Oral evidence: SME Lending, HC 1008Tuesday 25 February 2014
Oral evidence, 25 February 2014.
Witnesses
Priyen Patel, Senior Policy Advisor, Federation of Small Businesses, and Matthew Fell, Director of Competitive Markets, Confederation of British Industry, gave evidence.
Chair
Thank you very much for coming to give evidence this morning. I will start with Mr Fell and then I will ask the same question to Mr Patel. Clearly, something went very wrong with small business lending. Are we going to have five more years like the last five?
Matthew Fell
Clearly, something went very wrong in 2008. I do not think the situation is going to continue for the next five years as it has for the last five. I think quite a lot has changed since then. I do think particularly in the straightforward bank lending sector, we are seeing something emerge that we at the CBI have described as a new normal. Regulatory reform, particularly additional capital structural reform hitting banks, the banks themselves having to restructure their balance sheets and, frankly, a more realistic pricing of risk has changed the rules of the game. More encouragingly, I think banks’ balance sheets are in better shape than they were five years ago, so their appetite for lending is on the increase. We have seen quite a lot of exciting developments happen to increase choice and competition, both in the banking sector and with alternative forms of finance, which we can come on to. I also think that even within the last six or nine months on the demand side of the equation, which has been as much a problem in previous years, small and medium-sized firms’ appetite for growth and investment is returning and they are now more actively seeking finance than they were at the height of the crisis.
Chair
We are going to come on to that issue in a bit more detail with questions from colleagues. On the competition side, you will know that this Committee, and the Banking Commission as well, have pressed very vigorously for changes, some of which are now being implemented, to try to generate a more competition-friendly environment. Mr Patel, is there anything that you would like to add to Mr Fell’s initial analysis of the conditions for small business lending?
Priyen Patel
In terms of what we are saying at the FSB, there is steady, positive progress. We have seen, over the course of a year or so, a slight reduction of spread that small businesses are getting on their credit, whether that be loans, overdrafts, credit cards, whatever they happen to be. You can put that down to a generally slightly more upbeat economy, so the general stock of credit small businesses around the country is slightly higher, or we could put it down to FLS, the Funding for Lending Scheme.
Chair
Do you think that is a success?
Priyen Patel
I think the Funding for Lending Scheme has been relatively good in terms of its business side. There was a lot of discussion at the start of the scheme that it was quite focused on the mortgage side, and one can understand that because of the relatively simplified range of products in the mortgage market compared to the very diverse applications and processes banks have to do to lend to even relatively small businesses with relatively small loan applications. We have seen nearly 1%. The FLS ambition is to knock at least 1% off a loan or an overdraft. We have not quite seen 1% but it is not far off.
Chair
What is the average spread at the moment?
Priyen Patel
For our members, it is roughly 4.2% or 4.3%. That has come down over five or six quarters, certainly in the time FLS has been alive. It has come down steadily progressively over that period to about 0.8% or 0.9%. There are areas where it is slightly different when you start segmenting businesses, sizes, turnovers, and so on.
Chair
What is the variance? How big a range is there of the spread? Are we talking about most businesses being concentrated within a percent or so, or 100 basis points of that central rate, or are we talking about a very diverse lending market?
Priyen Patel
In our quarterlies, you would see roughly 70% within a 2% spread of the average.
Chair
That is very helpful.
Mr McFadden
Good morning. I want to ask you about whether the politicians’ perceptions of this situation have become out of date, which touches on your answers a minute ago. We have been operating for five or six years with this dichotomy where small businesses were saying it was really tough to get credit or the terms have changed adversely or if they default on one thing the banks are down on them like a ton of bricks, and the banks are saying it is all about demand, they want to lend, and so on. We have all struggled with that in recent years. Do you think that the change in the economic conditions—and I will start with you, Mr Patel, given what you were saying a minute ago—means that that sort of dialogue is becoming a bit out of date and the situation is changing?
Priyen Patel
I think there was, and there probably still is, a debate, and I am putting it very simply, from maybe the business side, the press and maybe parliamentarians, saying businesses cannot get money, and on the other side, once again simplifying, banks and financial institutions saying the demand is not quite there. That is probably not the most helpful argument in the world, because it is probably, like most things, somewhere in the middle. We have seen gradually more businesses asking for loans and to the credit of the banks, certainly under FLS, but before that under a variety of other schemes, banks have been sending letters out to businesses not pre-approved but saying, “You can get roughly this amount of money at roughly this sort of price if you want it.” There is a debate and there is quite a lot of evidence in terms of both the work we do and I am sure what Matthew does but also in terms of the Finance Monitor where businesses are repaying quite a lot of debt, so this gross and net lending figure is often discussed. The net lending figure is often quite down, but I am sure you hear from banks that their gross lending is up, and that is quite accurate. I think events maybe have moved on from five or six years ago. I think they have moved on from two years ago. While we think the market is not quite perfect, the volume stock of businesses being able to access some form of credit, maybe not the credit or the price they wanted, is steadily improving.
