The announcement of funding from Europe for Ireland's SMEs is helpful but shortfalls in working capital remain a key problem for business, writes FRANK DILLON

LAST WEEK’S announcement of a new €300 million loan package for small businesses from the European Investment Bank (EIB) came as welcome news for Ireland’s hard-pressed SME sector. The EIB is providing loan packages of €100 million each to AIB, Bank of Ireland and Ulster Bank, in addition to the €50 million in EIB funds already drawn down by Bank of Scotland Ireland through its UK parent, HBOS.

The funding will be available within weeks and is expected to be priced at rates just below 4 per cent, making it cheaper than any other finance currently available to the small business sector.

The EIB says its initiative is about providing extra liquidity to the banks at attractive rates to extend the volume of lending to the SMEs sector and is part of a Europe-wide programme to help stimulate entrepreneurship. The bank lent €8.1 billion to the sector in the EU last year, one-third more than in the previous year. Significantly, around half of this total was lent in the fourth quarter of 2008.

The EIB has made it a condition of its lending that preferential rates are passed on to the SME clients, although it will not reveal the rate at which the banks are accessing the funds.

The finance takes the form of loans for specific development projects and excludes funds for restructuring or working capital.

However, the funds can be used to purchase a plant or to finance research and development; building or taking over distribution networks; filing or acquisition of patents or in certain cases, the acquisition of another small enterprise.

Small firm representatives welcomed the initiative last week although ISME said that the banks should have moved faster as it had lobbied them for over six months to access the funding.

A spokesperson for the EIB, however, said that the perception that Ireland was slower than other EU countries in accessing these funds was not correct.

Funding has been available to UK firms under this scheme since January. Barclays Bank has said that every small business loan application that it receives would be assessed against the EIB criteria and that the preferential EIB rate would be offered to all appropriate applications.

The Irish banks are expected to announce details of their packages within days. In this phase of the scheme the Irish banks are taking the risk involved in the lending, but the EIB says it will announce a risk-sharing extension to the scheme later this year that will widen the scope of lending. In a further development, the EIB and the European Commission are planning a pan-European micro credit fund aimed at very small enterprises. This fund will allow loans to be granted, through around 30 European microfinance institutions, for the creation and development of very small enterprises, as well as to provide technical assistance to such companies. This will focus in particular on companies located in sensitive areas.

Such initiatives provide a welcome good news story in bank lending for small business, but access to funding remains a problem for some customers.

Finance for working capital and extension and/or renewal of facilities such as overdrafts remains a problem, according to Mark Fielding of ISME, which carries out regular surveys of bank lending to the sector.

Fielding said that his latest figures, covering the period up to the end of February showed refusal rates of 48 per cent on lending applications but admitted that this was an improvement on the high point at the end of last year of 58 per cent. The comparable figure for last summer was 24 per cent, he said.

Fielding also said his members had reported instances where banks had asked firms to reduce their existing overdraft facilities within 60-90 days and, in general, banks were being more active and critical in reviewing facilities than they had in the past.

One effect of the credit crunch has been the lengthening of the terms of credit by businesses, some of which can easily afford to pay, he says. Prompt payment regulation, which was supposed to prevent this happening, has not been widely adopted, he says.

Felix O’Regan, of the Irish Bankers Federation, agreed that banks were being much more proactive in managing the accounts of small business. “There’s a lot more bankers back at the coalface. Relationship management is now a big issue for the banks again so there are a lot more conversations taking place than you had during the boom years,” he says.

Three factors were influencing this, he said. Firstly, there was the general liquidity situation affecting financial institutions, secondly, the more challenging business environment was forcing banks to scrutinise financial information more thoroughly to assess exposure, and thirdly, new regulatory conditions imposed by the Basel 2 agreement, meant banks were restricted in what they could do. Basel 2 sets out specific criteria against which banks must make their lending decisions both in terms of their portfolio of lending and individual lending decisions.

Banks are also making greater use of behavioural scoring, also known as customer or predictive scoring, which rates customers on the way they operate their financial affairs, based on the pattern of activity observed by banks on existing customer accounts, O’Regan explains.

Behavioural scoring is typically used where customers have been with a bank for a period of time. This information is used to consider credit applications, and for the ongoing management of account facilities, as it builds up a picture of how a customer manages their money. An example of a negative indicator might be where cheques or other items have been returned unpaid.

O’Regan acknowledged that the tightening of banks’ lending policies has been difficult for some small businesses, but says that banks look at individual cases on their merits rather than displaying a bias towards the sector, pointing out that €3 billion has been advanced to the small business sector, aside from the EIB initiative.

“If a business is experiencing cashflow problems, you need to assess whether that stems from a structural problem where a question arises about whether it can be sustained or whether it is a viable business with a future that needs to trade its way through a tricky period. Banks are endeavouring to make these judgments and respond appropriately,” he says.

Lending is clearly more selective now, with a bias towards low risk, but there are alternatives to traditional bank finance. “It is fair to say that problems of the banking sector have meant that access to credit has been problematic but a combination of equity and debt is very much accessible for SMEs with growth potential,” says Norbert Gallagher of Equity Environmental Assets Ireland, which invests in green projects.

Gallagher says the bar has been set very high for access to bank loans. “High growth potential companies have a lot of convincing to do and have to deal with competition for these funds. Realistic valuations of where the company stands given the turmoil in the markets is also critical when dealing with both the banks and venture capital funds. That said, innovative companies can turn this around and use this to their advantage in formulating performance-related clawback on their equity deals,” he adds.