Memorandum submitted by the Forum of Private
1.1 The Forum of Private Business has extensively
researched the relationship between private businesses (generally
small businesses) and their banks.
1.2 The statement by the Chancellor of the
Exchequer on the Competition Commission finding was welcomed by
FPB, and it supports the recommendations to provide:
Easier changes (switching) of banks,
with a portable credit history.
Removal of "bundling" of
Transparent charges and interest
payable on current accounts.
Sharing of branches to provide a
better local service.
1.3 However, FPB has shown that the business/bank
relationship is complex and diverse, and great consideratin needs
to be given to the detail of this relationship, and in particular
the understanding of the "small business ethos" and
the "decision deficit" outlined in the comments below.
It is vital that the competitiveness of UK SMEs
is maintained in the global economy, and any constraints on finance
or the provision of bank services must act counter to the SME
competitive characteristics of flexibility and versatility.
1.4 Clarity and consistency are essential
to the relationship, as well as the real understanding by SME
managements of the options to their funding opportunities. Education
and training of small business owner/managers plays a significant
part in this understanding.
2.1 The Forum of Private Business evidence
to the Competition Commission on "Banking services to SMEs".
The Forum of Private Business has researched
in depth the relationship between banks and private business in
its biennial "Bank Survey" over the past 14 years, and
through regular questions in the FPB Quarterly Survey. The FPB
Reports "Private Businesses and their Banks" are based
on an analysis of around 10,000 responses, from both FPB members
and Bank customers, written by Professors Martin Binks and Christine
Ennew of Nottingham University. The evidence collated in the Bank
Reports and Quarterly Reports was presented in detail to the Competition
Commission on SME banking, and to the Business Banking Code Review.
2.2 What is FPB?
The Forum of Private Business (FPB) is a leading
campaigning business organisation, empowering independent business
to influence, directly, laws and policies affecting their profitability.
Founded in 1977, it serves its members as a non profit-seeking,
non-partisan organisation, representing some 26,000 business owners.
It is active on many campaigns and is the only
UK member of UEAPME, the pan-European Association of SMEs. With
a permanent representative in Brussels, FPB is continually in
touch with the European Commission committees to respond to current
issues on behalf of UK private business.
FPB is essentially "customer orientated"
as it has continuous contact directly with some 26,000 UK SMEs,
and through its "affinity" memberships, with circa.
74,000 SMEs in the UK. Membership of UEAPME (European Association
of SMEs), extends contact to some 7,000,000 SMEs in the EU.
3. GENERAL COMMENTS
3.1 Evidence to the Competition Commission
The analysis of successive years of detailed
FPB Bank Surveys, together with a wide range of anecdotal comment
provided by member contact with the FPB Member Information Service,
has enabled FPB to confirm significant substantiation for the
evidence presented to the Competition Commission.
There are several barriers to be overcome in
developing the optimum relationship between a private business
and its bank:
The multiplicity and diversity of
the market that, according to several banks, restricts their profitability
in managing SME accounts. (Counter to this position was the finding
expressed in the Cruikshank Report of cross-subsidy in account
operation from the more profitable SME sector to the personal
The poor quality of financial management
understanding by private business owners and managers (especially
in the "micro" business group).
The perceived dominant position of
the bank in the relationship, especially where borrowing is involved.
The nature of the entrepreneurial
personalityindependent, convinced of the viability of the
business, reluctant to display lack of confidence, generally assertive
(in many instances, autocratic) and often hesitant to seek advice.
A parochial outlook in private businesses
(most micro businesses operate within a 20-mile radius that focuses
on local rather than national, and informal rather than formal
contacts ("the small business ethos").
A lack of understanding of bank processes,
particularly risk assessment on the part of private business owners
and managers, and a belief that the relationship is unequal and
often distanced (the "decision deficit").
3.2 FPB Recommendation for a Written Contract
For some years FPB hs suggested that a written
contact could "equalize" the perceived power of both
parties, and would clearly define the terms of the relationship.
This concept has generally been rejected in favour of the Business
Banking Code, and FPB fully accepts this principle, although it
will continue to advocate a more definitive contractual and binding
agreement between a private business and its bank.
