Small businesses must be allowed to think big

SME’s need help to compete with rivals in Europe, writes Bill Hobbs

The dramatic decline in domestic banking activity illustrates the need to redirect banking activity to funding the development of an export-orientated, medium sized indigenous businesses sector.

While the savings rate is increasing, household deposits are declining. The savings rate measures the percentage of disposable income not being spent on consumption. This money is either being stored as bank savings or used to pay down debt. And if borrowing to fund consumption drops the savings rate increases.

Since January 2010 household deposits have dropped by €7.3bn and household borrowings have declined by €10.2bn. These show that households are using less credit than before and paying down debts at a faster rate. This is also seen in the drop in spending at retail tills, with, for example, credit card usage declining by 6%.

The fall in business levels is even more dramatic. Deposits which are down €8.3bn and business loans have collapsed by €54bn, largely due to NAMA.

Overall the domestic banking loans to deposit ratio which peaked at 215% in May 2008 has dropped to about 155% but remains far higher than 2003 when it was 133%. The old adage applies: loans create deposits. As banks must continue to shrink their balance sheets, their capacity to make new loans is almost non-existent.  

Furthermore given that about a third of short term consumer and small business loans need to be rolled over every year, any contraction in new lending adversely impacts on all important interest income and associated fee income. Perversely the drop in demand for loans causes prices to rise rather than decline, as banks are forced to increase interest rates to make good the fall off in new lending.  

Of greater concern in terms of economic recovery is the continuing contraction in business lending and savings volumes. Businesses are not accessing longer-term loans, are increasing short-term borrowings and burning up savings in their struggle to trade through an economic depression. The drop in savings and increase in short term borrowings, principally overdrafts is indicative of worsening cash-flow pressures. 

The decline in bank borrowings is a factor of two things at play. The financial stress many are experiencing as turnover drops and bank reluctance to lend to struggling but viable businesses. However credit access alone will be insufficient.

If economic recovery is to be built on exports, then it’s abundantly clear that indigenous business performance needs to exponentially improve. With the SME sector only generating only 11% of turnover and less than 5% in revenues through exporting, in comparison to other similar sized economies, Ireland has quite a poor record in building a vibrant cohort of medium sized businesses capable of competing internationally. We have too many small businesses employing less that fifty people and not enough medium sixed businesses employing between fifty and two hundred and fifty. The business sector is missing some vital ingredients.

The first is access to affordable credit and capital. The overreliance on bank credit and lack of any other market for capital hinders the best from expanding. There must be a comprehensive small business loan guarantee scheme and a supporting investment programme to fast track them to larger medium size export oriented size similar to those found in Britain and Germany whose medium sized businesses are the drivers of export activity. This could be supported by a new dedicated development bank specialising in business lending.

The second is allowing for business bankruptcy. Truly entrepreneurial societies do not penalise risk taking. If a business fails the entrepreneur is allowed to dust themselves down and start again.

In the past this country nearly failed as an independent economic entity with its policy of promoting import substitution and trade protection tariffs. There is no going back to the small closed economy that nearly failed in the 1950’s. In the same way there is no going back to the small open economy that created and sustained an explosive asset bubble.

Today the challenge is to understand that buying and selling stuff on credit – consuming goods and services won’t cut the mustard. Unless we find a way to export things that others value and are willing to buy, then we will not achieve economic independence again.

The impetus for recovery will be demand driven by international growth, which it at risk of flagging. Unless we find a way to fund and drive international export-orientated medium-sized businesses then the chances of achieving long term sustainable economic independence are slim. Maybe this time we will discover how to thrive as a small nation state by finally building meaningful sized, internationally competitive indigenous businesses. 

A version of this article appeared in the Irish Examiner, Business Section, Monday 4^th July 2011.