to provide a cheap route for fledgling flotations. With backing from substantial names like merchant bankers Singer and Friedlander and accountants KPMG Peat Marwick, Cisco is now talking about going it alone, with hopes that within a couple of years it could be trading in the shares of more than 200 companies. But although Reuters, British Telecom and Nasdaq, which runs the flourishing US over-the-counter market, have all been mentioned as possible commercial operators, nothing has yet been signed and sealed nor has the estimated £5 million launch capital been definitively raised, though there is fairly confident expectation that it could be raised from various venture capital and institutional sources. One of the most useful tasks for the Nelson enquiry might be to help the various sources concentrate their minds.

Seeking a public-company quotation, though, comes fairly far down the road to corporate maturity. Before that can happen a business needs to be launched, nursed through its early teething troubles and brought to some kind of maturity. Though in very rare cases this can be achieved purely by profit retention and internally generated resources, it normally means, sooner or later, tapping into some source of out-side support.

The big banks, though bitterly criticised for their current harshness and lack of sympathy, are likely to remain, overwhelmingly, the most important source for such midwifery and early nursing. And despite their recent bruising experiences, they are still determined to remain very active in the small-business arena.

There is nothing particularly altruistic about that decision, just hard-headed pragmatism. However difficult to cultivate profitably, it remains one of the last sectors where the high-street clearers do not yet face direct competition from the non-bankers such as building societies, capital-market operators and other financial service specialists which are increasingly invading - and often conquering - their other traditional territories. They still rely on it as an invaluable source of low-cost deposits and hopefully remunerative lending fees, plus a steady stream of day-by-day servicing charges.

The deposits are particularly enticing. Like Barclays, NatWest has roughly one million small-firm accounts (Lloyds and Midland claim another 500,000 apiece) of which the majority have an annual turnover of under £100,000. But between them, they give the bank virtually permanent use of around £4 billion. Admittedly this pays a small interest charge, but at today's rates this is little more than nominal and allows plenty of room for its custodian to make a distinctly healthy profit.

The charges, too, offer a valuable income stream. It is too valuable, perhaps, for it is their current level - up by more than 20%, it was reckoned, in 1992 alone - that has generated the most bitter criticism. The nation's corner shops and jobbing builders complained vociferously that they were being squeezed to pay for the losses engendered by past unwise lending - not to them, but to heavyweight disasters like Brent Walker and Canary Wharf - and the Government agreed sufficiently to call in the Big Four's chairmen for a session of knuckle-rapping. This produced only the most formal expressions of regret, however, and very little sign of either true contrition or real change.

In terms of the bigger picture, though, this is all slightly peripheral. Deposits and charges are nice to have, but they will never generate really big money. That comes, if at all, from the interest levels generated by large-scale lending, and it is here that the banks are on the horns of their sharpest dilemma.

There are several factors involved. First, there is the fact that many firms at the lower end of the corporate ladder rarely borrow at all. Jane Bradford, of NatWest's small business department, reckons that half her clients finance any expansion plans they may have entirely from their own cash resources, and her opposite number at Barclays, David Laverack, would put the proportion as high as two-thirds. Those who do decide to seek backing - and remember we are still talking about well over one million mainly tiny operations - represent a different and much more intractable set of problems. They usually have little or no track record. It is as costly to assess their prospects and credit-worthiness as it would be for a much larger (but probably longer established) concern, and the amounts involved tend to be individually minute. But getting the sums wrong, as in 1992, can easily bring heavy retribution.

To meet these challenges, the Big Four are each mounting a three-pronged attack. They are investing heavily in automating and simplifying their loan-processing techniques, as a way of systematically cutting costs. They are refining their risk-assessment and risk-pricing techniques, thus reducing their vulnerability to unanticipated losses. And they are putting a much heavier emphasis on bespoke tailoring and extending the variety of their financing services, as the best way to stimulate customer demand.

This is long overdue. Whether through ignorance or inertia, small companies in Britain have always been excessively wedded to the short-term overdraft. Their reliance on these has always been far heavier than their overseas competitors - four-fifths of corporate loans in Germany are based on long-term, fixed interest rates, and for France, Japan and the United States the figure is in each case over 60%. But in the UK less than half of business debt takes that form, and that includes the giants like BP and British Gas. For lesser lights, without sophisticated treasury departments, the proportion shrinks much further.

This is good neither for borrowers nor lenders, and a concentrated drive is on to encourage a major switch to longer-term loans. The carrot is security and foreknowledge of future commitments; the stick, the steep rise in the penalty for running into unauthorised overdraft territory, which is only too easy at a time of chronically slow inter-company payments. In two years NatWest has reduced this sort of expensive backsliding by 43%, thereby cutting out a whole load of its own associated costs. And at the same time it has moved half of its £10 billion small-loan book on to an agreed fixed-term basis, with 9% of these arrangements now on comfortably extended maturities of 10 years or beyond. This is a very healthy development, helping significantly to offset Britain's endemic addiction to 'short-termism', about which everybody complains but does little to correct. With luck the conversion process has a lot further to go.

It is part of the re-establishment of 'relationship banking', which is one of the recession's more positive results. The idea that you and your bank should work closely together in lasting partnership took a savage beating during the go-go '80s (especially as it had always, until then, been a fairly passive ideal). In those sky's-the-limit days, boards and finance directors saw little reason to stay loyal to old friends - especially if they were unable or unwilling to match the terms so readily on offer elsewhere. But now things are very different. Both parties have painfully rediscovered the extent to which they need each other, and the gratifying result is - or should be - a much more supportive and understanding association all round. From the bank's point of view the position is clear. They want the business but they are no longer prepared to accept it at any price. Recent bitter experience has taught them the need both to keep a much sharper eye on margins and to minimise (or at least to charge appropriately for) any element of risk that they agree to undertake. The dramatic spread of information technology - in which they have all hugely invested - allows them, for the first time, to analyse accurately and virtually instantaneously the amount of profit and exposure that any particular corporate customer represents.