Mr McFadden
Is the credit crunch over?
Priyen Patel
I will get back to you on that one.
Matthew Fell
I agree that the debate was frustratingly generalised and had this chicken and egg element about whether it was an issue of demand or supply while the economy was really subdued. A few thoughts on that. Firstly, getting a bit more forensic analysis into where the problems lie is a really important part of this, and for us we still see it is not an issue of sheer availability right across the board. Where problems continue to exist, it is much more around terms, conditions and covenants, particularly at the smaller end of the market, and I do think there are particular sectors of the business community that still find things tougher than others. If I was to pick out two, I would say anything that is exposed to construction and commercial property and so on, where banks particularly have their balance sheets overexposed to those sectors. That still needs an outstanding lending proposition relative to anything else. The other parts of the economy that I think still find things trickier are in sectors such as the creative industries, areas that rely on intellectual property and are more ideas-based businesses than have physical assets on which banks can secure lending against. Things are trickier there. I would agree, though, that we are now approaching the moment of truth where the economy is beginning to pick up and we will flush out whether this is a supply or demand issue. Things are encouraging so far and some of the Bank of England’s latest data suggests that things in terms of availability of finance are starting to pick up, particularly at the medium-sized end of SME as opposed to the smallest firms where they have yet to see the full benefits kick in.
Mr McFadden
Do you think that the credit crunch is over?
Matthew Fell
I do think that the credit crunch is easing.
Mr McFadden
You mentioned ideas-based businesses. Surely, it is worrying if these cannot get access to finance. This is a great British strength. It is going to be an area of growth for us. It is internationally fantastically important. Politicians right across the piece want to see our creative industries go from strength to strength. If they cannot get access to finance, that is really worrying.
Matthew Fell
That is a problem that has existed for them before 2008, before the credit crunch hit and has clearly been exacerbated by it. Our sense is that banks historically have been much more confident lending against businesses with physical assets to secure that lending against than they are for intangible assets such as the creative industries, and we do think that is an area that should continue to be looked at and explored. There is scope for improvement there.
Mr McFadden
You mentioned the Funding for Lending Scheme. Would you share Mr Patel’s view that this has been good for business?
Matthew Fell
Yes, it has had a positive impact. It is very difficult to judge and assess what the situation would have been had Funding for Lending not been in place, so what the counter-factual would be. I would also agree with the sentiment that it had a positive impact first on the housing and mortgage markets and that has now clearly been refocused on to the business banking sector, where it is starting to have an impact. I agree it had a net positive benefit.
Mr McFadden
One final area I would like to ask both of you is about the number of very small businesses that are using credit cards as their form of credit or debt. Professor Griggs estimated that over 80% of funding for micro-businesses comes from credit cards. Why do you think so many small businesses use credit cards for finance and is this a good thing or is it something that we should be worried about? I will start with Mr Fell.
Matthew Fell
On use of credit cards for micro-businesses, I think this is perhaps less at the CBI’s core constituency for small and medium-sized businesses. Most of our members in this space would operate in the medium-sized end of that spectrum, as opposed to micro-businesses, so I have less expertise on this. Clearly, if you are using credit cards for business there are a number of advantages to that in terms of flexibility, ease of payment and swiftness. You do not have the same sort of approval processes as you would do for more formalised lending. One of the issues I think the credit crisis in 2008 flushed out was that right across the spectrum businesses were not always using the most appropriate form of finance for their particular need, and that is as true in the credit card space for short-term lending as it would be for using bank loans when other forms of finance or equity would be more suitable. I do think there is a need to have a sharper focus on what form of finance provision is most suitable for the business situation.
Mr McFadden
Mr Patel, is it a weakness of the British setup in this area that so many very small businesses run on their credit card?
Priyen Patel
I am not sure it is a weakness. I agree with Matthew that we do have a concern across probably most business sizes of businesses accessing the most appropriate forms of finance. You heard from Professor Russel Griggs about invoice discounting. There are a range of other things out there in the marketplace. Specifically on credit cards, I suppose if we go down to the micros and talk about start-up businesses as well, the easiest sort of finance to put into the business is the finance you already have and that could be a personal credit card. For lots of our members the difference between the commercial and the personal is often very grey, and they often mix quite regularly. We see a lot of use of personal credit cards in the business environment. We also see a lot of commercial credit cards being used as part of the business environment, mainly as a replacement for or an alternative to short-term credit, be that invoice discounting or small amounts of overdraft money. Credit cards generally are perceived as slightly more expensive than an overdraft, but for a small business starting up that is the credit you have automatically or the credit you already have without going to the bank. There is a mentality that, “Instead of going to the bank, I am going to start using this right now,” because they may not know better.
Mr McFadden
I think we are going to get into alternative forms of credit finance, but that will be covered by other people. Thank you.
