A survey of SMEs (Small to Medium sized Enterprises) I once read laid bare the hard facts about running a technology-related business in Canada.
On the upside, the ingredients for growth for SMEs were easily identified; they include better access to management, planning, marketing, manpower and product development. What was surprising, perhaps, was the realization that Canada’s banks and other financial institutions were seen to be major impediments to the growth and development of SMEs.
Considering these respected institutions came into existence (in part) to provide finance to Canadian businesses, it begs the question: what’s wrong?
Well, to begin with, few of us in the general public realize how radically banking has changed in the past few decades.
Commercial banking used to be rather simple; they’d hold depositors’ savings and then recirculate those saving (on a fractional reserve basis) as interest-bearing loans. Banks would lend mortgage money to homeowners, supply local businesses with a variety of debt financing options and grease the wheels of commerce by making personal loans for variety of purposes.
Bankers provided a ready supply of relatively cheap capital for the industrial economy. This was possible because the bank’s loan principal (the capital invested) was secured against a tangible (collateral grade) asset. It was normally a property asset or the plant and equipment in a business. With the loan principal secured, the only risk the bank carried was payment of the interest – which was why your bank manager looked you in the eye so carefully in those days.
Almost all this has changed in the past 40 years, and the reason is obvious.
Post-industrial societies are rapidly changing their engines of growth. According to the Brookings Institution in Washington DC, today (bankable) industrial type assets only contribute 25 per cent of GDP, (un-bankable) market services and intangible assets (goodwill, brand recognition and intellectual property, such as patents, trademarks and copyrights) have exploded in importance and now contribute over three-quarters of GDP.
How have banks reacted to this change in the economy?
Not surprisingly, commercial and industrial lending by banks has fallen with the decline of tangible assets from a high 60 per cent of bank assets in the ‘60s to a low of 18 per cent today.
Banks are no longer pure lending institutions. They’ve become broadly-based service industries; profits are driven by banking services, electronic funds transfer fees, and fees associated with asset-based loan securitization. Furthermore, since the elimination of restrictions on banking activities in the later part of the 20th century, there has been a wholesale movement of banks into the highly competitive (volatile) arenas of ‘financial services’. Indeed today many of the most famous names in banking are selling insurance, brokerage and investment counselling services, underwriting equity activities, while engaging in foreign exchange and credit card transactions.
So, what can banks do to help Canada’s SMEs?
We live in a changing world. SMEs today are building knowledge-based business by developing innovative software, patented technologies, network applications and, of (increasing importance), value-based communities of practice.
The hard reality for banks is, these modern intangibles are ‘invisible’ to them, and as such they no longer have security for lending purposes: no surprise they tend to avoid the technology sector like the black plague.
This problem is fixable; there are real assets being generated and the harder forms of intangibles are potentially collateral grade. However, before we can begin to solve this problem we much recognize that it’s a MUCH bigger issue that it appears.
The intangible asset problem begins with management; almost all SME’s today have ‘empty’ balance sheets, that is, they have none of their important assets identified and capitalized on their (formal) financial statements.
Why is this the case? Well, very few corporate leaders recognize their true sources of value. Even fewer have the confidence to capitalize their intangible assets (according to GAAP) on their balance sheets, which are universally prepared for tax purposes (and therefore expense all associated costs).
Banks have both the interest and expertise to start formalizing the treatment of intangibles so (some of them) can be collateralized for banking purposes.
Banks could take the lead, bringing together important players including government policy makers, tax authorities, accounting professionals and corporate leadership to translate society’s long standing asset management protocols from the declining industrial era assets to the creative assets of our modern economy.
Given the prize that awaits, a new banking business model with the potential to extend loan and other services to existing customers and gain new banking customers, the banking industry would gain significant new profit opportunities. In addition it would make life easier for angel investors (who also need asset security) and in the process unleash the economic potential of the most knowledgeable, innovative and globally connected generation in history.
Robert McGarvey is an economic historian and former managing director of Merlin Consulting, a London, U.K.-based consulting firm. Robert’s most recent book is Futuromics: A Guide to Thriving in Capitalism’s Third Wave.
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