Inclusive economy? It’s time to talk about banks
This blog is about banks, but it’s not really about banks; it’s about how we get more investment into businesses to help them grow and create jobs.
In particular it’s about the ongoing failure of many of our banks to invest in businesses led by women or Black people or based in the North of England. It’s about why the UK’s economic performance has lagged many other countries.
The banks complain that many communities are ‘hard to reach’, but it turns out that the banks are the ones who hung up the phone.
This is the second blog in a short series looking at what ‘inclusive growth’ might look like and how to make it a reality.
“Manchester, we have a problem”
Firstly, why is a blog about ‘banks investing in businesses’ relevant to us today?
Finance is crucial to businesses wanting to get started or to grow or to improve their productivity. Financial investment in businesses in the UK is one of the key drivers of economic growth and the creation of new jobs.
Having helped to start a business myself, I can tell you that it would not have got off the ground without those founder investors nor survived its early years without a timely loan. Like most businesses, it needed money from other people to get it rolling.
Traditionally, most of this finance will come from banks, or similar financial institutions, in the form of loans or maybe equity investment (i.e. buying shares). It’s what these banks and institutions were set up to do.
Except, there is a problem.
Many businesses in the UK find it difficult to access this bank finance and have done so for many years. There is a wealth of research and literature identifying the challenges that these businesses face in finding the finance they need to grow. Strangely, despite much policy attention over many years, this problem has not been fixed.
The problem is even worse for many businesses outside of London or described as ‘hard to reach’ (an interesting term we will discuss later).
This lack of private investment matters because it is now one of the main drags on the UK economy, which has been stagnant for many years. The failure of many businesses to find loans or equity investment is like a huge handbrake on the UK economy.
But rather than the businesses themselves being the problem (‘not investment ready’, ‘hard to reach’) it seems that in recent decades the UK’s banks themselves have been steadily withdrawing from their traditional role of investing in business and industry.
This blog looks at the reality of business finance today and explores whether our banks may be a major part of the problem and in need of urgent fixing.
Factcheck: Is business investment really that low?
Am I exaggerating the problem?
A recent report comparing business investment across the 31 OECD countries found that the UK was one of the worst performers internationally. (Business investment is capital investment by private sector businesses in their own growth and development, for which bank lending is a key source.)
The new IPPR report[1] found that the UK’s business investment has been low in comparison with competitor countries since the 1990s and almost at the bottom of the table since the Financial Crash. Currently, the UK ranks at number 28 out of 31 OECD countries for business investment and is the bottom of the G7 countries for the third year in a row. The chart below illustrates this.
Make it stand out
Chart from: Dibb, G & Jung, C (2024) Rock Bottom: Low investment in the UK economy, IPPR
So, yes, this is a real problem.
Three findings about bank lending to business
My review of recent research on bank lending reveals three striking findings:
Bank lending to businesses in the UK has fallen in recent decades and is now a small part of what they do
Banks are not inclusive in how they lend money, being particularly bad at lending to businesses led by women or people from ethnic minorities or businesses in deprived areas
Banks are slow to invest in businesses through equity (shares) making it harder to start and grow businesses
Below, I summarise the evidence for each finding before concluding the blog with some thoughts about what steps the Government might take to fix this.
Finding 1: Bank lending to UK businesses is low
Firstly, what is an SME?
A small and medium sized business (SME) is one that employs less than 250 people.
There are 5.6 million such businesses in the UK and they account for some 99.9% of all UK businesses. Between them, they also employ 60% of the national workforce and contribute about 50% of the UK’s GDP. So, pretty important.
There are few large businesses in the UK (roughly 8,000 at the last count) although they employ the other 40% of the UK workforce.
Bank lending to businesses
The long view of bank lending to businesses and industry in the UK shows that banks have, by and large, lost interest in doing much of this kind of lending now that they have found much more lucrative methods of making profits – inter-bank investments, overseas investments, property speculation – almost anything except investing in British businesses to help create jobs.
Figures show that bank lending in the UK to private non-financial businesses declined from 60% of all lending in 1950 to just 10% in 2010[2].
More recently, just to show that this decline appears to be ongoing, gross bank lending in the UK to SMEs fell by 14% in real terms from 2014 – 2023[3].
This fall in overall bank lending to small businesses is despite the growing diversification of lenders in the UK and the growing number of banking licences being issued to new organisations. It would appear that the ongoing decline of traditional bank lending is undermining these innovations in the banking marketplace: so far, businesses are not any better off.
The declining interest of our banks in lending to businesses matters because these banks remain the main source of loans for most businesses – there are still relatively few realistic mainstream alternatives. The Bank of England estimated that in 2020[4], some 85% of outstanding loans to businesses were from….banks.
Why has bank lending fallen?
On the whole, the UK’s banks have found easier ways to make profits and have lost interest in the ‘bread and butter’ of lending money to real businesses to do real things. They have become heavily involved in the complex world of international financial investment, currency markets, derivatives, etc and these markets have grown substantially.
It has been argued that this kind of financialisation of our economy has led to the crowding out of more conventional investments and is undermining our productivity and economy. It is part of a wider shift in our economy. (I have written about this at greater length in a previous blog: We need to talk about rentier capitalism)
Finding 2: Bank lending to UK businesses is still not very inclusive
If you are a women leading a business or someone from an ethnic minority leading a business, or if your business is based in a rural area, a deprived area, a town by the sea or indeed anywhere outside of London, then….well….your chance of securing a bank loan for your business is even lower than everyone else.