From where that customer stands, this is both a threat and an opportunity. He knows that facilities can be withdrawn or sharply reduced if his business is seen as shaky or unremunerative. But equally, if he can convincingly represent himself as a reliable source of current earnings and future potential, he is likely to win the assurance of greatly enhanced short-and long-term support.

That puts a high premium, of course, on communication. The more the bank knows about the people to whom it is lending money and providing services, the better equipped it is to improve its overall level of help - and, very importantly, the more understanding it is likely to be if things, for some reason, turn temporarily sour. So the most successful firms, big and small alike, tend to be those which are best at creating confidence. The Olympia and Yorks of this world, which never tell anybody anything, are the first to be dumped when the going gets rough.

Part of the trick is to make sure that it is always a senior member of the firm who is charged with keeping in contact - it is no good relying on a junior, without either high-level information or real decision-making authority, to carry out an effective job. But it is also necessary to appreciate that even banks have a living to earn. Keeping abreast of a customers' affairs requires a significant investment of time and personnel. So maintaining good terms includes making sure that it is worth the trouble, and that not just one partner - yourself - is profiting from the exchange. 'A relationship that costs nothing is worth nothing,' says David Harris, who used to be finance director of Rothmans International and now runs a London-based consultancy on the best way for companies to organise their financing needs.

His business and that of a growing band of similar specialists is to guide firms that are too small to support their own full-scale treasury department through the proliferation of complex sophisticated and usually fee-carrying services that are increasingly on offer. As many businesses are ruefully discovering, it can be just as difficult and challenging to ride the rapids of recovery as it was to survive the recession that preceded it.

One vital key to success here is the efficient management of working capital, particularly as it relates to credit requirements. The old-fashioned overdraft obviously retains its importance but it often proves a blunt and inadequate weapon. Nowadays it can be supplemented by a varied array of useful alternatives.

The first of these, at a time when most businesses are bedevilled to some extent by slow payment and some have been driven by it to the edge of bankruptcy and beyond, go under the names of 'factoring' and 'invoice discounting'. These can be provided either by bank subsidiaries or independent speciaIists like Trade Indemnity-Heller Commercial Finance and offer an effective way to shift the burden of this particular headache. Invoice discounting releases up to 80% of the money tied up in a specific group of trade debtors, while factoring, which is now a very big business in its own right, essentially involves a company selling its whole receivables ledger (and any associated problems) so that it can forget about debt-collection and concentrate instead on what it does best.

Then there is the whole huge area of leasing - anything from a single photocopier to a whole factory complex - which provides a way of boosting fixed assets without depleting scarce capital resources.

Capital itself has become much easier to generate recently, and many companies (despite the USM problem) have taken advantage of current stockmarket buoyancy to raise many billions via rights issues and new flotations. But for those unable or unwilling to exploit that opportunity, there is also an ever-expanding UK market for commercial paper (following the example of the US where this has long been a prime source of day-to-day finance).

The practice essentially involves the issue of short-term unsecured promissory notes, written for any period between one day and one year, and capable of raising virtually any sum required (though the practical minimum is probably around £500,000). The banks' in-house specialists, such as NatWest Capital Markets, reckon they can set up an effective programme for any suitable client inside six weeks. All the customer needs to provide is a favourable credit-rating from one of the recognised vetting agencies like Standard and Poor's.

Once you have got the money there is now an array of electronic and other aids to help use it efficiently. Some, like NatWest's BankLine, are capable of automating transactions for an entire global enterprise, handling invoices, orders and internal transfers in any conceivable array of currencies and tax regimes, and tipping out even momentarily-arising surpluses so that they can be earning their keep in appropriate interest-bearing accounts. But others, which are less purely transactional, are directed more to that increasingly essential skill, the management and transfer of risk.

Nowadays this is perhaps the fastest-growing and most innovative area of the financial services industry, and you do not have to be a sprawling multinational to benefit. Even for relatively modest enterprises, the use of such devices as interest-rate caps and foreign-exchange hedging offers extremely valuable reassurance. Indeed the idea of risk-hedging, in all its myriad varieties, is likely to become of increasingly central importance at all levels of business - especially if other countries follow the American precedent. The courts there recently sustained accusations of commercial negligence against one firm (a Midwest farming co-operative) which had failed to use grain-futures as a way of protecting the value of its stocks. With the current global explosion in option-markets of all kinds, finance directors in many industries might find it hard to defend themselves against similar charges. And even without that spur, there is a growing understanding everywhere that hedging and the imaginative use of derivatives are a way for both borrowers and lenders to sleep easier at night.

There is one important area of risk, though, that remains dangerously uncovered as far as Britain is concerned. Business start-ups - especially when they involve new ideas, unfamiliar products, or any sort of untried innovation - have always found it hard to attract seed capital, and the process has been getting even more difficult lately after so many of the 1980s venture-finance funds got their fingers so badly burned. Yet this remains the crucial trial-ground for the providers of tomorrow's jobs, prosperity and economic growth.

Kenneth Clarke's November 1993 Budget promised the setting up of an Enterprise Fund to take the place of the discredited and widely-misused Business Expansion Scheme, but its precise size, nature and function have yet to be defined. If Anthony Nelson is seriously seeking gaps to fill and deserving candidates for the next issue of umbrellas, he need look no further.

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