Mr Ruffley
Mr Patel, on standalone swap mis-selling, I imagine you have a bit of experience with that with your members. Jeremy Roe of Bully-Banks has suggested that the sophistication test applied in the case of the interest rate hedge product review has ruled out many unsophisticated SME customers and, he says, “including care home owners, garage owners, manufacturers, retailers and property companies”. Is that your experience from among your membership?
Priyen Patel
I have spoken to Jerry Roe a number of times.
Mr Ruffley
Yes, but his basic point is about the sophistication test and that it seems to have branded quite a lot of small business owners as “sophisticated” and therefore outwith the review. Is that your experience?
Priyen Patel
Yes, it is. We have a number of members who have been sold these products, mis-sold these products. We do not know exactly if they have been mis-sold because they have not had a chance to go through the process but, as they are excluded from the process, the only mechanism of redress they have is to go down the legal route and because of their relative small scale that is quite an expensive process for them. The three or four tests the FCA instigated to judge sophistication—balance sheet, turnover, the number of employees and so on—is not something that we would disagree with as a whole in principle. Those sorts of tests are used across Whitehall for a vast number of things. In this instance, for example, agriculture businesses were particularly hit by this because they were turning bits of property that were once used for farming and agriculture into office space or cottages or whatever it might be, and were being sold these products. They are relatively large in turnover scale and have lots of employees, albeit relatively low-skilled and low-paid. They ticked two of the three and they are now sophisticated, therefore excluded from the cohort who can go through the FCA redress process. There is a concern there and that concern has been flagged up by us to the FCA, to Martin Wheatley and to a number of Ministers as well. In terms of the process itself—
Mr Ruffley
If I can just stop you there, what has been the response from Ministers and Wheatley?
Priyen Patel
While being very sympathetic to it and in some cases looking quite in-depth at particular cases, the formal structure of the scheme, sophistication versus unsophistication, has not altered.
Mr Ruffley
What percentage of your members would feel a grievance at being deemed to be sophisticated and thus outwith the review?
Priyen Patel
In terms of our membership, it tends to be at the smaller end of SME, so we have heard from maybe half a dozen or so businesses who think they have been mis-sold but are outside of the redress process because of their scale or perceived scale. They are not members of ours, but I imagine there are quite a few businesses out there who feel that they are unsophisticated.
Mr Ruffley
Mr Fell, do you want to come in on this?
Matthew Fell
Only to point out that I think almost the reverse is true, so for the CBI’s constituent base of small and medium-sized businesses even at the smallest end they are typically companies with pretty rapid, high-growth aspirations, so they would have slightly more sophisticated management structures in place earlier in their life cycle, so that would be the only point of clarification.
Mr Ruffley
Understood. Back to you, Mr Patel. On the proposal where banks have admitted culpability, they are offering businesses 8% interest on the amount of any redress as distinct from consequential loss. They appear to be offering this 8% interest on redress as a substitute for consequential loss. Do you have any views on behalf of your members on that?
Priyen Patel
I am not sure if that is exactly how I understand it. The 8% is part of one of three outcomes from the redress scheme, the first outcome being complete tear-up, a cheque plus 8%, the second outcome being, “No, this product was sold to you correctly so no redress,” and the third outcome being, “Yes, you were mis-sold, but the most appropriate thing for you is a different product, so it is not just a money product; it is not just a cheque; it is maybe some other type of facility that protects your interest rate.” In terms of the 8%, I think the way we have understood it and the way the FCA has explained it to us is that because of the swiftness that they want to get through this cohort, they will look at, in the first instance, the redress mechanism and then at a later date, pretty soon after the three outcomes have been judged, the consequential loss will be looked at. The reason for that and the reason why we support it is looking at both in one go is a very long process. You would have to include the banks, plus the loss adjusters, and that would take quite considerable time, and some of these businesses frankly do not have that much time to wait.
Mr Ruffley
Barclays appear to be the only remaining big bank not to have split initial redress from consequential loss claims and settlement. Why did they do that?
Priyen Patel
You would have to ask Barclays.
Mr Ruffley
What is your understanding?
Priyen Patel
My understanding is that, informally, they have done that. Formally, they have not announced it. Informally, we think all the banks have split the redress and the consequential. The three other large banks came out on a single day and all announced it at the same time through, I think, it was a BBA. From my understanding from conversations we have had with customers affected through Barclays, they have certainly had redress through the first part and consequential is being offered as a secondary part.
Mr Ruffley
What percentage of your members who have gone through this redress process would you say judge themselves satisfied with the outcome?
Priyen Patel
I would judge very few, for two main reasons. One is the length of time from the FCA first deeming a problem in this marketplace to a mechanism being set up that they can go to and, secondly, the mechanism itself. There is a strong perception out there that the independent assessors who are there to look over the shoulders of the banks are not as independent as they could have been. We were suggesting a different type of mechanism—a mechanism quite commonly used for consumers—but the FCA chose this model. In those two aspects, I would judge many of our members have been through this and have had either a different product or a cheque back and are not that happy.
