« Previous | Contents | Next »
Listen
CHAPTER SIX: BANK MANAGERS' DISCUSSION OF GENERAL CRITERIA WITH SME PROPOSALS
Introduction
6.1 As well as conducting the protocol analysis based on the selected five case study scenarios, the interviews with the bank managers also covered more general questions relating to their dealings with their SME business customers. This covered questions relating to each of the three participating bank's protocols and procedures, the type of information they would typically require about clients and their business propositions, and the importance they attached to various criteria in making funding decisions. Although there were some interesting differences between the three banks, most of the answers confirmed the findings of the protocol analysis presented in the previous chapter.
6.2 In addition to the interviews with the eight bankers, an additional interview was conducted with the Princes Scottish Youth Business Trust ( PSYBT) in order to obtain a better insight into the problems of accessing finance experienced by start-up businesses run by young entrepreneurs. This interview focused particularly on the extent to which these new businesses also approached banks for finance. The results of this interview are presented in the final section of this chapter.
Protocols and Procedures
6.3 All three of the interviewed Scottish banks indicated that they have a segmentation approach to the SME business market. In two of them, this is based on the turnover size of businesses , with a turnover of £1 million being the threshold. For the third bank, the segmentation approach is based on the size of the credit facility within different 'tiers' of lending requirement. A £250,000 credit facility is one threshold, although there is some overlapping authorisation between different tiers. Therefore, the size of the SME concerned and the borrowing requirement would dictate, partly, how the business customer would be dealt with in terms of the processes of the bank and the nature of the relationship with the manager.
6.4 All the banks have a 'relationship management' approach. With existing customers this could lead to a streamlined decision-making process where the bank manager undertakes a minimum due diligence procedure, particularly where an existing business customer is facing what is perceived to be temporary difficulties ( e.g. the foot and mouth crisis in farming). It is evident that considerable time could be spent with individual SME client businesses. Following an initial approach, time would be spent understanding the business, its management and visiting the premises. For one bank manager, it is considered to be 'very important' to meet the client face to face.
6.5 For existing businesses the standard three years' trading accounts would be required and the way that the account was managed is clearly important to determining whether the facility would eventually be approved. Financial modelling would be used in most cases, however, for smaller amounts (such as that involved in case 2 in the previous chapter), a more streamlined credit-scoring system would be used. However, this varied between the banks (see section 6.3 below). Such a system gives more limited discretion, producing one of three outcomes i.e. accept, reject or refer. A refer decision would need sanctioning by a central decision-making credit department; in other words it might be approved if a case could be made acceptable to the central credit unit. Generally, however, for existing customers considerable discretion for authorisation is given to the bank managers themselves.
6.6 For start-up propositions additional forecasting information is required. The interviewed bank managers implied that more time may have to be spent with start-up propositions in order to establish the information required, with one banker commenting that 'a lot more information is required with start-ups'. They are generally willing to use Business Gateway as a referral mechanism for start-ups in order to ensure the entrepreneurs received appropriate advice, training and support with preparation of business plans. Authorisation and discretion is more limited with start-ups and all start-up approvals are required to be sanctioned from a central credit department by at least one of the banks.
Information Required
6.7 Some discussion of the information required has been given above, especially in terms of the differences between existing business customers and start-up businesses. Beyond this serviceability is an important factor, or the viability and sustainability of a proposition. For example, one banker commented that they needed to be 'convinced about the business and the serviceability of the debt'. The nature of the client's credit history is regarded as essential information and generally historic information is considered to be more important than projections for existing businesses. As noted later, this means that greater information is required for start-up propositions, even if the entrepreneur may have been associated with a previous business. Additional or more specialised information would depend upon the purpose of the proposition. All the managers indicated an ability to bring in a specialist team of staff if necessary, dependent on the nature of the proposition. For example, if the application was from a technology-based, company, concerned a management buy-out, or concerned property investments, the bank managers have the ability to call on specialised staff and intelligence usually from within the banks themselves.
6.8 As was apparent in the case scenarios, the bank managers would seek an understanding of the business and the management team by visiting premises. The importance of the company's management and strategy compared to financial information varied a little between the interviewed bankers. Interestingly, two managers from the same bank when presented with the same case scenarios were found to have contrasting priorities.
6.9 In taking propositions forward all the banks use a financial modelling system, apart from in the case of some smaller applications. The indications are that this produced a risk-reward categorisation which is a guide to decision-making.
Credit Scoring
6.10 As mentioned earlier, credit-scoring is used with smaller applications in a more streamlined situation. The bank managers that participated in this research were relatively senior and would not normally deal with applications that might be allocated for credit-scoring. Of those that discussed this issue, one banker indicated that it would only be used for credit facilities below £100,000 and another that it would only be used for businesses with a turnover below £1 million, indicating that alternative thresholds were applied by the different commercial banks. One banker indicated that where credit-scoring is used with a new business proposition it would provide re-assurance rather than be used as the sole basis for making the decision.