Two elements are vital to the improvement of
the private business/bank relationship:
The motivation of private business
owners and managers fundamentally to improve their own understanding,
and knowledge of, financial management (there is a requirement
for a much wider and more radical approach, both modular and "tailored",
to training provision for SMEs.)
Appreciation on the part of banks
that SME confidence in any "formalised" process will
be greater where small firms' own representatives are seen to
be involved with, and have endorsed, that process, and have set
up clear contingencies to overcome any relationship problems.
4. DETAILED COMMENTS
4.1 Diversity of SMEs (Competition Commission)
In its original evidence, FPB suggested consideration
for the diversity of SMEs within the Competition Commission Terms
of Reference that includes all businesses with a turnover below
£25 million. The Commission considered the supply of banking
services as either a single market, or a number of individual
markets. FPB evidence also pointed to the likelihood of a number
of categories of purchasers of such supplies.
The Forum of Private Business is well aware
that there is significant difficulty in defining a "threshold"
point between "personal" and "business" operation
of trading, especially for the individual who is running a single
person business. This problem not only involves definition by
the banks, but also extends into other Agencies, such as the Inland
Revenue, where there is still dispute over the definition of "employment"
and "self-employment". This is compounded by instances
where Industrial Tribunals, for example, have applied definitions
at variance with other bodies.
It is FPB opinion that such variation in definition
can only serve to complicate the conclusion of any enquiry relating
to "SMEs". The characteristic differentials within the
generic term "SME" are such that the activity within
the bank relationship at one end of the scale must be totally
different from those at the other end of the scale.
It is in this context that FPB would view the
limitations imposed by the definitions of "personal"
and "business" as being restrictive in their purpose,
and as operating to the detriment of SMEs, particularly those
that are now often categorised as "micro" businesses.
The Forum of Private Business also suggests
that it is very likely that a "personal" account may
well be relevant to "the bulk of the SME sector", when
it is recognised that 63.2 per cent of UK businesses can be defined
as "self-employed", and therefore as single individuals.
A further 26.2 per cent are operating with four or less employees,
and thus may well be categorised as trading at a level more akin
to the "personal" rather than the "business"
The Forum of Private Business suggested consideration
of the variation in the supply of the relevant services between
the "lower" end of the SME market (ie to the "micro"
businesses) and the "higher" end (ie to the "medium"
sized businesses, or those with a turnover of several million
Effectiveness of competition in the supply of
bank services does appear to diminish significantly in relation
to size and financial vulnerability of businesses, ie for the
smallest business there is a greater difficulty in obtaining an
alternative supply of individual services. In the view of FPB
this supports the Competition Commission's finding of a complex
monopoly, as the basis of supply should be risk rather than size.
4.2 Constraints on Bank Services Supply to
Money Transmission system
There appears to be only one source of supply
for the principal clearing banks, which is the service run by
APACS. The clearing time for a cheque is a minimum of three days,
unless a particular bank chooses to have same day clearance. There
are two known examples of this,
(i) the Royal Bank of Scotland when banking
into a branch where both accounts are held;
(ii) personal customers of Barclays Bank
up to £1,000.
It would appear that if there is only one source
of supply, the supplier can choose how to operate the clearing
system and the customer has no choice in the process used.
Electronic transfers can also take five days,
whereas Switch payments can happen instantaneously.
Provision of Overdraft and Availability of Loans
Our evidence suggests that it would be very
surprising if the banks were prepared to provide an overdraft
where there was no current account and/or deposit account and
in some cases, life cover. The supplier controls the lending decisions,
which the customer must accept. FPB suggests that the practice
of association of both overdraft and loans with the requirement
of provision of another form of account does "prevent, restrict
or distort competition", most certainly in connection with
the supply of loans. The Chancellor's recommendations on "bundling"
should be viewed in the light of this evidence.
Interest Rates and Charges
When the range of interest levels is examined,
that apply to the following:
Margin on Loan Guarantee Scheme.
The evidence suggests that there is severe limitation
of the range of margins (high and low) applied by the banks, and
little evidence of the relationship of those margins to risk.
