Many entrepreneurs loaded themselves down with debt as they chased the property dream, or followed the mistaken prescriptions of their professional advisers. The self-employed have looked on as their business drained away and their banks shut up the shutters, retreating into the virtual world.
Estimates suggest that as much as €25bn in loans to the sector could be categorised as troubled; that is, one half of the total funds lent to SMEs. Many businesses are clinging on by their fingernails. Bank lenders, when not pressing hard for repayment, are a bundle of nerves, fearful of adding to their bad debt burden.
It is hardly the ideal environment for a sustained economic recovery, yet we are all counting on our SME owners to generate the jobs that can contribute to sustained growth. Business groups have fallen over each other to condemn the banks for their failure to approve loan applications.
Many SME owners believe they have been strung along in the course of long, drawn-out approval processes, or have been told informally to not even apply as part of an effort to massage the loan application statistics.
As late as the second quarter of 2013, loans to SMEs were down €364m, or 1.4%, compared with the previous quarter, and down by 5.8% on an annual basis. This in part reflects loan repayments, as well as a lack of confidence on the part of SMEs.
UCD economist Karl Whelan has been scathing about the failure of the pillar banks, AIB and Bank of Ireland, to meet commitments on lending. Prof Whelan crunched the data for a blog post in 2012, in which he pointed out that while new loans out in 2011 amounted to €3.133bn, repayments were almost double this at €6.032bn. He also concluded that the State-owned AIB accounted for the majority of the €1.7bn reduction in 2011 in loans to SMEs outside the property and financial intermediary areas.
The Government did set up the Credit Review Office, in 2010, to provide unsuccessful loan applicants with a means of redress. The office, led by former banker John Trethowan, has taken time to make its mark, but Mr Trethowan has begun to flex his muscles. He has become noticeably more critical of the financial institutions and, earlier this year, called for his office to be given powers to hear appeals in respect of loan refusals covering amounts up to €3m (the current limit is €50,000).
The passage of time, the emergence of economic greenshoots, and the development of internal lender capacity — these are the key reasons which could explain a recent uptick in lending, one which was recorded by Red C in its latest credit demand survey. The findings were released early in December and covered the period April-Sept 2013. Among the key findings were a decline in the rejection rate for credit applications, from 24% in the preceding six months to 20%. Some 51% agreed the banks are lending — this compares with just 39% of respondents holding that view in the corresponding survey in 2012.
While the banks may be slowly opening their wallets, there is an awareness in official circles that Irish businesses remain excessively dependent on a banking system which remains fragile.
According to a recent Central Bank report, ‘The importance of banks in SME financing — Ireland in a European context’, Irish SMEs are either the most, or the second most reliant on banks among European countries. The report’s authors call for actions at both national and European level to create a “more diversified set of funding options”.
Their analysis of data from the ECB covering the period Sept 2012 to Mar 2013 reveals that Irish firms top the league when it comes to the use of (expensive) overdraft facilities. There is a relatively low use of term loans, reflective of a reduced appetite for investment.
Between 2005 and 2012, use of bank finance plummeted. However, there was a 33% increase in the use of internally generated funds for investment purposes.
The shift towards trade credit and equity was most marked among small- as opposed to medium-sized firms.
The authors share the view of ESRI professor John FitzGerald that a restoration of normal lending activity in the banking sector, along with the development of non-bank alternatives is critical to medium-term growth prospects. “Policy must aim simultaneously to stimulate the flow of bank credit and to create well-developed markets for a range of alternative financing sources to compliment the role of banks in the financing of SMEs,” he said.
A separate Central Bank study concluded that “potential areas for Government initiatives include support for export financing and other financing sources such as peer-to-peer, or P2P, lending and retail mini-bond markets. These ideas were recycled in the recent Government action plan which contains little in the way of critical analysis of the proposals.
P2P involves the matching of borrowers with investors on a net-based platform. It has become common in the US but as the Central Bank authors admit, “it is not without its risks”.
Concerns persist that the lightly regulated P2P lending market offers much in the way of opportunity for fraudsters as opposed to genuine entrepreneurs. One British P2P company, Quakle, closed down having incurred bad debts of almost 100% of its loan book.
According to Avine McNally of the Small Firms Association, “the worrying trend from the Red C survey is that 78% of those who received credit approvals had conditions attached in the form of personal guarantees, or facility charges”.
“It is critical that the cost of credit be not too high and that loan terms and conditions are manageable,” said Ms McNally. “There is an increasing trend towards more onerous conditions.”
Ms McNally echoes complaints about automation, centralisation, and the disappearance of the bank manager decision maker “who understood the business he or she was dealing with”. While the skills of lending are being rebuilt, this is only happening in specific sectors, she says.
Calling for “a form of relationship banking at grassroot level”, Ms McNally also expresses concern at the failure of State bodies to communicate information on the supports available. “Very few small firms are aware of Micro Finance Ireland, or the loan guarantee scheme,” she said. “Only now are they becoming aware of the Credit Review Office which has been there a long time.”
According to Sean Murphy of Chambers Ireland, “an ongoing incremental improvement is under way. Demand is still an issue. The recovery is still fairly soft, but we are much more positive about 2014. The economy had a heart attack five years ago. Until that experience is put to bed, people will be cautious.”