Reasons for Non-procedure
6.11 Non-procedure would usually result from a failure to meet the requirements in the process that has been outlined above. Generally, this meant that there are historic problems with credit history or with a lack of historical information on trading accounts. One bank manager referred to 'holes' in the information set which could lead to non procedure or seeking to do a different level of credit facility.
Importance of Different Criteria
6.12 The bank managers were presented with an extensive list of different criteria, verified in advance by the research team, and asked to comment on their importance for decision-making. There was some variation between them in the importance they attached to a number of the criteria but also some consistency on others.
6.13 There was a consistent consensus that knowledge of the business owner/managers is very important, which confirmed the importance of this factor from the analysis of the case scenarios. The personal relationship between the SME owner and the local bank manager is a critical factor and as indicated during the case analysis, bank managers invest considerable time and effort in developing their relationships with their SME business customers. For example, for a new potential customer, one banker considered that it is essential to be satisfied that they have the right competencies and skills. Another banker commented that in the case of a new to bank business customer it would help 'if a recommendation is made through an accountant or valuer, or one of our other professional contacts'.
6.14 Location, particularly related to the issues of peripherality, accessibility to markets and where local markets are perceived to be limited, is regarded as a factor that could be important, confirming its importance from the case scenario analysis. The discussion also reinforced the importance of local knowledge and local business relationships. Although some bank managers have extensive regional and geographical remits, one manager commented that 'they tend to deal with clients within 25 miles of our centres'.
6.15 There was some variation in the importance attached to sector between the bank managers. For one banker 'no sector would be ruled out'. There was consensus that all sectors would be considered, apart from those excluded for ethical and legal reasons. For another banker, the sector did matter, indicating that some sectors may be out of favour, although propositions would always be considered. As indicated by the case scenarios, some sectors are regarded as competitive and additional information may be sought on them centrally for financial modelling purposes. One banker considered that there are some sectors that are 'not actively pursued.'
6.16 Previous trading history, authorised accounts, profitability and the management track record are regarded as essential by all the bank managers. This would give them a trend analysis. As mentioned previously, banks like to have three years' trading history. This allows them to 'benchmark' against central information on the nature of businesses and their performance in different sectors as part of the overall appraisal. Forecast information is more important for start-ups and new businesses, forecast cash flows being essential for new businesses.
6.17 The importance of personal factors such as age, gender, and experience varied a little between the interviewed bank managers. There were strong opinions expressed that gender is irrelevant and 'never considered'. However, one female banker thought that there may be a perception amongst female entrepreneurs that gender could be important (which may support other evidence of discouraged borrowing by female business owners). Certainly the banks' protocols and systems should, in principle, be gender neutral with all banks reminding their managers regularly that all customers and potential customers should be treated equally. There was some variability between bank managers on the importance of the age of the business owner. Some were concerned that, with older owners, there should be succession planning in place and one banker commented that, with younger owners, it is lack of experience that could be a factor. Another banker commented that 'age is not barrier, but experience is'. Experience, generally is considered to be very important.
6.18 All the bank managers considered that available security is of secondary importance to the main considerations which focus on previous financial history, management track record, forecasts, serviceability and an understanding of the business. As with the discussion of the case scenarios, the interviews revealed that security could become an important issue, although it would not be the first issue to be considered. As one banker commented, 'security is considered, but it's not the main thing as the first consideration is can the business repay its debts'.
6.19 A related issue is the importance that the banks give to the Small Firms Loan Guarantee Scheme ( SFLGS). The discussion of the case study scenarios revealed that in certain specific cases the bank managers found that it had become more difficult to apply the SFLGS since the Graham Review 1 largely because the Scheme now targeted businesses less than five years old and entrepreneurs from social groups under-represented in enterprise. One of the bankers commented that they refer to specialists 'who are up-to-speed on the Graham Review'. Another said that 'where possible we will use it but [for] many of the businesses we deal with there are alternative forms of security that we should be using first'. One the bankers said that they had not used the Scheme since the changes, even though the sector criteria had been relaxed. One manager commented that 'we do use it on occasions, (but) it really is a lender of last resort for a viable business'. Generally, therefore, the SFLGS is used very much as a last resort and only for certain qualifying small businesses. However, these findings need to be treated with caution and are not surprising given that the SFLGS has become more targeted at start-ups and young businesses. Data from the Department for Business, Enterprise and Regulatory Reform indicates that in Scotland the Scheme is achieving expected take-up rates following its re-focusing after the Graham Review ( BERR, 2007). There were 235 approvals granted in Scotland from a total for the UK of 2,702 (8.7 per cent of UK approvals, but 9.6 per cent by value) under the revised Scheme to the year ended 31 March 2007.
