Bank or pawnbroker?

There was a time when as a small business owner you could go to your bank with a reasonable business plan and you would get a modest overdraft. But not now: what has happened to make the banks so dislike overdrafts?

Are banks now behaving more like pawnbrokers than old fashioned banks?

Banks don’t like unused overdrafts

I was at a talk last week by a senior manager from a national bank, and he explained that his bank requires that an overdraft has to be covered by a capital reserve. And this is the case even if the overdraft is secured by the borrower.

And fundamentally, what the bank doesn’t like is unused overdrafts – they have a capital reserve for funds that have not gone out of the bank!

This is why, if you go in to talk about a long term facility, they move you towards a loan.

Short term support

However, the presenter did say that many clients make the mistake of asking for a long term overdraft facility when what they really need is short term help.

Especially for working capital to cover orders in hand, the banks like invoice factoring because they can let you have funds that are secured on invoices – they get their money when your client pays them and you get the funds a month or two in advance.

And there are now companies in the market that will factor single invoices, so you don’t have to enter into long term commitments with high charges to get access to short term money.

A short term overdraft

Nevertheless there is still the alternative of a short term overdraft. If they can see and believe that your business is sound and just needs help over a few months, they will consider a short term overdraft.

But like a pawnbroker, they will probably ask for business or personal security. Even so, this may be a decent option.

Squaring the circle

So here we have the dilemma. Banks don’t like having a capital reserve against a facility that is not being used; banks are reluctant to take any risk, and ask for security even against short term funds; and borrowers don’t like the idea of securing their overdrafts against their business or personal assets especially if they are not making use of the funds.

Surely, to square the circle, banks should be encouraged to go back to lending small amounts of money over a short term without needing security. For a micro business, 8% of turnover (equivalent to one month’s receipts) over 3 months would seem like a a good starting point.

Posted by Peter Johnson, Business Advisor with SGBA. Call Peter on 07714 093406 or email him at peter.johnson@sgba.co.uk if you would to talk to someone about your business.