Local knowledge is vital for SMEs seeking finance
When I undertook the Access to Finance review for the Welsh Government that culminated in the recommendation for a Development Bank for Wales, it was important to ensure that detailed research was undertaken to demonstrate the case for closing the finance gap faced by small to medium-sized enterprises (SMEs).
Given that prior studies had showed that, in general, SMEs had encountered increased difficulties to access bank credit following the global financial crisis, we wanted to understand if this was the case in Wales and whether the geographical location of banks across the UK had any impact on SME access to bank finance.
To do this, we analysed data on bank lending gathered by the SME Finance Monitor which, since 2011, has questioned 5,000 different SMEs quarterly in the UK about their borrowing events. More than 65,000 interviews have now been conducted as part of this survey, building into a considerable dataset on the past and future finance needs of SMEs in the UK.
We have recently published the full study into this area in the Journal of Economic Geography, one of the leading periodicals in its field but to summarise the main results, our work did find evidence suggesting the economic region where SMEs are located does matter in obtaining finance.
In particular, the further the distance between the branch of a bank (where lending information on a business is collected) and the bank’s headquarters (where the decision on a loan is normally made) leads to lending constraints for SMEs.
This suggests that the local branches of a large centralised bank, especially in more peripheral regions such as Wales, face disadvantages in meeting the credit needs of local SMEs as compared to a small, local bank with more independent decision-making autonomy.
This may explain some of the problems that the SME sector has experienced since the recession. Indeed, with only five significant players, the UK banking system is notoriously centralised when compared to banking systems in other countries that have a more diversified base of providers.
In addition, the way that branch banking has recently developed in the UK has produced a system of decision-making that is now largely based in the banks’ strategic centres located in a few key cities.
As a result, the importance of local knowledge in the underwriting of bank credit towards SMEs that used to be the norm in the UK banking system has been downgraded. This, along with the continuing reduction in the number of branches across various banks’ networks, has begun to reshape the UK’s financial infrastructure.
Simply put, our results suggest that small business borrowers based in more peripheral regions such as Wales risk being marginalised when it comes to accessing bank finance with serious consequences for local economies.
Of course, politicians would argue that since the economic crash of 2008, they have put together various measures to enhance the access of SMEs to external finance. Unfortunately, these have been formulated largely at a national level and have been delivered through the network and the professional experience of private sector banking institutions on a risk-sharing basis.
And despite various reports that have emphasised the need for more regionally-based banking, there has been largely a failure to date by successive UK Government in the last decade to consider regional disparities in funding within its financial policy initiatives.
Clearly, the development of a British Business Bank to focus on increasing the amount of lending to businesses is to be welcomed but until the announcement last year of a Northern Powerhouse Investment Fund by the UK Government, there were concerns that it was not responding to the different regional economic contexts of parts of the UK.
More worryingly, it could mean that regional differentiation between prosperous and peripheral areas could increase with consequences for poorer economies at a time when we need to be closing the gap across different parts of the UK.
This in contrast to the UK Government’s business policy which has focused on developing more locally based economic development approaches through initiatives such as City Deals and Local Enterprise Partnerships in England.
In fact, it is surprising that policymakers are happy to focus on developing more responsive local business support mechanisms whilst ignoring the need to encourage and support a more regionally-focused banking approach that uses sufficient local knowledge for the successful understanding and the management of the investment of local SMEs.
Fortunately for the Welsh economy, the establishment of a new Development Bank for Wales later this year should help to address this issue and potentially provide our economy with a competitive advantage.
More importantly, if it evolves into the type of organisation that can address the key issues identified in our paper, then it could begin to make a real difference in ensuring that Welsh businesses do not lose out in accessing finance if, as many expect, the banking system in the UK centralises further over the next few years.