Can new loan scheme break business credit drought?

The National Loan Guarantee Scheme is another state-backed bid to persuade banks to lend money – this time to firms with a turnover of less than £50m. But in a climate where banks narrowly failed to meet lending targets set out by the government under Project Merlin, critics fear the scheme may not be adequate.

The scheme means that banks will have access to cheap funding from the government, which will enable them to lend money at a more competitive rate than they would otherwise.

However, the criteria banks use to decide which firms they are prepared to lend to are not likely to change. As the Federation of Small Businesses has pointed out, despite the launch of the NLGS, if you did not qualify for a loan yesterday, you are unlikely to qualify for one today.

Overdraft refusal

And this appears to be key to the success or otherwise of the scheme. A small business owner from London, who asked not to be named, told Channel 4 News of his struggle to secure emergency funding from his bank when a customer failed to pay him.

He said: “I run a plumbing and electrical business and at the end of last year, for the first time in 15 years, we were faced with a bad debt and decided our best option would be to go to our bank and ask for an overdraft facility of £200,000.”

Our business turns over £5.5m annual and our net profit is between 5-9 per cent of that. But our bank, which we’ve been with for 12 years, said no to a £200,000 overdraft. Small business owner

But that simple request was met with a month-long wait and then a refusal from his bank: “Our business turns over £5.5m annually and our net profit is usually between 5-9 per cent of that. But our bank, which we’ve been with for 12 years, said no.”

Instead the institution offered him credit in a form over which the bank ultimately had control: “They said they would help if we changed to something called invoice financing, whereby basically the bank becomes the debtor for your clients but the bank chooses which clients it will act as debtor for.

“It helps improve your monthly cash flow but the bank doesn’t pay you for all of your monthly debts, only the ones it deems suitable. And they charge you a fee for the service. But we didn’t want that, we just wanted an overdraft.”

He said the bank’s sales representative justified their terms by saying: “We’re a no-risk business”.

Non-bank finance

If a firm cannot persuade traditional forms of finance to part with their cash, it needs to be creative. As the small business owner told Channel 4 News: “Even six years ago, when we expanded and we asked for a loan of £250,000, the bank came back with some ridiculous terms so we ended up going out and raising the money ourselves.”

There are other options however. In February, the Federation of Small Businesses called on the government to champion non-bank finance to get round the near-impasse on banks lending to business.

It made a series of suggestions to achieve this, such as peer-to-peer lending (although these sources are unlikely to lend to start-ups as they require a credit history before they will commit) and for community lending facilities to be brought into the mainstream.

In January, it became theoretically possible for credit unions to lend to business. So far, however, according to ABCUL, the industry body for credit unions, no unions have made use of that capability, although it is still early days for that option.

The Bank of England’s credit conditions survey cited a sharp drop in demand from small businesses for credit, though it did not make clear what could be the reasons behind this. Following a drop in the number of defaults by small businesses, compared with their larger cousins it also predicted defaults to be stable in the early months of 2012.

Only the coming months will show if the NLGS has the forces to break the business credit drought.