Overdraft Lending

A recent survey showed that overdraft lending to SMEs has fallen 37% in the last 5 years. Overdraft lending to larger businesses has risen by 25% in the same period. The squeeze on SME cashflow finance from traditional sources has got more intense.

The problem for many SMEs is that with irregular income and little influence over debtor payment terms they are often reliant on overdrafts to survive.

So why have overdrafts seen such a reduction?

Legislation or Reputation?

There are reasons why banks don’t like overdrafts. The first being that they have no control over them, the only time they ever know that a business is struggling is when the overdraft limit is breached, by which time their money has gone and the risk is at it’s highest.

However, not all businesses use an overdraft because they are struggling. For many it is all part of normal trading, so why are banks still reluctant?

Much comes down to the cost of capital. I wont bore you with legislative science, let’s just establish that for every £1,000 a bank lends they have to set aside cash to cover it, that is cash that cannot be used for any other purpose. Different lending products require different levels of cash to be set aside. An unsecured overdraft to an SME requires the highest level of cash to be set aside, so naturally banks don’t like granting them.

Legislation or reputation? The answer is a little of both.

So what can the SME do?

Alternatives to Overdrafts

The worst time to seek an increase in an overdraft is when you need it, that is normally the time when the financials are at their most stressed and the bank least likely to help out. There are alternatives.

For most SMEs the perception is that the only alternative to an overdraft is payday finance. It isn’t. There are plenty of alternatives which we can access for the SME. Rather than list the alternatives it is about understanding what is required and why the need exists. The questions that the SME needs to answer are;

Why is there a need for finance? Is it;

• Due to making losses
• Because debtors owe you money
• A bad debt
• Seasonality
• Poor management
• Something else

Depending on what the reason is depends on the best alternative. There are different options available for each.

The next question to ask is about timing;

• How long do you need the money for. Is it now, just for once or an ongoing basis
• How quickly do you need the finance. Today, tomorrow, next month

The bottom line is the further ahead you can project the need then the more options and lower the cost. Again, in each situation there are options available.

If the SME is seeking overdraft lending then given the squeeze on providing this type of lending then the alternative may be a better solution. It may certainly be the easier and quicker solution. If you want to know the full options then get in touch.

By Dave Farmer

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