According to the Bank of England, there is a £22 billion funding gap for SMEs, largely due to the incumbent banks' inability to provide credit or working capital finance to many credit-worthy SMEs, purely because they don't 'fit the mould' in terms of meeting their eligibility criteria.
In this blog post authored by our Head of Strategic Growth, Nick Reid, we explore how banks are missing out on a 'golden opportunity' to earn greater revenue and establish themselves as the first port of call for SMEs looking for growth capital..
I first wrote about credit and its role in working capital for corporate treasurers three years ago. Corporates had been slow to realise the benefits and, if anything, the supply of credit from commercial banks exceeded demand. Today, it's still very apparent that credit is a luxury; one that is much less readily available to SMEs from those same banks.
At the same time, SMEs already have to contend with the widespread 'late payment' epidemic. The Federation of Small Businesses attributes around 440,000 of small business failures every year directly to late payments - this is even before inflation and rising costs are factored into the equation.
In short, the demand from creditworthy businesses is far exceeding supply from institutional lenders. But why is this the case?
Specialist forms of finance involve high-cost and time-consuming underwriting processes. There are some very laudable attempts to change this. In recent weeks, the government quango CFIT launched its inaugural coalition paper on Open Finance, with access to finance for SMEs as one of the focal points.
CFIT's paper was in response to the Bank of England's call to action for Open Finance to address the £22bn SME funding gap and specifically two 'data asymmetries':
- Between lenders and borrowers – i.e. a borrower knows far more about its prospects than a lender, whose view may be limited to their own transaction and lending history with that business.
- Between incumbent banks and competitors – i.e. if my business account is with one lender, another lender is immediately disadvantaged because it has little or no historical data about the borrower.
The second has some validity, but I would argue that addressing point 1 is more pressing for banks. Here's why:
- Most businesses turn to their own bank first for any financial needs. This mentality is partly inherent but has also been instilled in them by the industry. For instance, businesses were advised to apply to their 'primary' bank for BBLS and CBILS funding, and most banks only accepted applications from their own customers.
- Banks don't usually reject applications just because a business doesn't bank with them. Instead, they impose rigid eligibility criteria such as minimum turnover and trading history. Of the UK SMEs refused funding by an institutional lender, 71% do not meet the eligibility criteria, 56% are deemed too risky and 44% have unsuitable financial history.[1]
- Not being an incumbent banking provider is not holding back specialist lenders and challenger banks, whose smaller business lending levels reached a record 55% market share, overtaking the big five major banks.[2]
This is problematic for banks for the obvious reason that they are missing out on a growing market. But the problem becomes two-fold when you consider that 54% of UK SMEs refused finance by institutional lenders turn to a broker or adviser for support and 51% went to a specialist lender[3].
This then becomes an image problem for the bank. They are much less likely to be top of mind for those businesses' future financial needs. That frustration doubles if the growth funding provided by another lender helps the business cross the institutional lenders' eligibility criteria.
Are institutional lenders at a crossroads when it comes to SME lending? This may be so, but there are ways in which these incumbent banks can lend to their SME customer base better. Watch this space...
[1] Fund the Gap, Financing the Future of UK SMEs, Praetura Lending, released in October 2023.
[2] Data from the British Business Bank's Small Business Finance Markets Report 22/23, released in March 2023
[3] Fund the Gap, Financing the Future of UK SMEs, Praetura Lending, released in October 2023