Mr Ruffley
What are the grounds for thinking that they are less than purely independent?
Priyen Patel
I do not have a concern, for example, that a large auditing firm who works for a bank or who has been appointed by the FCA to a bank is not impartial. I think they are.
Mr Ruffley
Is there a conflict there?
Priyen Patel
The perception among lots of our members is that there is a conflict and auditing firms generally work for businesses within a bank in all sorts of areas.
Mr Love
In the answer given to Mr McFadden earlier on the issue of the credit crunch, one said that the credit crunch was easing and the other that things had improved. That leads obviously to the question, is the lack of bank lending now the biggest problem faced by small businesses? Mr Patel?
Priyen Patel
It is certainly a very big problem. In terms of pure numbers, we do a quarterly report and we ask what the barriers of growth for our members are, and generally the top three tend to come out as general economic climate, which encapsulates consumer confidence, and then skills levels. Bank finance, access to bank finance and bank finance in terms of cost of finance are still very high on that list. Combined, they would be higher, but, as I mentioned to Mr McFadden, there is steady progress in this area, both in terms of what the banks are doing but also in terms of some of the reforms to the market, both regulatory and the capital, that the Government and regulators have been doing in the past three years.
Mr Love
Mr Fell, according to the SME Finance Monitor, access to bank finance comes a lowly fourth in the order of priorities of the small businesses themselves. Do you find that in your surveys?
Matthew Fell
Yes. I do not think access to finance is the biggest problem or challenge facing small businesses. I think that remains due to uncertainties on the economic outlook and being confident enough on the demand side for their businesses. I think that is the single biggest problem. In our own surveys, we have indicators from businesses right across the piece that ask around access to finance as a constraint on business and that survey data has pretty much normalised at the level it was at prior to the credit crisis. As a constraint on business, we do not think it is top of the list.
Mr Love
I am almost minded to ask you whether you think this inquiry is relevant, since we are looking at bank finance and it may not be the major problem, but let me go on. I am really harking back to answers you gave earlier on. At the top of the list of the monitor came the state of the economy. It was mentioned as a major priority for a quarter of all businesses. Does that justify the banks’ insistence all the way through this whole process that it was the lack of incentive to invest that was the problem and not bank finance? Mr Fell?
Matthew Fell
I do not think that was the sole reason. I think there were constraints going on on both the demand and the supply side. The lack of demand appetite was certainly true from 2008 to 2011-2012, when the economy was at its most depressed. There was a reluctance from firms to be seeking expansion, and that held down the demand for finance. Even for those firms that were looking to invest and expand where they were able to do so, our experience was that they were self-financing that expansion rather than seeking it from banks, because to some extent they had been deterred by their experiences in 2008. Equally, I think it is true that on the supply side there were constraints, particularly for those parts of the economy that I mentioned earlier, where banks were either overexposed to those sectors or had insufficient expertise or confidence to lend to those. I think the answer was genuinely on both sides supply and demand and it was not wholly the answer that demand was suppressed due to a downturn in the economy.
Mr Love
One of the interesting and rather surprising things that came out of the monitor report was that legislation and regulation came higher than external finance among the small businesses that they were surveying. What sort of response have your members given, Mr Patel, in relation to how they rank the major priorities? There are different figures for lesser priorities, but how did they rank the major priorities for them looking forward?
Priyen Patel
I will just clarify the monitor compared to the work that we do, or Matthew does. The monitor has population surveys, which is the entire SME population from the very small to the medium-sized businesses. Our membership tends to be at the smaller end of the scale, so results do differ because we are asking slightly different people. In terms of where Government legislation and regulation comes, it is slightly below other topics such as access to finance, but not the cost of finance, the level of skills out there in the employment and labour market and things like energy prices, for example, and generally just the economic climate as a whole. Regulation and legislation do play a part, but it is slightly lower down than where the monitor puts it.
Mr Love
I think we have agreed that access to bank finance is a priority but not the only one. Which other areas in our inquiry should we be looking at with particular reference to the future success of small enterprises? Mr Fell?
Matthew Fell
I think in the whole access to finance space, broadening it out beyond bank finance is quite important. Bank finance clearly continues, and will in the future, to make up a significant share of the overall finance that business uses, but I do think it is really important to continue to look at competition and particularly choice in the market—and I would make a distinction between the two—in terms of answering some of the issues that the previous evidence session and Professor Russel Griggs got into around looking at where companies turn to if they are refused by a particular bank. I think that is important to address. I also think that alternative sources of finance, and particularly equity finance to support growth businesses, are very important to look at in terms of broadening out the whole access to finance landscape. There are two other areas where we could see major contributions from the small and medium-sized business community going forward. I would have a look at the whole skills agenda and particularly the internal and management capabilities of businesses. I would look at the level of aspiration in some of those businesses to kick on and grow still further, which is perhaps a cultural issue in the UK. The last area I would point to is our export capability. Not enough of our medium-sized businesses in particular are looking to export, particularly to some of the faster-growing economies around the world, and that is something where having an uptick in the performance there would help to drive forward the performance of the SME economy.
