Tim Breedon is the former CEO of Legal & General Group. He has served as Chairman of the Association of British Insurers, and a Director of both the Financial Reporting Council and the Investment Management Association. In 2011 he was asked to chair the UK government’s Non-Bank Lending Taskforce, an industry-led team that looked at the structural and behavioural barriers to the development of alternative debt markets in the UK. The “Breedon Report” was published in March 2012; Government and industry are currently seeking to enact many of its recommendations.

This conversation took place in April 2013.

Stephen: Your report last year looked at non-bank lending. Do you think there has been too much focus on the major banks?

Tim: The political and media focus had certainly been on banks, and possibly rightly so. But you are right; I thought it was important to take some heat out of what is still a very highly charged debate. First of all we tried to establish the nature and the scale of the problem we actually face. What is the shortfall in lending? Is this a problem of demand, or supply? And how is this problem likely to develop over time? I wanted to get beyond the blame game. The debate had become dominated by political rhetoric – and that undermines confidence, and then itself becomes part of the problem.

Stephen: I think it still is, but at least an alternative and more constructive debate about what we can be doing is now happening – albeit quietly – alongside.

Tim: Yes. It is certainly true that banks’ lending to SMEs has fallen … but it is also the case that demand for funding from businesses is down, and that is principally because of a lack of confidence in the broader economy and … a lack of ambition or drive from the companies themselves? It is well known that SMEs are currently net depositors with the banks. They are collectively sitting on records amounts of cash. But maybe – when the media and public policy agenda is dominated by austerity and bad news – it is rational to be risk averse. That doesn’t mean we shouldn’t be trying to change that. We need to provide the support, advice and confidence that businesses need to make them want to invest. Because not only are cash deposits at a record high, investment by small businesses is also at a near record low.

Stephen: Yes – history tells us very clearly that what is arguably a rational approach in a gloomy economic climate, is storing up trouble for tomorrow. Under-invested companies will suffer ... and more than that they are simply missing so many fantastic opportunities to grow. Do you think much has changed since the Report was published?

Tim: I do. At a macro level I am actually quite positive about the economy, and SMEs in particular.

Stephen: I agree. It is very easy to paint a picture of doom and gloom – but we are seeing lots of growing and successful small businesses, strong pockets of growth and a new, emergent entrepreneurial spirit in the UK. We are also seeing a greater willingness to engage with different funding sources, and lots of product innovation from new entrants, as well as from the traditional banks.

Tim: The call for more competition is interesting. I don’t believe we simply need more banks. We don’t need lots more institutions processing payments, holding retail deposits etc. What we do need is more alternatives for SMEs looking for finance. That means more competitive and alternative products … and these don’t all need to be provided by fully fledged banks.

Stephen: You have also seen some progress on some of the specific recommendations you put forward. Not least the proposed Business Bank … of which I am very pleased to have been asked to sit on the Advisory Group charged with helping to establish it.

Tim: The Business Bank could be really important. It could make a real difference. In general I think we are beginning to see a more mature, more evidence-led debate. We have made some progress on advice, on supply-chain and invoice financing. And as you say we have, in the shape of the putative Business Bank, a new institution which could potentially take forward some of the ideas to encourage new institutional investment into UK SMEs.

Stephen: Support and advice is an interesting area. I am constantly surprised by the number of businesses that don’t have a strategic plan. They have an idea, they have a sense of what they want to or could achieve, but they don’t have a plan. It isn’t written down and they find it difficult to articulate. It can be hard to invest in that business!

Tim: That is why advice is so important. One of our recommendations was a Business Finance Advice Scheme. This has been enthusiastically picked up by the accountancy profession … small companies in particular need help and guidance in getting the best out of a more diversified and complex financing landscape.

Stephen: The Report talks about businesses needing to be “enabled to be better consumers of finance”. Advice is a big part of that. And companies need advisers to talk in a language they understand. Too often finance people talk down to companies. If you can’t understand something an adviser or investor is saying, either it’s not being explained properly or they don’t want you to understand it. And business owners won’t put up their hand and say: ‘I don’t understand’.

Tim: The other component of advice is simplicity … I think the proposed Business Bank has a real opportunity to play an important role here. It can also do a lot more besides. I am very interested in how it might aggregate SME loans and so enable and encourage some of the UK’s major financial institutions such as insurance companies and pension funds, to invest in SMEs.

Stephen: I hope so. There has long been talk about establishing a bond-market for UK SMEs. There are many issues, lots of challenges involved with getting this up and running … but I think the Business Bank could prove to be a real catalyst in this regard.