6.20 Other factors that were discussed with the interviewed bankers included the nature of existing (additional) shareholders or investors, the role of support agencies such as Business Gateway, referrals from third parties and the role of credit references and customer recommendations. The role of additional investors, including business angels, is considered to be a potential benefit, but with a need for managers to understand their role. One bank manager commented as follows: 'it depends on what influence they exert, whether that's good or bad, in terms of their investment. If you can raise some additional finance it would help to get the deal off the ground. I would welcome that, but if it came with strings attached, or if it is a cash injection looking for a return, or a cash injection and keeping an eye on running the management, I really need to know who I am dealing with'. The use of referrals to support agencies is variable, but Business Gateway is seen as particularly valuable for referrals of start-ups. Referrals from third parties are treated generally favourably, although this is not an important factor. The use of credit references and customer recommendations is an 'added comfort' level, but again not an important factor in decision-making, apart from sometimes in the case of new to bank business customers.
6.21 There was further discussion of the relative importance of existing and new business customers. Whilst bank managers have targets for new business, the importance of existing business SME customers was reiterated, indicating that a higher level of information is required for new business customers. Finally the current credit environment (at the time of interview 2) was perceived to have no effect on current relationships with SMEs, nor was it restricting lending.
Summary of General Criteria
6.22 The discussion in this chapter has reinforced the importance of a significant number of criteria that were revealed in the findings from the analysis of case studies with the bank managers. As indicated earlier, there were some variations between the bankers in the importance attached to different criteria, but this is partly attributable to differences in their seniority as well as to different internal processes within the three participating banks. In summary, the following factors emerge as important criteria:
- The management track record of the management team.
- The existing personal relationship with the SME's local bank manager.
- The immediate financial history of the SME including the previous three years' trading accounts.
- Location for some businesses.
- SME sector, particular if some sectors are 'out of favour'.
- Security is seen very much as a secondary factor, but, taking into account the case discussions, it is a factor that could be important for 'high risk' lending situations with some SMEs.
- A related issue is that it appears from the interviews with the bank managers that the use of the SFLGS has declined since the Graham Review which might be expected given that the intention of the Review was to make the Scheme more focused on young businesses and entrepreneurs from under-represented groups. However, this may be acting as an additional constraint on well-established SMEs without identifiable security (as they are now ineligible under the Scheme).
- Existing business customers should find it easier to seek bank finance than new to bank customers.
Additional Consultation with PSYBT
6.23 The Princes Scottish Youth Business Trust's ( PSYBT) clients in Scotland are young entrepreneurs, less than 26 years of age, seeking to establish a new business. PSYBT support young entrepreneurs that qualify and satisfy their funding panel with a loan of up to £5,000 and a grant of £1,000. Successful clients are eligible for Development Loans of up to £10,000 and Accelerator Loans of up to £25,000 for business growth, if they have been in business for less than five years and are aged under 31.
6.24 The PSYBT deliver support through business advisers who provide 'aftercare' for two years. PSYBT considered that up to 15 per cent of their clients would seek commercial funding after the two year PSYBT support programme, but it was considered difficult for the client group to secure commercial funding due to the lack of personal credit history and a limited business trading period. It was considered that only about five per cent of clients of PSYBT succeed in getting any support from commercial banks at the start-up stage and that some of their clients go to three or four banks before being allowed to open a business account. Business Gateway and Highlands and Islands Enterprise are close enterprise partners and participate by referring 67.9 per cent of all new clients to PSYBT and by filtering out projects which are unsustainable (Scottish Enterprise, 2007).
6.25 In order to qualify for financial support a client has to be 'disadvantaged' and have used up any other source of finance that is available. PSYBT is seen as the 'lender of last resort'. In the case of young entrepreneurs, their age, lack of both experience and trading history can cause them problems with banks and other lenders. Evidence gathered from the research conducted for Scottish Enterprise (2007) about PSYBT found that the main source of finance for 82.7 per cent of start ups came from personal savings and their family. Bank finance was used as the main source of funds by 5.7 per cent. Most young people said they had, on average, £1,000 to invest at start up.
6.26 However, the evidence of market failure present in the PSYBT client group takes the form of a perceived problem of securing finance from external sources. Seventy per cent of respondents did not try to get funding from another source before approaching PSYBT, even though 61 per cent of them knew of other ways to secure finance. The reason given was a belief that they would be unlikely to obtain the necessary funds (Scottish Enterprise, 2007).
6.27 PSYBT makes 500 agreements a year, with typical lending on average £3,600 and, in their experience, 80 per cent of their clients repay on time. However, they did consider that a lack of financial record keeping is a problem, with only 25 per cent of clients having adequate financial records. Therefore, it is reasonable to assume that there would be problems with raising finance at the banks, once their clients are out of the Aftercare Scheme.
6.28 Overall, PSYBT considered that there is a funding gap for their client base with relatively small amounts of funding, perhaps less than £10,000. In general a funding gap for smaller businesses was considered to exist for amounts less than £100000.
« Previous | Contents | Next »