Mr Love
You have just expanded our inquiry immensely. Are there any other issues? I can understand that equity finance might not be appropriate for federation members, but others will cover alternative sources in further questions. Mr Patel, is there anything you would like to add?
Priyen Patel
I disagree. I think equity is really important. A lot of start-up businesses will get themselves into a situation where they are over reliant on debt finance, whatever form that debt looks like, but we see a space for a lot more thinking to be done around the equity space and how equity can become more apparent to the start-up sector but also more available to those types of businesses. The other parts you may want to focus on, I suppose following on from what Russel was saying earlier on, is the sub-25 category. Those businesses tend to be loss leaders for banks. We have heard about how they are credit scored; we know from the monitor their success rates. Their interest rate levels tend to be worse than if they were a slightly larger type of business, so those two areas are important. I agree with Matthew about the financial capability in skills. I know you had a conversation earlier as well about professional advisers and there are schemes out there. The ICAEW run a scheme and there are lots of mentoring schemes, but that landscape can be cleared up a little bit. It is quite cluttered, and so a start-up business, a business that has been ticking along for a while and wants to grow, can just access those types of products. That can help them improve as a business and then make themselves a little bit more attractive to banks as well.
John Thurso
I would like to turn to the area of embedded swaps and tailored business loans. If I start with you, Mr Fell. What representations have you had from your members or businesses on this subject?
Matthew Fell
Not a huge number of representations to us directly on this. On the issue around embedded swaps, my one observation would be that it is less clear-cut than some of the other interest rate mis-selling issues on the face of it. If I just take the example of fixed-rate loans, which often would have embedded swaps in them to make them work, on a fixed-rate loan the ultimate issue for the regulator to judge is was there a case of mis-selling? A fixed-rate loan, both for an individual or a business—
John Thurso
Can I just stop you? Which regulator do you think is going to make that judgment?
Matthew Fell
That is a conduct issue, so I think it is for the FCA to make that judgment.
John Thurso
Martin Wheatley says it is nothing to do with him because it is consumer product, because the hedge is embedded. Their legal advisers have told them it is a credit product, so there is a lengthy correspondence that we can show you that we published over the fact that the FCA have held their hands up and said it is nothing to do with them.
Matthew Fell
My view on that would be that if the charge is mis-selling or not, then surely mis-selling is a conduct issue.
John Thurso
We are trying to persuade them, but we are not there yet.
Matthew Fell
My broader point was that for a fixed-rate product if you take out a fixed-term loan for three or five years, it is a fairly straightforward product. You know what you are buying at that stage and you know if it performs against that description or not. I think there is a bit of an issue to be made about was something genuinely mis-selling or was it the benefit of hindsight? That is the reason I say I do not think it is as clear-cut as some of the other issues that have been debated around mis-selling.
John Thurso
Mr Patel, what representations have you had on this?
Priyen Patel
We have had a number of representations, certainly not as much as the interest rate swaps issue. We are starting to see and hear more and more members complain about this or bring this to our attention. The only thing I would add to or repeat from what Matthew has said is that we have certainly discussed this with the FCA at official level, and while not asking them to do anything at the moment because we are still forming a judgment and looking at as much evidence as we can before we state a position, we would certainly deem this as a conduct authority matter.
John Thurso
Can I just save you the bother? I would refer you to the letter from Martin Wheatley to the Financial Secretary to the Treasury dated 9 May 2013 that was finally published after this Committee insisted on it. I would refer you to the letter from Martin Wheatley to myself on tailored business loans of 4 June 2013, also published. I would refer you to the oral evidence by Martin Wheatley to the Treasury Committee on 10 September to myself and the oral evidence by Martin Wheatley to the Treasury Committee on 4 February to Mr Hosie, in all of which he makes it abundantly clear that he has written to the Minister stating, “We do not legally have anything to do with this. We do not control it. It is a consumer product. Minister, this is a problem. Minister, what do you want to do about it?” I am paraphrasing slightly, the language is somewhat fluffier. The point I am driving at then is here we have two representatives. Between you, you cover everything from the tiny business at one end to the largest plcs at the other end. You both do not know what is happening in the regulation. I attended your dinner a couple of weeks ago and sat next to the chairman for Scotland, who told me it was one of the biggest problems they are facing in Scotland. Forgive me, but you are here to represent business: you do not know the size of the problem; you do not know who is regulating it. Do we need to ask if you really have a handle on the problem?
