Key takeaways

The SME Lending Market

• SMEs form a vital part of the UK economy.  In the UK SMEs include firms with fewer than 25 employees – in 2023 there were more than 5.55 million SMEs in the UK contributing around 16.7 million jobs and £2.4trillion in annual turnover.  Following on from its 2018 Report the TSC identified that there is still significant pessimism amongst SMEs around access to finance.

• Over the recent past challenger banks and specialist lenders have increased their share of the market at the expense of the 5 largest banks taking 60% of the market compared to 40% in 2012. No particular reasons are given for this change although the implication is that the larger lenders have a more cautious approach to risk than in the past.  There is apathy amongst the smaller businesses where research has shown that many businesses do not apply for finance as they believe they will be declined as well as a low level of awareness about alternative sources of finance.

The 5 key areas

• Basel 3 – under the PRA’s Basel 3.1 proposals the PRA has proposed introducing a new treatment of SME exposures which will increase the risk weighting from the current 75% to 85% as the PRA is concerned that the current risk weighting does not adequately reflect the risks of SME lending.  If implemented this proposal will make lending to SMEs more expensive and importantly will put the UK out of step with the EU and the U.S.  The TSC is particularly concerned that the change will impact international competitiveness and as a result recommends that the PRA must ensure the final implementation on Basel 3.1 in this area is no more stringent than the current system and international competition is not harmed.

• Dispute resolution – whilst the majority of SMEs now have access to the Financial Ombudsman Service (FOS) this is still highlighted as an area of concern by the TSC.  Whilst the feedback on FOS is broadly positive, there are some concerns as to whether FOS has adequate resources (both in terms of the size of the SME team and its expertise) to deal with SME complaints so the TSC highlights this as an area HMT and the FCA should continue to review.  Of greater concern are those SMEs which fall outside the scope of the FOS regime.  Although the Business Banking Resolution Service has been extended into 2024, it is widely viewed as being not fit for purpose, and as a result the TSC states that HMT must find a way of offering the larger SMEs an appropriate dispute resolution scheme, including considering whether the FOS regime should be expanded in scope, an option previously rejected by the FCA as being too costly

• Business debanking – the TSC is concerned that a number of SMEs are being excluded from access to finance purely because of the sector in which they operate. It received evidence from the pawnbroking and amusement machine sectors of banks withdrawing facilities despite these being legitimate businesses.  Evidence from the banks re-iterated that the main reasons for debanking customers are related to fraud and financial crime although “risk appetite” or “reputational risk” can also be a factor.  The TSC recognises that the HMT proposals to extend the notice period for terminating accounts and the requirement to give a clear reason will extend to business accounts (see our Engage article). It states that the FCA should continue their work into better understanding “reputational risk” or “risk appetite” and report on its findings by the end of Q2 2024.  The FCA should then provide guidance on these criteria to ensure consistency of approach.  In addition the FCA should continue to monitor business account closures through obtaining quarterly data as well as ensure FOS continue to publish statistics on complaints around account closures.  Of course, depending on the account providers’ approach to exercising the corporate opt-out,  HMT’s debanking reforms will not protect an SME which is not a micro-enterprise if the payment account is subject to the corporate opt-out under the Payment Services Regulations 2017.

• Role of the British Business Bank – similar to FOS the British Business Bank gets a positive report from the TSC.  The TSC recognises the significant role of the Bank during the pandemic and welcomes the decision of HMT to extend and rebrand the Recovery Loan Scheme into a “Growth Guarantee Scheme” until March 2026. However, it believes more can be done to educate SMEs on ways to access finance and so the Government should consult with the Bank on an on-going basis to ensure it has adequate resources as well as considering looking at making the Growth Guarantee Scheme permanent.

• Personal guarantees – the TSC received feedback from both SMEs and others that lenders’ requirements for personal guarantees lead to many SMEs deciding against taking up borrowing.  Some examples were given where the request for a guarantee was seen as being disproportionate to the lending being taken and there was evidence that the request for personal guarantees was restricting lending to social enterprises or those operating in deprived areas.  In the light of the Federation of Small Businesses (FSB) super-complaint to the FCA regarding the unfair use of personal guarantees and the FCA’s work in this area to see if any further guidance can be given in areas within the FCA’s remit (which is limited to lending falling within the scope of the Consumer Credit Sourcebook (CONC)), whilst the TSC would not be supportive of expanding the FCA’s remit into unregulated business lending, further protections should be given, including giving FOS the powers to look at any complaints where currently there may be a gap (although it was unclear from the report whether these gaps are perceived or real). HMT also agreed that this was an area it would consider, especially where it was seen as having an adverse impact on the smallest businesses.  However, set against this was clear feedback that any extension of the FCA remit would likely impact some lenders’ participation in the sector as well as limiting the scope of competition.

What do firms need to be thinking about?

The TSC Report highlights a number of areas where many lenders have already expressed concerns as to how future developments will impact their businesses.  Whilst lenders will welcome the recommendations on Basel 3.1 and the role of the British Business Bank, there may be concerns that their ability to properly assess the risks associated with SME finance will be adversely impacted by expanding FOS’ jurisdiction or limiting risk-based decisions through debanking restrictions or the ability to request personal guarantees.  In a sector which is seen as being key to promoting economic growth, the TSC recommendations will need to be carefully considered by HMT and the regulators.