There is a "take it of leave it" attitude. Once again
the customer has little or not chance of being able to influence
the levels of margin, or go to another bank for overdraft or loan
facilities without moving banks completely, and when negotiation
is permitted by the bank, there may be problems as suggested below.
There is doubtful price competition because
it is possible to negotiate lower prices than are advertised publicly
by banks for all their services. This flexibility in the bank
must surely demonstrate cross subsidy or overpricing, as it can
be used in the same way that supermarkets use "loss leaders".
It also suggests that the customer cannot effectively compare
the value for money that can be achieved from other suppliers.
If there were a fully transparent price structure
with quantity discounts for SMEs, it would be possible to judge
and compare prices and value for money. The worst example is the
flat rate charge per month for interest and transactions, irrespective
of the customer demand. It is difficult to imagine any other supplier,
eg a petrol station, suggesting that customers can pay £100
per month and take as much petrol from the pumps as they wish.
The widely publicised "free banking" for premium customers
must also be provided at a cost to other customers.
Switching (Changing Bank)
There is significant evidence of differentiation
between personal and business accounts, even at the level of a
single individual who trades as a business rather than a personal
customer. This must be wrong in a fully competitive market, in
that charges may well be applied to one account and not to the
other. It is difficult to understand in the case of an individual
that there should be a greater risk for one account in the same
name rather than the other.
As suggested above, there is evidence that negotiation
of charges is used as a means to differentiate, when switching
to another bank is considered by a business customer. However,
as customers know little of the process of charging calculation
(eg how it is associated with risk) they are often unaware of
the factors of calculation covered in the prices they pay. Negotiation
of a lower price on one service could lead to overcharging on
4.3 SME Management Awareness and Understanding
There is anecdotal evidence to suggest that
a significant majority of SMEs are totally unaware of the provisions
that may be available from their own bank. The failure to disclose
such opportunities whether intentionally or unintentionally may
well restrict or distort competition. However, this disclosure
failure does not appear to be limited to set-off, swap or sweep
facilities, but also applies to such facilities as BACS.
The Forum of Private Business has on two separate
occasions in the last ten years, conducted detailed pilots with
the banks in order to educate SME customers more effectively in
their understanding of bank practices. The first example was in
transparent risk assessment using the Forum of Private Business
Risk Assessment Form. The second was with the Bank Finance Review
document. Although we know that bank staff with responsibility
for face-to-face contact with SME customers consider both these
guidance documents to be excellent, to date no bank has accepted
officially them as a principle.
There is a fundamental lack of transparency
on the determination of loan terms and assessment of risk. This
Issue has been explained above, but the Forum of Private Business
must emphasise its belief that risk assessment lies at the heart
of any relationship between the bank and the business, which is
borrowing. Not only can the bank operate limits on transparency
in charges or other services, by withholding information on risk
assessment calculation to its advantage, but it also holds the
key to the understanding of risk assessment calculation by its
Unless SMEs can fully understand the process
whereby banks assess risk, they must be inhibited from comparing
terms and switching accounts to other banks. There is also evidence
that SMEs have been inhibited from switching accounts, both by
the element of fear imposed and also because there is no real
understanding by the customers of the associated risk assessment
or risk related margin. Presumably it is not in the interest of
the bank to provide this understanding.
Businesses therefore do not know the value of
risk assessment, and there can be little competition if the customer
is unable to compare the terms of different banks.
4.4 The "Decision Deficit"
As indicated above, the two principle competitive
attributes SMEs possess are flexibility and versatility. This
implies that policy decisions can be made quickly in reaction
to changes in market circumstances, but that their predominant
planning is generally short-term rather than long-term. Research
by Manchester Metropolitan University, for example, has suggested
that: "the difficulty many SMEs have is anticipating future
change and its impact on both the organisation's business processes
and its skills profile. The need to deal with the here and now
is overwhelming . . . short-termism or a need to concentrate on
the here and now means that SMEs are unlikely to devote time and
attention to the . . . needs of the future. It is not surprising
that the skills to analyse current . . . needs and forecasting
. . . are not available to the SME when the responsibility for
these lies with the owner/manager who undertakes a multi-faceted
and heavily pressured role within the company."
