SMALL BUSINESS:A lack of cash and bank finance is hurting Ireland's small businesses, writes Fiona Reddan

THE CREDIT crunch of the past 18 months has hit Irish small businesses hard, with banks pulling back on financing facilities and firms struggling to get the cash to meet their short-term needs.

While industry associations representing small firms argue that the crisis is leading to perfectly valid businesses collapsing, is this actually the case? And if so, should Government, which once came to the rescue of the sector through the establishment of ACC Bank and ICC Bank, look to play a role again in helping to finance the small business?

According to Dr Aidan O'Boyle, joint managing director of Aalto Bio-Reagents and chairman of the Small Firms Association (SFA), the major problem facing small and medium enterprises (SMEs) at the moment is a lack of credit to meet short-term needs.

"The big problem for small businesses at the moment is paying suppliers - there is just not enough cash around and everyone is leaning on everyone else," says O'Boyle.

This is leading to a vicious circle whereby one firm isn't being paid so it looks to extend its credit with its supplier, which in turn isn't receiving payment, so it looks to postpone payment and so on.

Traditionally, small businesses would look to their bank for a loan or an extension of an overdraft facility in order to meet short-term cash flow problems. However, this option is not there at the moment.

According to a recent Irish Small and Medium Enterprises Association (ISME) survey, 54 per cent of companies have been refused applications for new finance and/or the extension of existing credit lines over the past few months, while of the 46 per cent of firms that were "successful", 38 per cent could not meet the stringent conditions attached by their banks to secure the additional funding.

"The crisis affecting small businesses is deteriorating on a daily basis and is so serious that companies, who have successfully traded through previous recessions and downturns, are indicating that they will have no option but to reduce staff or, in some cases, close up shop unless they get badly needed finance," says Mark Fielding, chief executive of ISME.

Start-up companies have been been particularly badly hit by the freeze on credit. While the economic environment may have led to many postponing their business plans, the difficulty in getting finance has been another factor.

The latest Bank of Ireland Business Start-up Barometer for the third quarter of 2008 shows the number of new Irish companies has fallen by 20 per cent, down to 11,591 in the year to September, compared to the same period in 2007. The barometer, which tracks the number of new businesses starting in Ireland, shows that the construction and finance/real estate sectors have been worst hit, recording declines of 42 per cent and 40 per cent respectively.

Emma Cadden, corporate finance manager with Farrell Grant Sparks, says that those considering starting their own business need to do their homework before approaching the bank.

"In the current economic environment, it is all the more critical to support applications for bank funding with a strong business plan and detailed financial projections, showing the viability of the project and the ability to service debt," she says.

While in the past few weeks, the main commercial banks have come out with firm plans to renew lending efforts to the SME sector - for example, AIB has put aside €3 billion to lend for working capital support, €1 billion in funding for increased investment, and €200 million to help start-up funds - it is yet to be seen what impact such announcements will really have.

The fear is that banks, who themselves are suffering from a lack of credit, will hold on to their capital and lend only on a very restricted basis. Moreover, they are likely to be increasingly risk averse over the next few years.

While four Irish banks are currently in discussion with the European Investment Bank (EIB) to avail of some of the bank's €15 billion pan-European fund to lend to SMEs, O'Boyle says it will take until next March for the EIB to give formal approval to its lending programmes.

In the meantime, SMEs are expected to continue to suffer, although Philip Bourke, professor of banking & finance at UCD, says that there is a lobbying aspect in the arguments from the SME sector that good businesses are going to the wall because of a lack of credit.

"It's not only a funding problem, it's also a business problem. Losing 6-7 per cent of our GNP as the property/construction market contracts to a normal size will wipe out many small businesses in all sectors and banks will be properly cautious in lending to all businesses in this environment," he says.

So, if the banks are right to be cautious is there anything else that can be done to alleviate the situation? In the UK, city councils have already started taking the initiative by announcing plans to create their own banks.

Birmingham city council, the UK's largest local authority, is drawing on its past to help SMEs hurt by the current crisis. In 1916, Neville Chamberlain, the Birmingham mayor who later became prime minister, set up a municipal bank to help the city contribute to the war. By 1950, the bank had 66 branches, and it later merged with Lloyds TSB.

Now, the city council is looking to follow a similar path by creating a bank which will lend up to £200 million to small businesses. The Bank of Birmingham (BoB) as it will be known, will also take retail deposits, and will use its ability to access loan markets to help fund small businesses which have been suffering from a withdrawal of credit by high-street banks.

And it is not alone. Essex County Council is hoping to raise up to £50 million to set up its own bank and is looking to get funding from the council, local health and police authorities and the EU regional development agency.

Is this something Irish local authorities should consider? While the funds from such an initiative would be most welcome, O'Boyle says it wouldn't be a runner in Ireland, as most city councils wouldn't have the scale to set up a bank.

"Birmingham is not only the largest city council in the UK - it is also the largest in the whole of Europe," he says.

Another possibility is for the Government to play a greater role in lending to cash-strapped small businesses. There is precedent for the Government to get involved, having previously set up two state banks aimed at solving similar problems to those being faced today.

Established in 1927, the Agricultural Credit Corporation, (ACC Bank) was set up to provide financing to the agricultural sector, and was followed, in 1933, by the creation of the Industrial Credit Corporation (ICC Bank), which gave loans to the SME sector.

The two banks were sold earlier this decade - ACC to Rabobank and ICC to Bank of Scotland - as part of an overall strategy to divest from the banking and financial services market.

However, the consensus is that the Government was right to get out of banking when it did and that it is unsuited to assessing whether a business is viable or not. Indeed, the difficulty in anyone but the banks lending to SMEs is that the banks are the best people for the job - they are the ones who know the most about small businesses and are in the best position to assess whether they are viable businesses.

So, until the banks are ready to assume more risk, it seems that there is no end to the difficulties facing SMEs in sight.