Banks, SMEs and relationship banking

BoI Survey talk UpdatedThe last few weeks have seen the launch of two reports on SME Finance. One was the now regular Department of Finance report on credit conditions, the other a Bank of Ireland report on the financial situation of tech orientated SME’s, this drawing in large part on work conducted by a PhD student under my supervision. I launched the latter – my speaking notes are here BoI Survey talk Updated :   and the report here Bank_of _Ireland_ Technology_Research_Embargo. Overall the picture is, as always, mixed.

The good news first – the SME sector and the tech component are doing pretty ok. There is, in particular in the Tech sector, a massive export orientation. People selling business to business technology solutions cannot scale up to any extent in the Irish market so perforce are export orientated. 55% of Tech SME’s report being profitable, not a bad situation, with about 25% breaking even. They are however doing so on small turnovers, with only 17% having revenue of greater than 5m, and with 71% of companies having earnings (not revenue..) of less than 250,000e. Across SME’s as a whole Irish ones are smaller. 25% of Irish SMEs have revenue less than 500k, compared to 33% for Europe as a whole. These companies are

Nor are tech companies, despite what we might think, necessarily young companies. Less than 18% of the businesses we surveyed were less than 2 years old while 60% have been operating for 5 years or more. In terms of employment, 44% are employing less than 9 persons. A survey of tech companies in ireland was conducted and published in 2005 which found 80% employed less than 9 persons , 18% were less than 2 years old, as now and 40% were greater than 5 years old. Parsing this we can see that while there is a great degree of startup activity in this sector there is also a great deal of maturity. This is good, as more mature firms should have inbuilt a greater degree of corporate knowledge about survival.

50% of companies are still in self proclaimed survival mode, focusing on stabilisation with limited growth prospects being sought, with indeed 30% focusing solely on stabilization. To achieve that, in the tech sector, we see a focus not on hiring engineers and scientists but instead on sales and marketing specialists. With 75% getting the great majority of sales overseas this makes sense. It does show up however just how critically dependent on benign global economic conditions remains Ireland and its recovery.

The top two challenges for Irish tech firms are gaining more customers, with 29% and access to capital, with 23% stating it to be the main challenge. Compared to the ECB surveys we see there that 20% of EU and 12% of Irish SMEs state that finding customers is their most pressing problem, and for access to finance we see that this is the top priority for 18% of EU and 12% of Irish SME’s. Tech companies are more concerned about these areas than the normal SME.

So what about capital? Here we see something interesting. There is emergent academic research, including some from the central bank of Ireland, that the more concentrated the banking system the poorer are the results, overall, for companies. There is a quite extraordinary concentration evident in the Tech survey – with 43%, Bank of Ireland is the most popular bank for day-to-day business banking. AIB is a close second with 40% With 25% Bank of Ireland is the most popular bank for main business loans. AIB is a close second with 20% of business loans. This is a duopoly. 23% of Irish and 28% of EU SMEs had sought bank credit in the last 6m. 31% of the tech survey respondents were intent on seeking bank credit, mainly for working capital, over the next 6m. But fully 37% of tech companies have never sought a loan. 60% stated they were not going to do so over the next 6m. Digging further into the figures fully 35% of SME’s in ireland need capital but will not approach a bank.
This is despite the fact that as per the department of finance figures over 70% of all loans sought are approved with only 40% of loans requiring collateral. There may well be a degree of prefiltering going on in banks, to ensure that only really high quality applications are actually filed, but on the face of it access to bank credit is not a problem.
We may well have a problem here with discouraged borrowers. In the tech survey Bank borrowings were deemed a better sources of capital than equity from family and friends and crowd sourcing. While we WANT poor borrowers to be discouraged we DON’T want good ones. There is emergent research on the determinants of discouraged borrowers. One thing is clear- bank concentration increases discouragement. Central Bank research shows discouragement induced credit rationing is linked to poor employment outcomes.
We know that tech companies rely very heavily on retained earnings, and with the sector dominated by small, intangible asset heavy companies the only way a bank will give money is when they understand the business.
Herein lies the rub. Tech companies do not, overwhelmingly do not, feel banks understand them. Less than 25% felt that banks understood them. We know from other research that where there is proper relationship banking, where banks not only engage with the client on financial but also on the whole gamut of business, this results in dramatically reduced discouragement.

We have a duopoly in business banking. If this is not to, perhaps inadvertently, choke and retard the tech sector, bankers need to start to emerge from the crisis bunker and start to get to understand this small, export orientated sector. And one imagines the same for other areas.

This is a longer version of a column in the Irish Examiner


2 thoughts on “Banks, SMEs and relationship banking

  1. Noel Kinahan

    An excellent article outlining the challenges of our SMEs and peppered with excellent data evidence, however, as you outlined the key to success with any SME is its relationship with its bank. The current banking model in Ireland don’t use the “relationship banking” approach anymore. This was highlighted quite clearly by one of your fellow alumni Patrick Honohan where he said “there should be a second tier of banking which is geared more towards local concerns, with local managers and a greater level of local awareness”. (Overview of Banking Sector; Joint Committee on Finance, Public Expenditure and Reform Debate)

    In addressing the needs of our SMEs we need more competition in the banking sector, but not “more of the same”. Therefore we have to look at different models that can fulfil the needs of our SMEs (the backbone of any economy). A model where the nature of the bank is not purely short-term, profit-orientated but has a mandate from stakeholders rather than shareholders. A system which may seem alien in this small island of ours but one that has been successfully operating for the last 200 years and represents one of the three pillars of the German banking system, the Sparkassen (Savings Banks). This banking model, which provides 70% of SME lending in Germany, is by its nature geared towards local concerns, with local managers and greater local awareness and brings prosperity to local communities.
    Maybe something to consider and examine, an “alternative system” with a mandate to bank in the public interest.

  2. bossbutteringbee

    Nice piece of work guys. You might want to look more closely at the Irish practice of requiring personal guarantees and to what extent this bypassing of the limited company legal structure is found in other states. It amounts to a denial of credit to a significant proportion of businesses.


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