The short-term approach endemic to SMEs has,
in the past, relied on the ability to obtain speedy decisions
from external advisers, particularly banks, where the presence
of a local bank manager, familiar with local trading conditions
and the business itself, was able to provide rapid decisions.
Evidence from the 2000 FPB Bank gave a surprising resultquality
had deteriorated over the last two years (FPB Bank Report 2000).
This appeared contrary to the Bank's own views that technology
had improved their service by speeding up the flow of information.
It must be emphasised that the FPB Survey considered the perception
of SME owner/managers, as it related to their view of speed of
service quality of decisions. FPB concluded that the reason for
this decline in perception of quality was a result of what is
described as the "decision gap". This is illustrated
by the following figure.
There is no doubt that the speed of information
has increased dramaticallythe technological advance in
transmission of account information and in money transactions,
for example, has provided SMEs with far quicker and more detailed
information. This is illustrated in the upward trend from the
bottom left had corner of the figure to the top right hand corner,
from "slow" to "fast". However, the quality
of service has declined (top left to bottom right) according to
the results of the 2000 FPB Bank Survey. The difference between
the two is the available "reaction time" (left hand
side) to the SME management, and as the figure shows, the speeding
up of information flow and the slowing of decisionspart
of which may be caused by the superseding of the local bank manager's
role by call centres, regional business management and other technological
processesresults in the "decision deficit" shown
on the right hand side. This accounts for the perception of SME
owner/managers that quality has deteriorated. It is their basic
concern that where sudden market changes dictate a rapid review
of their business situation, which their size and flexibility
allows, the immediate decisions they require, based on instantaneous
information flow, now take longer to obtain.
4.5 The "Small Business Ethos"
There are many academic studies of "small business"
(or SMEsSmall and Medium sized Enterprisesas they
are often, misleadingly, called), but most of these focus on functions,
processes or procedures in small businesses, or on the ways such
businesses develop in the market place. Few have been concerned
with the "totality" of the way these businesses are
initiated and the complexity of their continuing and developing
For convenience, we have suggested the concept
of this "totality" in the generic term "the Small
Business Ethos". The study of Small Business Ethos"
would have, as its objective, the examination of the fundamental
differences between or institutions. Such examination must commence
with the many questions that would form the basis of a wide range
of studies, some of which would include:
The defining qualities of relationships in the
small business, and the diversity of these relationships in the
cycle of business growth or decline that would include:
Employer/employee relationships (Selection,
recruitment, terms and conditions, training, definition of responsibilities,
career path substitutions, etc).
Business/bank relationships (Financing,
understanding and application of risk assessment, alternative
funding, asset management, etc).
Customer/supplier relationships (Differences
in formal and informal quality control processes, informal understandings
within supply chains, etc).
Business/enforcement (How compliance
with "red tape" is achieved, the relationship with enforcement
There are many other elements to the "small
business ethos", and it is inevitable that other avenues
would be found for exploration in this very complex study. However,
it is necessary to have a starting point, and FPB suggests that
this may be a catalyst to initiate the study, that would not only
build on the body of existing research by defining a process under
which that research could be consolidated, but would develop a
greater understanding of the diversity which already exists.
An indication of the complexity of these relationships
can be illustrated by the following chart:
5.1 Whilst fully supporting the Chancellor's
recommendations for bank services to SMEs, following the report
of the Competition Commission, FPB is concerned that this only
represents a part of the action that it considers necessary.
5.2 Further recommendations that FPB would
Development of a standardised Risk
Assessment process for SME owner/manager, so that they may assess
the risk presented by their business more accurately, and as a
consequence, seek opportunities to reduce the levels of margin
they are offered on borrowing.
Development of a standard "Portable
Credit History" format between the major banks to ease the
ability of SMEs to switch banks, and therefore to seek fully competitive
Consideration of a written contract
between the business and the bank to enable the SME owner/manager
to "equalise" their relationship, even if only in "perceived"
Involvement of SME representative
bodies directly in the development processes for the recommended
documents detailed above.
16 April 2002