Two data releases came out last week that deserve the attention of anyone interested in SME finance – and especially anyone who like me has been struck by the ongoing disappearance of the small business overdraft. The steady drop in the number of overdraft approvals is probably the clearest signal of the huge structural change now unfolding in the way smaller companies finance their working capital. And it is no coincidence that Adam Tyler, who heads the National Association of Commercial Finance Brokers, puts the fast-rising popularity of alternative finance among his members down to the gradual demise of the overdraft.

 

Both data releases – the Q2 reports from the SME Finance Monitor and the British Bankers’ Association – shed interesting light on the question of what’s happening to SME overdraft borrowing.

 

Here’s my top-line take on what they reveal:

 

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• The latest BBA data confirm a trend that’s been running for at least four years: the number of overdraft approvals is shrinking fast. In the first half of 2012, BBA members approved 114,707 overdraft applications from smaller companies (usually defined as having turnover of up to £2m). In the first half of this year, they approved 60,133, a decline of 47% in three years. If that isn’t a structural change in a major market, I’d like to see one. Among mid-sized businesses (about £2m-£25m turnover) approvals dropped from 17,001 in H1 2012 to 13,240, a 22% decline.
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• But the conventional explanation for this – banks don’t like to say yes – looks shaky. The SME Finance Monitor (which surveys 5000 SMEs every quarter, making it easily the most robust set of data on SME finance available in the UK today) is recording success rates of 84% among overdraft applicants. Even first-timers and those with below-average risk ratings are seeing their success rates go up. This all suggests that the falling number of approvals is due to a continuing drop in the number of companies applying for an overdraft, rather than a spike in refusals.
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• Companies might have stopped applying for overdrafts because they no longer believe they have a chance of getting one. Given the reputation of most banks, that’s perfectly possible and the Monitor reports that 3% of SMEs wanted to apply for an overdraft but didn’t, the two main reasons being that they felt discouraged and that they process was too long and expensive.
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• However, some companies that would previously have applied to a bank for an overdraft are clearly now trying alternative lenders. A lot of loan applications on both loan and invoice discounting sites are explicitly intended to fund working capital requirements rather than major capital investments. The sums being lent via alternative finance sites are growing fast and brokers are finding them a good substitute source of working capital for clients, according to Adam Tyler of the NACFB. He says brokers’ P2P borrowing volumes have more than doubled in the past three years. So alternative finance may well be filling part of the gap created by the gradual decline of the traditional overdraft.
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• But the data suggest many are choosing to manage their finances differently. The amount of cash that small companies are holding is growing much faster than lending by alternative finance providers. In the past 12 months, cash holdings by small and medium sized companies have grown from £151.6bn to £157bn. But especially telling is where companies are holding their cash. Over the past year, according to the BBA data, the sums held in deposit accounts have grown 6.6% to £67.4bn. But cash held in current accounts, where it is instantly accessible to meet working capital needs, increased by 12% to £89.6bn. That’s an extra £9.7bn of cash on hand in just the past 12 months.
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• So it looks like several things are happening. Fewer companies are applying to a bank for an overdraft. Some of those that would previously have done so are being diverted to alternative providers. But a lot more of that former demand for overdrafts is being replaced by bigger holdings of cash.
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• It looks like arguments over access to finance are becoming more finely balanced, at best. The big question now is over demand. In 2012, the SME Finance Monitor showed 59% of smaller companies with employees were using external finance. By Q2 this year, that had dropped to 50%. Over the same period, the proportion of “permanent non-borrowers” recorded by the Monitor – those who had neither used nor applied for external funding of any sort in the past five years and had no intention of doing so – had jumped from 24% of smaller companies with employees to 35%.
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There’s no escaping the story the numbers tell: a huge shift is under way in the market for working capital finance and in how companies are choosing to meet that need.