Parliamentary inquiry on SME Finance SME0015

Introduction

This consultation response discusses the latest evidence on SMEs’ expectations of access to debt finance and growth after Brexit and highlights important implications for UK policy makers.


After the outcome of the EU referendum on 23 June 2016, a team of experts from the University of Southampton and University of Edinburgh have conducted a first-of-its-kind study using the Business Finance survey by the British Business Bank (BBB – a state-owned bank founded in 2014 with the objective of increasing the supply of credit to SMEs) to collect information on SMEs’ debt finance needs and the specific actions they would take. The survey of 1,535 English SMEs was conducted between 25th October and 22nd November 2016 through computer assisted telephone interviewing with individuals responsible for managing business finance.


Getting access to external finance is crucial for SMEs' growth. Previous studies have shown that when financial constraints become more acute, e.g. the global financial crisis, SMEs' growth rates are twice as slow when compared to those of large firms. SMEs and especially innovative firms are financially constrained and do not easily get access to debt finance. This is because SMEs are opaque as they do not usually have audited financial information and traded debt or equity. Furthermore, they do not exhibit the scale to diversify their investment portfolio. This makes them a risky investment for financial providers. Innovative firms are even more financially constrained as investments in innovation are hard to measure, costly to re-deploy, and characterized by uncertainty regarding their future successful commercialization.




SMEs' expectations of access to debt finance



The study results provide evidence that young (less or equal to five years old), innovative and small firms located in London and North England expect to be financially constrained as a consequence of Brexit. In addition, firms operating in other services (non-business service) expect difficulties in accessing debt finance. Moreover, the analysis reveals that firms located in London are not only changing their strategies (in terms of export, investment plans, and employment), but also expect lower growth rates and reduced access to debt finance after Brexit. Finally, the findings show that innovative firms located in the South & Midlands and in the North expect to be significantly and negatively affected by Brexit in terms of access to finance and growth. This is importance because innovative firms in peripheral regions are more likely to have their applications for finance (especially bank finance) rejected. Therefore, Brexit could further discourage them from applying for debt finance. * In this climate of uncertainty, SMEs can be reluctant to invest in innovation, as those investments are largely irreversible and invoke sunk costs that cannot be recovered. All these issues could slow down the British economy considerably as innovative firms play a pivotal role for the economic growth and SMEs are responsible for 60% of private sector employment and 51% of turnover in the UK.


To conclude, increased financial constraints and low expectations of growth can discourage SMEs, especially innovative firms, from applying for debt finance and can deter them from introducing new products. This could cause the economy to underperform as innovative firms are crucial in contributing to economic growth. This has important implications for UK policy makers. Policies aimed at reducing uncertainty and increasing the demand and supply of finance for SMEs in specific sectors and locations identified in this latest study could ameliorate the negative consequences of Brexit for the UK economy.


*The detailed survey analysis, including data and methodology can be shared by the authors upon request.