Project Merlin: Are the banks lending as much as they can?

Andrew Chappell 3rd August 2011

Project Merlin was launched earlier this year in an attempt to get the British banks lending again; in particular to small and medium size enterprises. The scheme encompasses the UK’s four biggest banks: HSBC, Barclays, Royal Bank of Scotland and Lloyds Banking Group (plus Santander) and tied them in to lending more to businesses and to pay out less of their earnings in remuneration of their staff. Their target for lending in 2011 is £190bn of credit up from £179bn they lent in 2010. Within this figure there is a commitment for £76bn of it to be made available for smaller businesses, representing a 15% increase on the level of credit made available to SME’s in 2010. The banks were also requested to provide £200m worth of capital to the Big Society Bank and also a further £1bn of equity capital over three years to the Business Growth Fund. As the current coalition governments’ flagship scheme, Project Merlin has come in for some criticism since its inauguration; its success has been questioned. Back in May the Bank of England announced that the banks were behind in their commitments for the first three months of this year, £2.2bn short to be precise. Further compounding the criticism it was announced at the end of July that business lending had fallen in June, starving the economy of required funds. 

These next couple of weeks will be crucial for Project Merlin as this week the participating banks are set to announce whether they are on track with their lending commitments for the first 6 months of 2011. At least the government can take some heart out of the first banks’ results. HSBC announced this week that they were ‘on-track’ for their lending commitments, having already lent £22.7bn, of which £5.6bn went to SMEs. The three other banks are set to announce their current lending statuses later this week. Moreover on 12th August the Bank of England is set to give their 6 month report on the status of Project Merlin and whether it is on the right lines for what it set out to achieve.

Despite Project Merlin sceptics one does have to look at it from the banks points of view too. Sceptics are saying that the banks aren’t lending enough but the banks return saying that there isn’t the demand for such finance in the UK market currently. The fact is not all SMEs want to borrow, not all of them need to borrow. According to the SME Finance Monitor only 51% are using external finance at the moment; 68% of all SME’s neither had a borrowing event nor felt the need for facilities in the past 12 months. The report also highlights the fact that the banks aren’t turning away large numbers of SME’s who apply for finance, in fact only 3% of SME’s were unsuccessful with loan and or overdraft applications. 

So why then might you ask is there a lack of demand for bank credit as suggested by these figures? As expected the fragile economic climate plays a strong role. When asked for the reasons for not applying for an overdraft or loan, SMEs replied that the poor economic climate was for 22% and 31% a reason respectively. Understandable, as any investor would know one can measure risk but uncertainty. Once one has reduced uncertainty, it becomes a much safer environment to invest in. With business confidence subdued in Britain many firms are waiting until the wider macroeconomic conditions are more structurally sound until they invest again. However some figures which were more interesting were other reasons for not applying for an overdraft or a bank loan. 57% and 58% respectively said that issues with the process of borrowing were factors in deciding not to apply. Issues with the process of borrowing included factors such as thinking it would be too much hassle, too expensive, the bank asking for too much security, too many terms and conditions and that the documentation was too hard to understand. It has to be said that these figures are quite revealing. Perhaps the problem of SMEs accessing bank finance needs to be approached from another direction: making the application and documentation of the finance easier to understand and quicker and simpler to apply for. 

Another set of revealing figures were also under reasons for not applying for an overdraft or bank loan where 60% and 55% stated that they wouldn’t apply for finance due to the principles of borrowing. Factors such as preference not to borrow, not to lost control of the business, ability to raise personal funds if needed, preference for other forms of finance and the possibility to go to family and friends played their part in dissuading SME’s from applying to the banks for finance. Having seen governments and banks borrow to excess and now seeing them face the consequences it seems that firms are now following suit by preferring not to become too indebted in an attempt to grow. This could however only be a temporary phenomenon due to the poor economic climate and lack of uncertainty. 

It is a little bit of a chicken and egg argument. The firms don’t want to borrow until the economic conditions improve but the economic conditions would more than likely improve if the firms began borrowing and investing more heavily. One thing is for certain: there will be many an eagle eye cast over the lending figures published this week and next. However it may be time to take accessing bank finance from a new approach. Improving clarity and comprehension of bank finance for SME’s where the business-savvy skills of the executives may not be up to a professional standard. Furthermore it may be time to enlighten entrepreneurs and SME executives to the available options for financing outside of the banks, so that they can tailor their finance needs to the products which suit them best.