The UK Federation of Small Businesses released new data on Monday showing that its members continue to find credit difficult to obtain. Half the small businesses surveyed say they intend to grow, and 22% of them had applied for credit in Q2, but of those 42.4% had been declined, a higher figure than in Q2 2012.
This tallies with our own findings about small businesses. In the latest European Credit Risk survey, released in July by FICO and Efma, 37% of respondents expected the aggregate amount of credit requested by small businesses to increase, and just 16% expect the amount granted by lenders to increase. That’s what we call the credit gap.
As John Walker, national chairman of the FSB, said, "Businesses want to grow and invest but they need a helping hand to do so. It is frustrating that bank finance is still difficult to get."
Unfortunately, this is another example of the Profitability Paradox. Banks want to lend to small businesses — particularly in the UK — but they don’t want to risk losses, which means they are less likely to lend to the cash-strapped businesses that are most in need of credit. Of course, if banks are tight with credit, SMEs will find another funding source, such as micro lending and official lending agents (like official development agencies). This will teach SMEs a new way to finance their business — which is not what the banks want.
One thing banks can do to overcome this is to build their confidence in how businesses will perform in the future, should the economy continue to struggle. Account-level stress-testing is possible through analytics such as the FICO Economic Impact Index, which measures the effect of the economy on credit risk.
One thing small businesses can do is to clearly divide their commercial assets from their personal assets. It can be difficult for potential creditors or investors to distinguish between the two. The entrepreneur may have re-mortgaged his or her house to acquire the start-up funds for the company, for example. If there are two cars in the driveway, can one or both be considered part of the company’s assets? The better information the lender has, the more they will loosen the purse strings.
We’re dealing with a cycle— increased business capital leads to economic growth leads to better business growth and easier credit. Both banks and SMEs must do their part, and both have a clear gain when the cycle becomes less vicious and more virtuous.