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Western EuropeNovember 2 2020

Credit options widen for the UK's embattled SMEs

Covid-19 has hit the UK's small and medium-sized enterprises hard, but wider sources of credit and new mechanisms for dispute resolution may provide a silver lining. 
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Credit options widen for the UK's embattled SMEs
Barclays

The outlook facing many small and medium-sized enterprises (SMEs) in the UK is challenging. Efforts to contain the spread of the Covid-19 pandemic are having a debilitating effect in every corner of the economy, while rising infection rates offer little hope of a return to commercial normality over the near term. For small businesses, this state of affairs is piling further pressure on their finances at a time when many are still recovering from a nationwide lockdown in March. With memories of the last financial crisis still etched in the minds of many business leaders, the sentiment of uncertainty that stalks the sector is grounded in experience. 

Research from McKinsey, a consulting firm, covering the early stages of the pandemic indicated that about 80% of UK SMEs experienced a decline in revenues between April and May 2020. About one in four businesses were reportedly concerned about defaulting on their loans. Though the economic situation has ameliorated in the intervening months, the outlook remains far from clear. Given that SMEs account for about 50% of the total revenue generated by UK businesses and about 44% of the country’s labour force, according to McKinsey, their health remains a key barometer for the state of the wider economy.

Positive outlook

But if there is a silver lining to British SMEs’ current woes, it is that the Covid-19 pandemic has accentuated several positive changes to their operating landscape since the last financial crisis. For one, the emergence of a new generation of more agile fintechs and non-traditional lenders has widened the constellation of credit sources in the British economy, particularly for enterprises on the smaller end of the business spectrum. Meanwhile, new mechanisms for complaints and dispute resolution, including the launch of the Business Banking Resolution Service (BBRS), will meet the needs of SMEs who do have relationships with conventional lenders. 

These longer-term developments have occurred as the British government has launched one of the largest and most comprehensive support packages for the private sector anywhere in the world. This includes, among other measures, the Bounce Back Loan Scheme (BBLS), which has provided £38bn ($49bn) in finance to the smallest UK businesses, and the Coronavirus Business Interruption Loan Scheme (CBILS), which has provided £15.5bn in support to SMEs with an annual turnover of £45m or less. For many enterprises, these measures have been a lifeline. 

The rise of fintech lending groups, catering to micro-sized businesses with annual turnovers in the hundreds of thousands of pounds, has been one of the notable success stories of the UK’s financing landscape in recent years

“There are imperfections with the schemes. But I think overall it has been a remarkable effort by the government, the banks and the non-bank lenders as well. I think the policies have been very effective in getting us to the place we’re at today. Default rates by SMEs remain relatively low,” says Alex Miles, head of growth at Capital on Tap, a UK-based small business lending fintech. 

This sentiment is echoed by many lending institutions across the country, from banks to fintechs. The UK example stands in contrast to several continental European markets, where government-backed funds have been harder to secure. In addition, it seems that the UK’s SMEs have been putting this money to good use. 

“I think the UK did a good job in terms of dispersing money. We saw our backlog of collections in the UK largely clear, as businesses used these funds to pay their late loans. If you look at other markets, businesses have had a harder time securing money,” says Scott Donnelly, chief executive officer of CapitalBox, an online pan-European SME lending platform. 

Funding issues

Nevertheless, the government support schemes are not without their flaws. For one, the National Audit Office expects losses of between £15bn and £26bn on the BBLS through a mixture of fraud and businesses not being able to pay back the loans over the longer term. In addition, some established UK banks have, at times, made it harder for SMEs to access government-backed finance by, among other measures, restricting the onboarding of new customers. 

This reflects a wider caution among UK banks in a market environment of lower growth and rising unemployment. Even if most of these support measures — including the BBLS and CBILs — come with a government guarantee, asset quality concerns remain front and centre for most. Ratings agency Moody’s expects that problem loans will increase from 1.9% of total system loans in 2019 to 4.1% by 2022, though consumer finance dynamics will also play a sizeable role in this increase.

alessandro roccati

Alessandro Roccati

“Large UK domestic banks’ overall asset quality will decline as a result of the coronavirus crisis, particularly among those that are more exposed to consumer lending such as Barclays Bank UK and Lloyds Bank,” says Alessandro Roccati, senior vice-president at Moody’s Investors Service. “Problem loans will increase due to weaker economic activity and a rapid rise in unemployment.”

Filling the gap

In general, however, the relationship between established banks and the UK’s SMEs has grown more distant since the last financial crisis. There are several reasons that account for this, not least is the banks’ inability to develop a profitable business model when it comes to serving smaller businesses. And from an SME perspective, many felt poorly treated during and after the last financial crisis, which has hit relations ever since. 

“In the years after the last financial crisis, banks have been retrenching their lending to small businesses. The reason is because it’s not profitable for them. It costs them a lot of money to service these customers because they have complex, manual underwriting processes,” says Mr Miles. 

“[As a result], you have a lot of non-bank lenders — fintechs like ourselves — who have come in and are able to commercially lend on a profitable basis. We have stepped into this funding gap. So I would say actually, on the whole, prior to the pandemic there continued to be quite good access for SMEs to funding sources, but increasingly it was coming from fintechs as opposed to big banks,” he adds. 