Priyen Patel
If I look at the swaps issue, for instance, when we starting hearing about that—
John Thurso
I am particularly interested in the tailored business loans and the embedded swaps, because I have a file this big of people who were sold this product. Some of them were told, “This is a fixed-rate interest. No problem, when you sell your piece of land, you repay the loan,” completely unaware there were break costs involved. That is one set of people. Other people who were told what they were getting into is a different matter. As you point out, hindsight is a wonderful thing, but quite a lot of people are in some severe difficulty now because they had no idea there were break costs. You then have particularly the Yorkshire Bank, who are arbitrarily transferring people from Yorkshire Bank to the National Australia Bank Recovery Unit in Leeds, who then tell them, “We now need a valuation. Your covenant is broken, so you have to repay,” and they are triggering deliberately—or that is how it seems—many thousands of pounds of costs that businesses do not need to face. I am being told by all the FSB people that I know in Scotland that this is quite a serious problem. I am concerned that here before us, you do not seem to know this.
Priyen Patel
We are certainly getting representation. I think I mentioned that. It is just the—
John Thurso
But what are you doing about it?
Priyen Patel
We are looking at all the representation coming through to us to try to make some form of judgment. There are issues around firm level problems we are getting, so there are certain institutions where complaints seem to be higher than other ones, but we are just trying to figure out, I suppose, if it is a market-wide problem. I think there is a consensus building that it is. In our representation to the FCA and to the Government about swaps, it took us a bit of time from the first representations coming to us to putting forward a judgment to the FCA and to the Financial Secretary. I suppose we are still in that process of trying to work out, first, the scale of this problem because it is very difficult to know numbers and, secondly, the regulatory space this lives in. We have had this discussion with the FCA and with other Government Departments, and there is confusion.
John Thurso
You know then that FCA does not consider itself to have the legal authority from Parliament to regulate this. That is its inhouse legal judgment. You know that they have written to the Minister responsible to inform him of that. We do not yet know what the Minister is doing about it, but I am hopeful that we will be able to ask the relevant Minister that question when they come before us. But it is particularly, I would suggest to you, a small business problem, because these are the kind of products that were originally sold—possibly mis-sold—to small businesses who would under no circumstances have the sophistication to unpick a plain vanilla swap, let alone one deeply embedded into what they thought was an ordinary fixed-term loan. You are here representing business as we look into what the scale of this problem is. Forgive me for saying this again, but it worries me that the representatives of business are as unaware of the scale of the problem as it would seem that parliamentarians are.
Chair
The source of concern is reinforced by the fact that when interest rate swap mis-selling first was broached as an issue, the representative bodies were slow there too, to come and inform us, and the regulators were certainly not on the case at all, even though the information was already around. The important thing here is to discover whether we are dealing with another sizeable problem or not. Perhaps you would like to come back to us, having had a chance to look at your respective records, and give us some more information.
John Thurso
I do not think I will ask any more questions at this point.
Stewart Hosie
Mr Fell, you said in relation to some of these embedded swap products a little while ago that you knew what you were buying. With the greatest of respect, we all have constituents who went to the bank and said, “Hold on. You have sold me a product with an embedded swap.” Behind it was a macro hedge the bank did not know it had sold, let alone the customer knowing what they had bought. I think that is part of the problem. However, can I turn to you, Mr Patel? The Government has granted the FSB the power to make a super-complaint or to make super-complaints to the FCA. Are they or are you considering using that power to complain about any of these ongoing problems, such as the embedded or standalone interest rate swap issue?
Priyen Patel
Yes. We received the status from the Treasury and the FCA very late in December. We are now looking at a range of areas that we have heard from members they have had problems with. This is one. This is very high up the scale. There are a number of others as well. I will not go through all the details, but to put a super-complaints status in is a long, laborious process. What we have done so far on this is we have spoken to the FCA quite regularly. We understand very clearly they do not think it is in their ballpark, but the conversations will have to happen in terms of where they can advise us to go, where the most appropriate Government body is. The super-complaint status applies to the FCA. If the FCA and the Government agree that this problem is not one that can be sorted out by the FCA, then obviously we would have to make a judgment whether a super-complaint was appropriate or not. We will obviously carry on making representations to relevant institutions in terms of this, but just in terms of the super-complaint, we can only obviously put it into the FCA where the FCA can then statutorily action—
Stewart Hosie
Of course, of course, of course. When would a decision be taken to move forward the super-complaint if you were able to do that?
Priyen Patel
As I said, we have only had this since December 2013, so we are looking at part-examples from other bodies. I suppose we are in a different space. We are the only SME body to ever have this. All the others have been consumer bodies, but generally when they have put in super-complaints—the PPI one, for example, that was a good eight months in work. There is a financial regulatory approach you have to take, there is a legal approach you have to take and, in certain regards, especially nowadays, there is a European regard you have to take, and you have to combine the three into a document, in effect.
Stewart Hosie
So even if you were able to, it would be some time yet before such a formal super-complaint could be made. Does the power to raise a super-complaint apply only to FSB members or to all SMEs or against a given product or range of products?
