Its report, The Benefits of Diverse Finance Markets for Smaller Businesses, found that core debt products such as bank loans, overdrafts and credit cards remain the most frequently used by SMEs looking to raise finance, but says a clear trend has emerged of fewer smaller businesses using core products since 2012.

Applications for new debt facilities fell to 4% of smaller businesses in the first half of 2017 (down from 11% in 2012) with the fall seen across a range of SMEs, from start-ups to older businesses and those specifically looking to scale-up.

The British Business Bank says, in part, these changes reflect the wider economic environment, and may also be due to a change in preferences, where smaller businesses generally prefer holding positive bank balances and funding growth plans from their own resources. Despite this, at an aggregate level, flows of finance to smaller businesses again grew in 2016.

Notably, after several years of contraction, net flows of bank loans (new loans, excluding overdrafts) were positive with nine consecutive quarters totalling £5.5bn through to Q4 2016. Asset and asset based finance grew healthily through 2016, with hire purchase in particular well above pre-financial crisis levels. Gross flows of lending to business via marketplace lenders reached £1.3bn in 2016, but they remain relatively small in comparison to sources of debt finance from banks.

The British Business Bank says one feature of SME finance has been the significant increase in flows of equity finance to smaller businesses over the last five years, though 2016 did however see a decline following a very strong 2015.  The analysis highlights the European Investment Fund (EIF) has made a significant contribution to UK SME finance markets, committing €2.3bn (£2bn) in equity and €438m (£385m) in guarantees and securitisation directly into the UK over the period 2011-15.This activity supports scale-up businesses and the bank says it will monitor closely market developments in this area.

British Business Bank analysis also indicates that structural imperfections persist in specific areas of the market across the UK and regional distribution of some products is uneven. Some of these problems apply to smaller businesses at all stages of development, whether they are a start-up, scale-up or seeking finance to stay-ahead. There is evidence that applications are still turned down due to factors that are symptomatic of an information asymmetry between prospective lender and borrower.

The report concludes this suggests that potentially viable finance requests are still not receiving funding. In addition, there are smaller businesses that are deterred from applying for finance, despite identifying a need for it.

London received the greatest amount of equity funding (47% by deal number, 56% by investment amount) in 2016, yet the region accounts for 20% of high growth businesses. The British Business Bank says this may suggest equity deals are underrepresented in other regions relative to the share of high growth businesses. Potentially one of, or a combination of, three factors are creating this uneven regional distribution of equity; either SMEs in certain regions are less aware of equity and its benefits, these SMEs are less aware of providers of equity, or there are fewer equity providers in these regions.

Keith Morgan, CEO of the British Business Bank said: ‘The diverse finance needs of our smaller business community are not always reflected in either the provision or take-up of available finance options, with pronounced differences seen across regions both in the supply and awareness of different finance options.

‘Today’s report sets out the benefits and importance of offering our smaller businesses a diverse finance market to support their growth and contribution to the wider economy. It again underlines the importance of ensuring smaller businesses are aware of and can access the right kind of finance they need to grow and succeed.’

The report also sets out the progress that the British Business Bank has already made against its objective, set by government, that over 75% of the bank’s stock of finance is facilitated through providers other than the four largest banks. In the last financial year (2016-17), 94% of the finance it supports was delivered by providers other than the ‘Big Four’ banks, a rise from 79% in the bank’s first year of operation (2014-15).

Responding to the report, Mike Cherry, Federation of Small Businesses (FSB) national chairman, said: ‘This report underscores both the over-reliance of small businesses on traditional bank products and the vital role that the EIF has played in supporting UK entrepreneurs in partnership with the British Business Bank.

‘Something has to change when only one in ten small firms is applying for credit and four in ten applications are rejected. We urgently need to increase the tiny proportion of firms that are seeking equity finance across the UK while supporting growth finance in all its forms.  

‘Brexit marks a make or break moment for small business access to finance across the UK. The EIF has contributed a staggering €2.3bn to small business finance markets in the five years to 2015 alone. That support must be replaced without any cherry-picking of particular funding streams.’

The British Business Bank report, The Benefits of Diverse Finance Markets for Smaller Businesses, is here.

Report by Pat Sweet