Do not bank on SMEs for growth Loan demand responds to supply and price

Lending to small businesses fell again in the first quarter of the year despite pledges by the banks to bolster the supply of credit to this potential powerhouse of the economy. The Bank of England's trends in lending report also showed banks are imposing onerous conditions and interest rates and trying to move customers from conventional overdraft facilities to more expensive loans.

The annual rate of growth in lending to small and medium enterprises (SMEs) has been negative since late 2009 and fell to minus 2% in February 2011. Data from the five major banks – Santander, Barclays, HSBC, Royal Bank of Scotland and Lloyds Banking Group – showed lending fell £2bn in the first quarter of 2011. The banks signed the Project Merlin deal in February in which they pledged to lend £190bn to businesses this year.

The latest fall in business lending came amid better news for the chancellor after official figures showed government borrowing was almost £5bn lower than expected in the year to March. Public sector net borrowing, excluding the cost of the bank bailouts, hit £141.1bn in the 2010/11 financial year. That was £4.8bn lower than George Osborne was expecting in last month's budget.

But hopes of fuelling the economy could be dashed by the Bank of England data showing that the smallest businesses were facing higher costs of borrowing even as terms for larger businesses and individuals were easing. And to secure growth, most small businesses need more cash on affordable terms.

The trends in lending report – which showed mortgage lending rose in January and February – said demand for credit from small business had fallen sharply. "Some smaller businesses have reported that requirements to offer personal guarantees have discouraged them from proceeding further with credit applications and that credit application procedures have been onerous," the Bank of England said. "Some have also reported that banks have been seeking to replace overdraft facilities with alternative, more expensive, credit products."

Access to finance for growth and innovation will be one of the subjects explored at the Institute of Economic Development Educational Trust conference on 26/27 October in Derby.