Priyen Patel
It applies to all SMEs, and it could apply theoretically to all businesses, so they do not have to be a member of the FSB.
Stewart Hosie
That is helpful. If I can just turn to you, Mr Fell. Clearly, even larger so-called sophisticated businesses have had the same or similar difficulties. You said there were small numbers that you have come across, which is interesting given that I have had businessmen with me in front of Treasury Ministers pulling their hair out at the way they have been treated by the banks, so I was quite surprised when you said that. But given these are in some cases more sophisticated and certainly larger businesses, would the ability to raise a super-complaint be something that the CBI would like to have?
Matthew Fell
No, that is not how we have ever thought or wanted previously.
Stewart Hosie
Is there a reason for that?
Matthew Fell
I think it is that we see ourselves as primarily a lobbying organisation, rather than one that has that capability to do that. We do not have a significant inhouse legal team or anything of that order to have the ability to take out super-complaints, if we wanted that power.
Stewart Hosie
No, I understand the answer—it was a very clear answer—but is that not something that you might want to consult with the membership on? It might well be the kind of function that even the larger businesses might like their membership organisation to undertake.
Matthew Fell
We do regularly survey all our members in terms of satisfaction and what they want from us. It is not an issue that has been raised with us to date.
Stewart Hosie
That is helpful. Thank you.
Mark Garnier
Mr Patel, can I turn to your report where you talk about the German Sparkassen, a different type of banking model, which you talk about being locally controlled banks with public interest criteria in their governing constitutions and 70% of the German banking sector is covered by these smaller community banks. What do you think would be the benefits of more of this type of bank within the UK market?
Priyen Patel
Primarily the report—I think it was alternative class reports—that we wrote was around looking at competition in retail banking, so not just banks, although Sparkassen obviously is a bank, but looking at a more pluralistic SME finance arena. I do not think there is a single bullet. I think even if you move Sparkassen to the UK, you would still have to do a lot of extra work in terms of all the technology-based platforms. We mentioned CDFIs and a range of others. I think the benefit it brings is there is a move afoot, I suppose, of banks shutting branches down in certain areas, and we have a concern around last bank/sole bank villages or towns. Those banks tend to be very important hubs of those communities. They tend to be actual small economic drivers in those communities; you remove those and you lose that driver. Those Sparkassen models—and there are other models around the world—
Mark Garnier
Yes, the cantonal banks and various other ones as well.
Priyen Patel
—have a commercial remit, but they also have a social remit as well, and we think there is a driver there that they can play. We think also they have a slightly more centred approach to lending. They have a lot of expertise in what the government is doing, so if the government has launched a scheme that can help in mentoring, for example, those Sparkassen managers tend to be very well plugged into what other bits of Government support and advice businesses can get.
Mark Garnier
Who are their shareholders, just out of interest?
Priyen Patel
Their shareholders are primarily a Sparkassen corporate body, but also individuals can buy those through German trusts—can buy shares in Sparkassen through trusts.
Mark Garnier
But it is not a traditional shareholder model that we would be familiar with?
Priyen Patel
No, it is not.
Mark Garnier
So it is more sort of a utility/social bank?
Priyen Patel
Yes.
Mark Garnier
I am quite interested in this particular area of alternatives to the kind of current banking model we have, but isn’t one of the problems with them though that if you have a Sparkassen type of model in a certain area—and step in, if you want, at any point, Mr Fell—that you are potentially amplifying the local problem? Zürcher Kantonalbank is a very big bank because you have Zurich as the area from where it is deriving its deposits, so therefore it is very successful, whereas other less prosperous cantons in Switzerland do a lot worse and their local cantonal banks do rather badly. You are amplifying the problems, because you cannot derive those deposit bases because there just is not the money there. Can these local banks potentially amplify problems as opposed to resolve them?
Priyen Patel
Sparkassen and other similar models all have a commercial remit, so they all have to make a profit. If they do not, they go out of business. I think the learning and the teaching from the Sparkassen, which is really valuable, is more at the regulatory stage. The Sparkassen in Germany have what is effectively known as a black box model, so if a new Sparkassen wants to start, they can effectively apply for a franchise to the central Sparkassen—and these are people with all the requisite regulatory approvals—and receive almost a toolkit version of the back office operations.
Mark Garnier
So it is like a white label utility bank that you can plug into?
Priyen Patel
Yes, and they can offer very simple retail products. When you speak to start-up banks and small banks here, one of the problems you often hear is the back office operations risk and IT. The Sparkassen German model offers a very simple model, admittedly, where people can apply to that.
Mark Garnier
This is similar to what we see in America. I think there are 7,500 banks over in America where you can buy effectively a bank in a box and set it up, sort of a vanilla bank, relatively straightforward. Did you want to add anything?
Matthew Fell
Just to echo that the barriers to entry and growth for start-up and challenger banks are primarily around the requirement for IT infrastructure, the level of collateral you need to access the payment system and the overall regulatory capital. I think they are quite significant hurdles to overcome for challenger banks.
