Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum submitted by the Forum of Private Business


  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 services.

    —  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.


3.1  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 sector).

    —  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 personality—independent, 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.


4.1  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" account climate.

  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 pounds).

  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 SMEs

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 overdraft.

    —  Margin on loan.

    —  Margin on Loan Guarantee Scheme.

    —  Margin on car loan.

  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 another.

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 SME customers.

  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 result—quality 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 dramatically—the 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 decisions—part of which may be caused by the superseding of the local bank manager's role by call centres, regional business management and other technological processes—results 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 SMEs—Small and Medium sized Enterprises—as 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 relationships.

  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 officials, etc).

  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 suggest are:

    —  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 services.

    —  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" terms.

    —  Involvement of SME representative bodies directly in the development processes for the recommended documents detailed above.

16 April 2002

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