DBS

25 “The beauty of the product right now is its lack of complexity and inherent flexibility.” – Jen Clarke, Grant Thornton PROVIDING FUNDING TO SMEs In 2012, when a government task-force headed by Legal and General CEO Tim Breedon warned that SMEs faced a funding shortfall of up to £191 billion in the wake of the global financial crisis, an SME-friendly bond market was cited as one of the possible solutions. The global financial crisis of 2008 certainly intensified the SME funding gap, with banks and traditional lenders becoming more reluctant to provide credit to borrowers. This was as a result of the mass deleveraging of banks to limit losses in those difficult economic times, but also because of higher capital requirements imposed by global regulators, understandably concerned about the level of risk banks had been taking on. The consequence in Europe was the Basel II Accord regulations introduced in 2008; the EU Basel regulatory frameworks for banks aim to maintain banks’ solvency by strengthening the regulation, supervision and risk management of the sector. This required banks to hold significant amounts of capital against risky assets, resulting in lending to small ticket loans of £250,000 or less becoming unprofitable for banks. Basel III, due for implementation from 2017 to 2019, gives even higher capital requirements to banks as security against potential financial shocks and to cushion against any failures of higher risk assets. The Basel III Accord brings in stricter rules on calculating the capital to be held for each type of asset, adds a requirement for capital buffers to be held and imposes liquidity ratios to ensure that banks have sufficient liquidity to deal with severe market shocks and can continue to run in the medium and long term. This amounts to higher costs for lending, particularly for higher risk transactions, such as loans to SMEs. WILLINGNESS OF BANKS TO LEND It’s hardly surprising then, that during and after the financial crisis, banks have been contracting their balance sheets and, in spite of the loosening of banks’ lending criteria in more recent years, Basel III is likely to encourage these to constrict again. The uncertainty of Brexit and the unpredictable effects of it, with the potential for an economic downturn and volatile markets, could also lead banks to look more carefully at the entities to which they lend. And consideration is also likely to be given to the greater amount of work required by lending to small firms; large firms take more money for longer and have more assets to secure loans against. As a result, the British Business Bank estimates that 500,000 SMEs are deterred or declined for finance every year. In 2015, the OECD voiced its concerns on this situation, stating that, “While bank financing will continue to be crucial for the SME sector, there is a broad concern that credit constraints will simply become ‘the new normal’ for SMEs and entrepreneurs. It is therefore necessary to broaden the range of financing instruments available to SMEs and entrepreneurs, in order to enable them to continue to play their role in investment, growth, innovation and employment 38 .” If we add to this the reaction of banks to the economic turbulence resulting from the Brexit decision, there is the prospect of bank interest rates on business loans rising to offset greater perceived risk in difficult times combined with the potential of further reduced lending volumes. The OECD suggested a solution: “Across OECD countries, the corporate bond instrument, which can serve the needs of medium-sized companies, providing an injection of liquidity to undertake investment and seize growth opportunities, has had only limited diffusion in the SME sector. However, in the aftermath of the global crisis, as other traditional GENERAL ECONOMIC OUTLOOK -60 -40 -20 0 20 40 60 WILLINGNESS OF BANKS TO LEND SOURCE: SURVEY ON THE ACCESS TO FINANCE OF ENTERPRISES IN THE EURO AREA, OCTOBER 2015 TO MARCH 2016, EUROPEAN CENTRAL BANK, JUNE 2016 MICRO SMALL MEDIUM LARGE SMEs