Mark Garnier
Going back, Mr Patel, to your report, you have a very helpful chart showing profit after tax and the percentage of the average capital shown on the balance sheet going from 2000 to 2009. The one thing with the German savings banks is it is pretty much a straight line. It does drop a little bit in 2008, but it is a pretty consistent return, whereas the volatility of the large commercial banks is absolutely staggering in terms of it going on down. What is it that is driving this straighter line return? Is it legislation? Is it specific business model? Can you enlarge on that?
Priyen Patel
I think it is the business model but also the culture there as well, so the culture is while the volatility of normal commercial banks does go up and down, dividends do follow those lines up and down, whereas the straight line approach, dividends are still going out but at a more consistent level. That culture is bought into by people who maybe want to make fewer returns but have a slightly more steady return outlook, whereas possibly the model operated by the commercial banks is to have peaks and troughs and for their dividends to follow those models.
Mark Garnier
They would argue it is peaks and peaks that would maximise shareholder return.
Priyen Patel
But it is primarily the culture and the boards of those organisations that drive that culture of very steady operations. It is also them walking away from certain types of business products and certain types of commercial products that have a lot of exposure to wholesale markets. They tend to look at everything from the retail space and then work up, rather than the other way down.
Mark Garnier
In outcome, and not necessarily in the structure, how do they differ from the mutual model?
Priyen Patel
The mutual model is a lot more based on a CDFI, to a certain extent, where the owners tend to be the people who have invested in it, small-scale investments, not quite charity sums but slightly larger, but also those people who use those organisations as well. The mutual banking sector in the UK is relatively small and has not the greatest reputation in the world, because the people who go through their doors tend to be the people who have been refused at X, Y and Z, so the people going through their doors generally tend to be higher risk; therefore they are priced at a higher risk. That perception is out there in the market, where people do not want to use mutual banks or CDFI banks because they fear the price is higher. It is not; it is just because of the people walking through their door and their customers, if you like, tend to be higher priced.
Mark Garnier
One last question, if I may. What do you think the dynamic is that is going on in the UK that has restricted our banking market? I think there are 47 banks outside the top four or five, but we never ever hear of them and, as we know, the vast majority of people, be they businesses or retail customers, bank with the big four. What do you think the dynamic is that is going on in the UK that has resulted in that, whereas in America, Germany, Switzerland and various other places around the world you still have this very strong local and flourishing bank market?
Priyen Patel
There are many. If I just pick one from America, for example, they do have regulations around size and community investment. If you want to activate an M&A, for example, if you want to take over a competitor bank or another bank or another financial institution, you do have to prove on the side of the scorecard that you are providing services to low-income areas, to business start-ups, slightly riskier things, and that does put a constraint on certain banks. But also flipping the coin, the other side, it activates a positive outcome where certain banks either invest by themselves or through third parties into areas that have slightly higher risk models. That puts, on the negative for a bank, a constraint on it; on the positive, it means small banks or state banks stay and want to stay in those types of geographical areas. We do not have the size of country as America or as geographically split in terms of states. We have counties or other areas, but that ethos we do not have to the same extent as in America.
Matthew Fell
The one piece I would say on the customer side of things is that we are starting from a very low base. We are starting to see, I think, some signs of improvement that SME customers are starting to look more at those challenger banks. Previously, if they were turned down on a loan application from one of the mainstream five or six banks, they would pack up and go home. I think now they are in a situation where they are starting to approach those challenger banks to see if it is a proposition that would be attractive to them. I think the next step on still would be the ideal, that they are approaching those challenger banks at the same time and in parallel with applications to the mainstream banks. Clearly, there is still a very significant dominance of market share within the main five or six players, but we are starting to see, driven from the customer side of things, an appetite to use those challenger banks more because they do not want that over-reliance on that single relationship that caused them so many problems previously.
Chair
You will have heard today the depth of concern about aspects of SME lending from this Committee. This Committee considers recovery in the SME market absolutely crucial to sustaining the economic recovery more widely, and put their interest in things that might get in their way as certainly very high on the agenda for this Committee to try to do something about. You have heard considerable concern expressed about embedded swaps. A number of businesses are coming to us because they feel they cannot go anywhere else, and I think it would be extremely valuable if the representative bodies feel able to be early warning centres for this, rather than find out about it to some degree, as appears to be happening, from the politicians. I would be very grateful if you could come back to us on any further information that is already in your organisations. Thanks very much for your evidence this afternoon. Oral evidence: SME Lending, HC 1008 6 [1] Note by witness: “Lending is a very linear process in that you have at one end little information to base the decision on and at the other all the information you will ever need. If you make the decision on little information then that leaves it open to risk and not always getting it right. Therefore I have been working with the bank to ensure they get enough information to make good decisions or they will have a lot of appeals many of which will be overturned on appeal.”