Indeed, the rise of fintech lending groups, catering to micro-sized businesses with annual turnovers in the hundreds of thousands of pounds, has been one of the notable success stories of the UK’s financing landscape in recent years. Capital on Tap is a case in point: established in the wake of the global financial crisis, the company has since lent over £2bn to more than 120,000 British businesses. This has been delivered in the form of business credit cards and revolving credit facilities. 

“We have stayed open for business throughout this year. We have continued to underwrite new business throughout the lockdown period and we are continuing to do so now,” says Mr Miles. 

Similarly, pan-European lender CapitalBox counts the UK as one of its largest markets. Offering working capital loans to micro-SMEs with typical loan sizes of €15,000–20,000, the group was established five years ago and has been turning a profit for the past three years. “We make the decisions and pay loans out in one day. It’s a five-minute application online. It’s just a competitive advantage to not have legacy systems — if you start fresh, you have an advantage over a slow mover who has a legacy organisation and infrastructure,” says Mr Donnelly. 

New route to resolution 

The rise of non-conventional lenders in the UK has helped to plug a funding gap that was particularly salient for the country’s smaller businesses. Encouragingly, as this happened, the rights of this business constituency to issue complaints against financial institutions has increased in tandem. In 2019, the Financial Conduct Authority expanded the remit of the Financial Ombudsman Service (FOS) to receive complaints from micro and small businesses, increasing the eligibility criteria to cover businesses up to a balance sheet size of £5m and that employs fewer than 50 people, building on its existing service for businesses with a balance sheet of less than £2m and fewer than 10 staff.

Meanwhile, the launch of the BBRS in November 2020 will offer larger SMEs with a turnover of up to £10m and total assets of up to £7.5m an avenue to direct their complaints. The BBRS will also cover historical complaints going back to 2001 for cases that included businesses with a turnover up to £6.5m and total assets up to £5m. Devised in the wake of the Simon Walker SME Complaints and Resolution Review, a detailed report covering the landscape for complaints and alternative dispute resolution processes for the UK’s SMEs, the BBRS fills a sizeable gap in the dispute resolution landscape for the country’s private sector.

lewis shand smith

Lewis Shand Smith

“One of the main conclusions from the Simon Walker Review was that, following the 2008 financial crisis, many SMEs had been treated badly and that there were problems and complaints with their banks that remained unanswered,” says Lewis Shand Smith, executive chair of the BBRS.

The BBRS will cover complaints received from the customers of seven participating banks, including Barclays, Danske Bank, HSBC, Lloyds Banking Group, NatWest Group, Santander UK and Virgin Money. Every SME lodging a case with the BBRS will be appointed a so-called customer champion to help the business secure and file the appropriate documentation, while guiding them through the complaint process. For British SMEs, the launch of the BBRS opens up new possibilities for effective dispute resolution.

“The BBRS has partnered with the Centre for Effective Dispute Resolution, who will conduct the majority of the complaint handling. We are also in the process of building up an in-house team who will deal with the most complex cases, as well as appeals. We hope to have a wide range of tools available to use in dispute resolution, from encouraging an early settlement to using formal mediation through to investigation and adjudication,” says Mr Shand Smith. 

The launch of the BBRS now means that most UK SMEs will be able to pursue complaints against financial institutions without resorting to expensive and time-consuming litigation. And, in light of the Covid-19 pandemic, its addition to the dispute resolution landscape is nothing if not timely: it is likely to play an important role in supporting the UK's SMEs through the economic fallout of the coming months and years. But more importantly, the activities of the BBRS could help to address some of the long-standing problems that have troubled the relationship between banks and larger SMEs since the last financial crisis. 

There will be a shift from fixed-term lending to more revolving, flexible facilities, whether that’s overdrafts or credit cards

“Part of the reason for setting up this organisation was to help rebuild trust between banks and their SME customers. That’s going to be really important as we move forward to rebuild and restore the economy, and I think the BBRS has an important role to play in this process,” says Mr Shand Smith. 

Looking to the future

Initiatives like the BBRS will go a long way to improving the operating landscape for the UK’s SMEs, marking a significant change from the years following the last financial crisis. So too will the presence of a new breed of more agile, fintech lenders who are better able to address the financing needs of smaller and micro-sized businesses. Already, for example, the availability of alternative financing solutions is driving a change in demand for credit products on the part of small businesses. 

“I think there will be a shift from fixed-term lending to more revolving, flexible facilities, whether that’s overdrafts or credit cards. This way businesses are only borrowing what they need when they need it. I think the flexibility of revolving credit will prove much more popular moving forward,” says Mr Miles. 

But with so much uncertainty hanging over the state of the economy, and as government support schemes begin to wind down in the coming months, the true cost of the Covid-19 pandemic is only likely to become clear well into 2022. Until then, the UK’s SMEs will be swimming upstream against strong and unpredictable currents.  

This article first appeared in the November edition of The Banker magazine. View a digital edition here.

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