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Has Lending to UK Businesses Turned the Corner?

  • By Will Banks
  • Published: 7/23/2015
The British Bankers’ Association (BBA) reported a net £1.6 billion increase in lending to non-financial businesses in March of this year, the highest upturn since February 2009. This demand for borrowing has been matched and possibly encouraged by an increase in lending approvals by the banking community. Small and medium sized (SME) businesses in particular have seen stronger lending, with more than 35,500 approved SME loans.

This improvement is the net effect of £5.7 billion of new loan facilities and £1.4 billion of new overdraft facilities, representing a 3 percent increase in loans and a 13 percent decrease in overdrafts when compared to this time last year. This fall in demand for overdraft facilities could be explained by better working capital management and improved economic conditions, whereby CFOs are finding it easier to engage in renewed long-term debt financing strategies.

But, has bank lending to businesses really turned a corner?

New challengers

Reinvigorated UK economic stability created by the reelection of the current government and their recognition of the constraints around SME lending has encouraged a refreshing attitude within the banking sector as a whole, particularly with new (challenger) bank entrances. The process to obtaining a banking license has been reduced from years to months, allowing challenger banks such as Aldermore, Shawbrook, Cambridge and Counties and Metro Bank to emerge as new players.

Challenger banks realize some businesses face difficulty obtaining financing. They have thus focused on offering SMEs simple and transparent banking, minimizing the risk of replicating the idiosyncratic and market wide turmoil of 2008. 

Their unique selling proposition (USP) is based upon a pragmatic view to lending. To date, traditional lending has been based upon algorithms, driven by risk mechanisms which arrive at a “yes” or a “no” response. The tough lending environment created by the financial crisis, encouraged the “no” response, making it difficult for CFOs to fund their businesses. This new and refreshing attitude taken by challenger banks, if replicated by the big traditional banks, could increase the lending trend at an exponential rate, further stimulating the UK economy.

Already the paradigm shift in the banking sector has helped many businesses turn the corner from the financial and UK economic troubles they have been experiencing since the financial crisis. However, until this point, CFOs have been forced to become sophisticated in their approach to management of debt financing, in order for their businesses to survive. Additionally, their enhanced relationship with the treasurer has now positioned treasury at the forefront of a business, with treasurers being recognized as crucial advisors in strategic decision-making and ultimately ensuring the survival of a business.

Funding, post-crisis

During the financial crisis, CFOs had the option of raising funding via the traditional banking mechanism or by seeking out alternative providers of finance, such as crowdfunding and debt factoring.

Customers who cannot pay on time cause significant stress on the cash flow and working capital of a business. Pre-2008, CFOs could approach their bank to obtain a bridging loan or overdraft extension to alleviate the funding pressures created by late payments. However, during the financial crisis, this solution wasn’t always possible, so many businesses sought the help of debt factoring companies. This was through a financial arrangement in which a factoring company took responsibility for collecting money relating to a business’s invoices, immediately paying that business a proportion of the total amount owed on the invoices.

Some CFOs will remain loyal to these methods of funding, where others with remain with the banks. Some CFOs will keep their options open, evaluating what the challenger banks have to offer as well, balancing their commercial objectives with what is viable in the market. This might be debt financing or the raising of additional share capital. Risk and reward analysis is always imperative as a means to arriving at the right financing decision.

To calculate the risks versus the rewards of each type of financing, CFOs need to consider a balance between the cost of funding and the commercial fit, with the contractual terms, such as break clauses and possible collateralization requirements and covenants. There is also the reputational risk and thus the potential loss of business if the financing arrangement does not comply with the market’s ethical expectation of that business.

Potential for the future

As the availability of financing improves, the potential for further UK economic growth is possible. Challenger banks domain recognize this and thus more of them are actively obtaining a banking license.

However, new liquidity and capital requirements could have an injurious impact on banks’ lending policies, which will in turn affect their corporate clients. But, those banks which operate under a prudent financial model should not experience too many issues. One would also hope that new banks going through the license application process are being directed by the Prudential Regulation Authority (PRA) to frontload their buffers, to take into account new regulatory requirements currently sitting on the horizon, such as the European Liquidity and Capital Directives (CRR/CRD IV).

With the positive changes already taking place in the banking sector and with the number of challenger banks entering the market, lenders have ambitious targets to meet. In order to achieve these targets, lenders will either have to compete on rate or loosen criteria, making it easier for businesses to borrow.

Will Banks is executive director and consultant CFO for Challenger Capital.

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