Many SMEs want easy and cheap credit from their banks — but it is not a self-evident market failure that this is not always provided to them.
Still, the UK’s Government has asked Tim Breedon (Legal & General’s CEO) to assess how smaller firms can meet their capital needs without simply being dependent upon the banks. The report is due in a week or so.
I have written previously about crowd-funding) which I see as a form of private placement, structured via the internet. This can work for equity — as I discussed in the previous blog — and also for debt issuance. For an example of the latter one can look at the Funding Circle in the UK. So far it has raised about £27 million in lending so far, with the average loan value being a little over £40,000. Ultimately the capital is sourced from retail investors, with their capital spread across various loans. This diversification, across both firms and — importantly — different industrial sectors, should be of great potential value to the Funding Circle’s investors.
Loans can be sold to other investors fairly easily if at par (subject to 0.25 per cent commission), i.e. there is liquidity for the investors, at least until a loan defaults. The interest rates charges to firms vary from 4-15 per cent (subject to a credit assessment of the borrowers is conducted by the team at Funding Circle). Other than this assessment, the same type of challenges that face crowd-sourcing (again, see the previous article) apply here too. The ability to trade debt introduces liquidity justifying a slightly lower risk premium.
The cost issue can be harder to resolve: there’s the cash cost of issuance (what leaks away to lawyers, accountants and other advisers) and, of course, the distraction of management from running the business itself.
It’s important to recognise that Funding Circle is quite different in concept from the modern conception of a bank (i.e. there’s no fractional reserve banking). It is facilitating the private placement of what are in effect corporate bonds, at a reasonable cost (2–4 per cent commission). There is probably not much that the Government needs to do, or should do, in terms of regulatory simplification (unlike with equity) — although Funding Circle may see things differently on that score of course — rather it can stand back and allow the market to make its assessment.
Whilst the above — and everything else that the Breedon Review considers — may need time to grow into the role of being major providers of capital needs of small firms, they do represent market-based solutions to our needs. This is important because it is in sync with the way in which business is done in the UK. A brute intervention to create the infrastructure required for a “hausbank”-style approach akin to Germany’s would be immensely costly and runs the risk of being a poor institutional fit for the British economy.