What is perhaps most surprising about this is that data from the British Business Bank (the Government’s official ‘bank for economic development’) shows that the chance of these kinds of businesses securing bank loans has not actually improved in the last decade[5].
That’s no progress in ten years.
These businesses led by different groups of people (‘women’, ‘ethnic minorities’, ‘people in deprived areas’) are often referred to by the banking sector as ‘hard to reach’.
Well, that’s nonsense.
They are, in fact, not hard to reach at all, they are literally queuing up outside of the banks asking for loans and investments. They are very easy to see. They have made themselves very easy to reach. It is the banks themselves who are hard to reach.
This is a poor indictment of the banking sector as a whole and hardly an achievement for the British Business Bank either – established in 2014 by the Coalition Government to secure greater investment in SMEs across all regions of the UK and to make this more inclusive. The British Business Bank appears to be failing in its mission to accelerate economic development outside of London or to make such development more inclusive. It is surely ripe for substantial reform and improvement under the new Government.
Finding 3: Equity investment in UK businesses is low
The huge concentration of banks and financial institutions in London has also led to a situation where the vast majority of equity investment into SMEs also happens in London.
Most of the UK’s venture capital and private equity firms are based in London. It means that almost two-thirds of equity investment into SMEs in the UK happens in London[6]. This is obviously great if your business is in London, but not so good if you are based in Leeds or Manchester or anywhere else.
If you are an SME based outside of London, data shows that you will find it significantly harder to access equity finance of any kind. Little wonder that the economic gap between London and the rest of the UK continues to widen, even today.
Women-led businesses are also even less likely to access equity investment in the UK (they account for only 8% of all UK equity deals) and this has not changed over the last decade; no improvement.
There has also been little or no improvement in investment in businesses led by people from ethnic minorities either and this performance also doesn’t seem to be properly monitored or measured.
The lack of progress on all of these issues is difficult to account for.
A side note on social investment…
Lord Victor Adebowale CBE chaired a thorough investigation into the world of social investment recently, looking at very similar issues, chairing the Commission on Social Investment.
The Commission’s final report[7] concluded that the performance of social investment bodies in relation to inclusive investment was perhaps not much better than the banks. They were not good at investing in businesses led by women or those from black and minority ethnic communities or enterprises based in deprived areas. They also shied away from making equity investments in social enterprises, preferring lower risk options.
Whilst there is much to celebrate about the growth of social investment in recent years, social investors clearly also still have much work to do in making their own investments inclusive and equitable.
Conclusion: the future is regional
Getting more bank investment into small and medium sized businesses matters a lot – not only to accelerate national economic growth more generally, but also to ensure that growth is more equitable. It is an important part of how we will close the North – South divide in the UK, as well as enabling the inclusion of more groups within the business world.
So, if we want more jobs created outside of London and more investment into businesses led by women or people from minority ethnic groups, then we need to fix how our banks invest.
A crucial element of any solution must be to bring finance and investment decisions closer to the areas where the money is being invested. Too many financial institutions are now centralised and focused in London.
Across the UK we need decentralised regional financial and capital markets enabling SMEs to borrow money or secure equity investment more easily. Bringing decision-making closer to the business makes for stronger and better-informed relationships with business owners and also reduces the distractions of international investments.
What could this new approach to ‘banking for inclusive growth’ look like?
It means bringing in regional banks, achieved through the reform of banking regulations. It might even mean regional stock markets. Regional banking is the norm in countries like Germany, Japan and the USA and used to be practised in the UK too. Recent reforms did encourage some regional mutual banks to form in the UK but these projects have stalled – more support is required for a proper revolution in regional banking. Purpose-led regional banks which are embedded in their regions have huge potential to bring finance closer to local businesses and ensure that it serves local needs.
It means that the taxpayer-owned British Business Bank and the UK Infrastructure Bank should be more thoroughly held to account by Government to ensure more inclusive strategies and stronger performance.
It means that the Bank of England and HM Treasury should have more decentralised teams across the UK so that they actually understand our very different regional economies better.
The sorts of challenges we have looked at are significant but addressing them could have transformational effects on the UK, bringing about a much fairer economy.
It will require more than tinkering by Government; it needs bold and decisive reform to bring finance back under control and back to the service of the people and businesses of this country. Is Sir Keir Starmer’s Government up for this kind of radical change?
In the meantime, the challenge for investors, banks and other financial institutions is to set themselves more serious targets for inclusive growth and show us what they can do. Are they up for it?
This blog was written by Tim Thorlby. Please sign up for the email alert if you’d like to know about future blogs, usually published once a month.
Notes
[1] Dibb, G & Jung, C (2024) Rock Bottom: Low investment in the UK economy, IPPR
[2] Data from the Bank of England, 2014, quoted in: Ron Martin & Peter Sunley (2023): Capitalism divided? London, financialisation and the UK’s spatially unbalanced economy, Journal of Contemporary Social Science
[3] Data from p16 of: British Business Bank (2024) Small Business Finance Markets 2023/24
[4] Bank of England (2020) Open Data for SME Finance
[5] Data from p10 of: British Business Bank (2024) Small Business Finance Markets 2023/24
[6] Data from p9 of: British Business Bank (2024) Small Business Finance Markets 2023/24
[7] Commission on Social Investment (2022) Reclaiming the Future: Reforming social investment for the next decade