Mr. Pat Farrell:

I thank the Chairman and committee members for the opportunity to make a presentation today. I will talk briefly about the SME sector to provide some context. Some 99.8% of businesses in Ireland are small and medium-sized enterprises. Therefore, the sector is a cornerstone of the economy. It is worth noting that more than half of SMEs - which employ 900,000 people - were established in the past ten years and are very new in terms of operating experience. Employment is concentrated in the domestically focused sector, which we are aware has taken serious hit. Some of the areas hit are distribution and retail, accommodation, food, tourism and construction, which is on the floor. This is quite different from the typical SME profile across the European Union.

The next slide deals with SME use of bank credit. It is useful to highlight the difference between ourselves and our European peers. Looking at how SMEs use bank credit in the form of term finance, we can see that Irish SMEs are about mid-table compared with other European countries. When it comes to the use of overdraft facilities, however, we are top of the table. It can be seen that there is a big reliance on overdraft facilities among Irish SMEs. Six out of ten businesses say they have used overdraft facilities in the past six months, far more than in any other country. Generally, Irish SMEs' use of bank credit is significantly higher than in other countries.

Mr. Trethowan was fair in mentioning the issues that face banks in terms of improving their performance, and those that face SMEs. The main challenge for SMEs is weak demand in the domestic sector. People starting a business in 2007 would probably have based their business model on 25% growth in the economy between then and 2012. Instead, the economy has shrunk by 25%. That is a cataclysmic drop in domestic demand, which is bound to have a severe impact on SMEs that are primarily focused on activity in the domestic economy. Few of them are exposed to export or external demand.

Another problem is that many SMEs are under-capitalised and, as their primary problem is capital, they have had to drain either owner capital or other sources. Banks are not primary suppliers of capital. A further problem is that microenterprises face particular challenges. Help is on the way in that respect and we will talk later about the establishment of the micro-finance fund. These companies tend to be younger and smaller in profile and they find it harder to make a pitch in terms of meeting the requirements when presenting business plans to access credit.

The big challenge for banks, on which they continue to work, is to ensure they have productive engagement with customers. This means that customers with sustainable businesses need to approach the banks. It is a myth that banks are not lending and it is a myth that if a business approaches a bank and is turned down, that is a blot on its copybook. It is not, as will be verified by Mr. Trethowan. Another challenge for the banks is to increase our understanding of growth sectors. Many new sectors are emerging in the Irish economy in the software, life sciences and green technology areas and significant work is being done by banks to improve their skills and understanding in those sectors so they can lend to these businesses.

A problem I referred to at the outset is that of rebalancing the debt-equity ratio and finding ways to get more capital into banks. John Moran, the Secretary General of the Department of Finance, spoke about this recently at a conference, referring to the need to find models to bring more equity into SMEs.

If we look at the nature of credit demand we see that the principal requirement for credit for small and medium-sized enterprises is for renewal or renegotiation of existing credit facilities and not for new credit facilities. That is very understandable. In fact, it would be illogical if it were otherwise, given the level of reduction in demand in the domestic economy, which is effectively the driver of activity in these businesses.

There has been considerable debate about what constitutes new lending and whether renewal of existing facilities matters at all or is value-adding. I contend, as does the Credit Review Office, that the renewal of credit facilities is very important for existing businesses. I have two case studies to illustrate that point. These are drawn from real-life experiences but suitably anonymised. Take a company that has an existing loan of €2 million, upon which repayment is due at the end of the month. It cannot make that repayment in time. The company is effectively in breach of its covenant and the bank can either call in that loan or refinance it with new contractual obligations. If the bank calls in the loan because of inability to pay, it will lead to the business folding with the loss, in this case, of 30 jobs. The bank decides to refinance the loan for a longer period of time and puts a new contract in place, which means the business can continue to trade and the 30 jobs are secured. That is not simply a paper transaction by a bank. That is a conscious decision by a bank to stand back, examine a business which is unable to fulfil its original contractual obligations and make a commitment to refinance that business. That is critical because if such decisions were not being made, the unemployment problem in this country would be much worse than it is at present.

The second case study involves a company which has an overdraft of €100,000 and a loan of €1 million. The company cannot make the loan repayments and the overdraft is at its absolute limit. Again, the bank is faced with the choice of calling in the credit facilities or restructuring the loan as interest-only. In this particular case the bank sat down with the customer, restructured the loan facility on a new, two-year, interest-only basis and, as a result, the monthly repayment is substantially reduced. That is freeing up cashflow in the business and, in turn, reducing the pressure on the overdraft facility, allowing that issue to be addressed over time, given that the business is sustainable in the longer term. The business and economic impact of the renewal, restructuring and renegotiation of credit facilities is every bit as concrete and valuable as new credit facilities. It is as important for an existing business that needs it as new investment is to a new company starting up.

On the issue of SME use of bank credit, members will know the figures, which were covered by Mr. Trethowan. I will not go into detail on them again but we have data on the amount of money that has been extended to SMEs in the past year, the amount that is outstanding and the amount available through overdraft facilities, which is in excess of €2.5 billion.

It is important to examine the use of bank credit. Mr. Trethowan spoke about the number of cases examined by the Credit Review Office this year, and it must be acknowledged that the office fulfils an essential role. In the first nine months of 2012, however, banks approved more than 80,000 applications for credit for SMEs. That works out at 2,000 credit applications from SMEs being approved by the banks each week. That is a substantial amount of activity by any measure. Less than 50% of the approved overdraft limits that are in place are actually drawn down. In other words, there is a further €2.5 billion in overdraft facilities that have been approved but are not used by customers.

Mr. Trethowan also spoke about challenges for businesses, and one of the biggest of these is good planning and financial management. Approximately 53% of SMEs were established in the past decade, so they are young, inexperienced businesses. Some of them have not gathered the kind of experience they need in these current times in terms of meeting the requirement to put together a proper business plan in the format required by banks. We are working with businesses and accountants to try to close that gap.

Those who put money into a business, be they investors, banks or Government agencies, need to know how the money will be used, the potential of the business to succeed and the prospects of them getting a return for their investment. That requires a very robust business plan and, in some cases, one of the difficulties in sanctioning loans is that the business plan falls short. In some of the cases reviewed by the Credit Review Office, the subsequent approval is based on additional information supplied by the business. The most recent Department of Finance Mazars survey showed that many small businesses need to do more to show their business is a good proposition either for an investor or for financial support. Management experience is also very important and is a key indicator of whether a business will be able to pay back its debts.

As I have said, each SME is different. Indeed, the Central Bank recently highlighted the importance of treating each SME on its own merits and examining them on an individual basis. Measures such as liquidity and current ratios, the level of trade debtors and profitability are quantitative factors, but qualitative factors are also very important, such as how much experience the management has at running the business. The default rate falls as a firm's size increases, measured by turnover, and rises as loan size increases, which is a measure of risk. Particular attention must be paid to the financial health of small firms or microenterprises and borrowers who have large exposures. There is a very high level of distress across the lending already in place for SMEs, and that must be a factor in making decisions about advancing further credit to individual businesses.

The Irish Banking Federation employs 16 people. We have a limited, but important role to play and we try to be solution orientated. We work very closely with those in the Credit Review Office and others in the stakeholder landscape. We have done a number of specific things, on our own initiative, to address some of the issues raised by Mr. Trethowan in successive reports and which we have identified ourselves in discussions with other stakeholders and our member banks. I will ask my colleague, Mr. Felix O'Regan, to elaborate because he was centrally involved.