How are small companies affected by the risk of recession and a tighter lending market?

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With nerves around extending credit to small businesses growing, the JEP’s Business Insider says that this situation could limit economic growth

THE local economy is lucky that it is so heavily dependent upon the finance sector, which is more insulated from the risk of recession than most other sectors of the economy.

The good news, therefore, is that the major employer of the local population (other than the government, which is the biggest employer) remains robust and is less likely to be damaged by recession and a tighter lending market. But what about other small businesses?

Banks are increasingly nervous about extending credit to small businesses, according to data compiled by Reuters and interviews with lenders and business heads, as rising costs of debt, labour and raw materials put the business case of lending to such companies under unprecedented strain. This is a concern because small businesses are already poorly served by the lending market because they are perceived by lenders as being higher risk than larger businesses.

They do not help themselves because they tend not to employ full-time finance staff, which means that their financial and management information is often not well presented, and this factor alone counts against them when trying to borrow money.

Lenders in the UK expected the supply of credit to the smallest firms, with annual turnover (not profit) of under £1 million, to fall by more than 10% in the last three months of 2022, a recent Bank of England survey found. This will probably get worse. The shortfall needs to be made up, perhaps by business owners using their personal resources, assuming they have not already used them up dealing with the fallout from Covid. The alternative is to cut costs which usually means people. It is reasonable to assume that the figure in Jersey is much the same.

Banks are still lending, but the risks and higher relative costs associated with funding the smallest businesses, some of which might be more vulnerable to recession, mean that banks often have no choice but to turn them away.

‘Businesses are finding it hard to demonstrate that they are still sound businesses,’ said Richard Burge, chief executive of the London Chamber of Commerce. ‘But they’re only going to be sound if they can get access to the loans they need.’ This pretty much sums up the ‘chicken and egg’ problem faced by the owners of small businesses.

Commenting on the situation, an Island-based spokesperson for NatWest International and RBSI said that the bank’s offshore lending centre meant that applications for credit were determined differently from in the UK.

‘We continue to support new business start-ups and SMEs in the current environment as we have always done through many economic cycles, with access to credit determined by an offshore lending centre, as opposed to UK-based decision making,’ the spokesperson said. ‘This allows us the opportunity to gauge the somewhat unique offshore environment on a sector-by-sector basis, instead of adhering to UK standards.’

And the message from a representative for Barclays was similar.

‘Jersey remains well served by the main UK banks, and a number of other professional bodies and lending providers, who can all support start-ups and growing small- and medium-sized businesses with advice, guidance and, where necessary, appropriate funding solutions,’ they said.

The bad news is that the local alternative lending market is less willing to lend to businesses because they generally do not have property assets which can function as security for the loan.

It will certainly be much harder for new businesses to get started, which will limit future economic growth.

If you want to start a new business, you will probably be more dependent on financial help from friends and family, which puts you in a terrible personal position if things do not work out well. There are a surprisingly large number of local ‘angel investors’, who are willing to back small start-up businesses, but the hurdle is high. The idea must be excellent and the management very credible.

Unlike the UK, there is no tax break to encourage more people to support start-up businesses. We may well cover this in a separate feature as there are some positive developments which will help support the future of the Island but, as things stand, this is a surprisingly underdeveloped ecosystem for an island that has had such a long entrepreneurial history. A much more supportive framework is necessary.

Major banks in the UK have already set aside hundreds of millions of pounds of extra cash to cover potential losses from the failure of small businesses. Lloyds recently disclosed a 30% jump in the most severe category of problem loans in its small business unit in the UK compared to the end of 2021, hinting at why banks may tread carefully in 2023.

While the situation in the local market is not as bad, it does make one wonder what stress is currently being suffered by small-business owners as they reassess their plans in early 2023 and find that they may have more difficulty funding future investment from borrowing at a time when their existing cash flows as under pressure from the twin problems of recession and inflation.

Companies of all sizes are already buckling under the strain in greater numbers in the UK. The number of quarterly company insolvencies in England and Wales hit its highest level in nearly 13 years in April-June, according to official data. This was before the impact of higher borrower costs really set in. We are fortunate that we are somewhat isolated, but we are not immune from the problem, and we must have issues under the surface.

As well as Jersey Business, there are people to see if your business is struggling and you want to get a health check. You can also get professional support to back up an application for borrowing. This has the great advantage of not just showing the business in its best light, with independent verification, but allows the application to be presented to the lender in a way which makes it easier for the lender to assess and, frankly, believe what is says.

Fundamentally, there is one thing the government can easily do to help and that is to speed up the payment to local suppliers to improve the cash flow of local businesses.

The government is simply too slow to pay its bills which starves local businesses of cashflow and forces them to rely more heavily on borrowing or pass the problem on to their own suppliers by paying them more slowly creating a negative circle. This is easily broken.

Ultimately the money is owed, and it is slightly shameful that the government is not quicker in paying it. It would make a significant difference if the government went out of its way to push this oxygen into the local economy as quickly as possible.

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