... than to invest in the growth plans of medium organisations. M Institute co-founder Jyoti Banerjee asks if the investment preferences shown by banks are really the results of market imperfections that need to be dealt with by policy-makers.
A few months ago, I took part in a meeting at HM Treasury organised by M Institute where a few leaders of medium organisations were invited to present their stories: how their companies became medium-sized, and the challenges they had to overcome and still have to deal with. A recurring theme for these business leaders was the way in which problems relating to access to capital impair their growth performance.
Should government be doing something about it? Clearly, the Treasury officials we spoke to did not think so as there is no evidence in their eyes of market failure. Without evidence-based market failure, how can the government generate its favoured route of evidence-based policies? (One wag recently commented that it is not evidence-based policy-making at work here – simply, policy-based evidence-making).
There is urgent need for a formal research study that can show if the evidence exists that access to finance is slowing down the growth of medium companies. This is particularly apposite in the context of a Brown government that has shifted attention from start-up enterprises to existing companies that demonstrate growth – an arena of business where medium companies are very successful. M Institute may not claim credit for engendering this shift in policy, but it certainly fits our policy recommendations. In this context, please see an earlier blog item commenting on Margaret Hodge’s enterprise policy.
Rehearsing the argument
If you are not familiar with the issues that medium companies face in accessing capital, let me rehearse the argument for you. Growing a business needs capital. Not every medium organisation has difficulty in raising capital, particularly when the capital is needed for buildings and capital equipment. But capital is difficult to obtain when the driver for finance is growth, and the company in question is a knowledge economy player with more invisible assets than ones banks like to deal with. It is even more difficult when the track record of the organisation does not demonstrate a steep upward year-on-year growth curve. Yet it is these organisations that are delivering the most consistent growth performance in the UK economy.
And why is it hard to raise such growth finance?
An M Institute report Empowering Medium Enterprisereported that UK banks have a short-term view on lending which does not support the longer-term growth finance requirements of medium business. UK banks seem to have a shorter horizon than European banks in this regard. It is also true that UK banks measure their performance on transactions – the more, the better. They reward their staff, and make more money, if they can make two five year loans, than one ten year loan. The fact that the second loan is simply taken to finance the repayment of the first loan is ignored.
Of course, wherever valuable collateral is on offer, particularly property, these same banks are happy to be as innovative as possible to get their share of the action. For example, Bank of Scotland runs an excellent schemewhere it invests as a joint venture partner with companies in business models where there is significant property involved, such as land development or hotels.
Rates of return
So why don’t UK banks want to put their money into the UK’s growth performers? Without presuming to answer a question that needs an appropriate quantitative-based response, I would like to point to a particular condition in the UK economy: banks don’t invest in the growth plans of medium companies because they can get better returns elsewhere.
These better returns are not because medium companies are rubbish in delivering consistent growth – that is certainly not the case, as the medium segment of the economy outperforms all other size cohorts. The better returns that banks can get relate to a particular set of conditions that are powerful economic forces in the UK marketplace.
A great place for banks to put their money is in ... banks. Not in savings accounts, of course, but in their own shares, which have historically under-valued these massive cash generators. In 2006, Royal Bank of Scotland did a share buyback of £1 billion. Edinburgh rival HBOS did nearly double that over a two year period. Market analysts applauded them for returning this money to their investors, which meant that they could not make acquisitions to grow their own businesses, or fund the growth of their customers. Instead of applauding them, we should be questioning why we have a situation where banks can make more money by buying their own shares back, instead of investing in their customers.
Of course, we have other market imperfections as well. The housing bubble continues to exercise the Bank of England’s inflation police, but it offers banks another sure-fire winner as they choose to funnel investments into property and mortgage finance, over and above the finance needed by medium companies. To the housing bubble imperfection we could add the gilt bubble.
Whatever the bubble responsible, we are in a situation where banks have an economic alternative to investing in medium companies. Plus, they have built up cultural patterns which disincentivise their managers from the type of medium-to-long-term engagement that medium-sized companies seek from them.
So let me state my position: sure, we need an evidence base to support the case for intervention in the matter of access to finance for growth companies. But without that evidence base it is easy to argue (as some policy-makers do) that the evidence does not exist for intervention, so why waste time on researching the market. It is clear that we have all sorts of market imperfections that are modifying the economic behaviour of banks and other players in the UK economy right now. It should not be so difficult to support evidence-based research that tests the theory that access to finance problems are holding back the growth prospects for UK medium companies. The answer should give government officials the freedom to engage in some genuine evidence-based policy-making.
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