Tim: Absolutely. In the round, we definitely have the potential to see the emergence of a more diverse, vibrant environment for UK business; banks of course will remain very much at the core, but businesses of all sizes should be able to make an informed and rational choice, based on readily available advice, across a range of potential instruments and funding mechanisms.

Stephen: It is interesting that you say that businesses should be able to make informed choices. For SME businesses, decisions are ultimately made by one person – the CEO, founder and main shareholder – all in one.

Tim: True. These individuals are sometimes not as knowledgeable as they need to be. And sometimes they are not as tenacious as they need to be, or we might want them to be. For the Report we asked companies how many different options they looked at when they were seeking finance. The majority that took an idea to the bank – and had their request for funding turned down – didn’t then look anywhere else. They simply walked away. They gave up.

Stephen: Perhaps they didn’t know where else to go. Or they feared going anywhere else. There is a general lack of trust across financial services.

Tim: Our research also revealed that where companies did look beyond the traditional banks and products, especially overdrafts, there is an expectation that alternative funding sources will come with some element of grant or subsidy.

Stephen: Companies require different types of support and different forms of funding at different stages in their growth. If you better understand where you are on that trajectory, you will understand the risk and return and the opportunity you present to a potential funder, and then you will have a much clearer sense of who to look to for funding, and how to approach them.

Tim: I think this tells us a lot about the way in which our small businesses work and think. In recent years, for SMEs there has been a fixation on debt, and on bank debt and on overdraft facilities in particular. I can understand this; it was cheap and plentiful.

Stephen: We see this, a lot: companies that have grown by using and extending their overdraft facility. I think some entrepreneurs even began to use the size of their overdraft facility as a measure of their current success – and then as a signal for how confident they can or should be. “If the bank is confident enough in me to double the size of my overdraft, maybe I should be confident enough to use it”. Conversely today – when many of these companies have seen facilities reduced, sometimes halved – the entrepreneurs are reading a signal that says now is not the time to take any risks?

Of course the truth is that the overdraft was probably not the optimum way to finance their business then, and it certainly isn’t the best or only option to be looking at today.

Tim: Yes … the challenge we face is about demand as much as it is about supply … in fact much more so. Why aren’t companies investing? It is a lack of confidence. We need to encourage businesses to want to invest. And we are not doing that. In fact there is a sort of indirect discouragement … a belief that the bank are likely to say no, and that simply asking the banks for anything at the moment is not a good thing to be doing. That needs to be reversed.

Stephen: The crisis here is not really a lack of capital. It is one of missed opportunities. Of companies deselecting themselves.

Tim: Government can play a role here too. Maybe through the Business Bank, maybe something else. But it does need to be something that sounds positive … that sounds friendly and that encourages companies to be confident themselves.

Stephen: Whatever it is also needs to be properly promoted. My sense is that a lot of good initiatives have underperformed not because they were poor ideas or poor policy, but because business owners didn’t know about them. Promoting new products, and building new brands takes time and takes resources … but it needs to be done.

Tim: I have always believed that government can play a role, and that well targeted interventions can help.

Stephen: Your report also considered the practical steps that big business can take in procurement and prompt payment to support UK SMEs. Do you see progress here?

Tim: I want SMEs to consider funding as part of their supply chain. They need to manage the way money flows “down” to them from the banks, from investors, and from customers, just as efficiently as they manage the flow of materials and products from other suppliers. We need to apply the science and the partnerships of supply-chain management to the way we finance companies. We’ve just been talking about how many small companies rely on their overdraft to absorb the impact of short term fluctuations in sales. If we could free up some of that headroom, not only would it release immediate capital, it would also increase their propensity to invest. Prompt, certain payment and greater use of supply chain financing could make a huge difference. The Government are working hard to get larger companies to sign up to a prompt payment code. I hope more can be done in this area.

Stephen: There is a lot going on, and my sense is that there is a new, and real, focus on small and mid-sized companies.

Tim: I’m optimistic and enthusiastic. Things are changing. The economy is not as bleak as some people want to paint it, and it is already evident that small companies have a greater range of funding sources than ever before. BGF is a very good example of just that, and I am hugely encouraged by what you are doing.

Stephen: Thank you. We are certainly positive. It is really important that we present the different routes open to SMEs, so there is real choice and higher awareness of what options exist. Equity investors, like BGF, need to work hard to explain what they offer and to earn the trust of business. And businesses themselves need to put aside some of their preconceptions, even misconceptions, about equity and other non-bank finance and have the confidence to plan for growth with an informed and open mind. We need more collaboration and co-operation. That will generate greater confidence. And, as you say, it all starts from there.