Britain’s SMEs must get over their aversion to debt to ramp up growth
Britain’s small businesses can power growth, but only with a rebooted SME finance market, writes Allica Bank CEO Richard Davies
By any measure, small and medium-sized enterprises (SMEs) are the backbone of the UK economy, accounting for 60 per cent of all employment, and nearly half of all business turnover. Yet SME lending only accounts for 3-4 per cent of the UK banking sector’s £7 trillion total asset base.
Having recently conducted a detailed analysis of the available evidence on SME finance covering the last four decades, the long-term picture is stark. The UK’s position both against its own history and international comparators does not read at all well.
An underlying shift in bank lending across the UK economy that has become increasingly biased towards residential mortgage lending is clear to see.
Alongside this, SME lending has become far more focused on collateralised lending. There has been a resulting growing gap in lending to SMEs that supports investment in productivity and growth.
The consequences are profound.
The UK has the lowest investment rate in the G7. Our GDP growth and productivity have flatlined. Record low levels of SMEs are seeking finance – the UK stands out here as an outlier both against our own lending application rate in the 1980s and 1990s, and all the international comparator countries the OECD reports on.
There has been a growing aversion from SMEs to debt, deterred by scandals in the global financial crisis and discouraged by a market that seems hard to access for the time poor small business owner.
There is a real need for a reboot of the UK’s SME finance market if we want to address the government’s growth mission.
Based on trends since the global financial crisis versus the last period of sustainable economic growth (1997-2004), there is a £90bn gap in bank lending to SMEs. Even though there has been growth of c.£25bn in non-bank lending to SMEs since the crisis, we’re still left with a total SME lending gap of up to £65bn against long-term trends.
Within this there has been a particular collapse in SME overdraft lending, which now makes up only five per cent of SME bank lending compared to 25 per cent at the start of this century. The picture is especially worrying for SMEs with less than £1m turnover: since 2000 these firms have experienced a 73 per cent fall in overdrafts.
This has not occurred in a vacuum. Bank lending has been shaped by regulatory and accounting changes, alongside business model changes with the rise of digital technology, resulting in the sustained shift towards collateral-backed lending, predominantly in real estate.
That shift may suit a mortgage-led banking model, but it’s fundamentally mismatched with the needs of Britain’s modern, service-led SME economy, where tangible asset ownership is low.
A range of non-bank fintech lenders have arisen to seek to meet the gap, however these are typically higher priced than bank lending, and can be hard for business owners to discover.
The result is a very low rate of SMEs taking ‘productive credit’ to invest in improving productivity and growing their business. Indeed, the Bank of England’s 2024 survey finds 77 per cent of SMEs would rather accept a slower growth rate than borrow.
To jolt the UK out of this position we propose government and industry work together on three critical actions.
First, an immediate doubling of the government-backed British Business Bank’s Growth Guarantee Scheme, with an ambition to expand the scheme by three or four times in the next five years, bringing the UK’s scheme in line with other countries like the US and Germany. This can be built on the existing scheme without additional costs to the taxpayer, and should be used to underpin a reboot of the provision of productive credit. This should be heavily promoted, to encourage disillusioned SMEs to try again.
Second, the government should ask the Bank of England to have a specific focus on SME finance (as it did in the 1990s), and as part of this the role of challenger banks in the SME finance market, given these players now account for 60 per cent of new SME lending. The evidence shows smaller banks holding higher capital levels than major banks, driven by lack of certainty over future capital requirements, alongside specific aspects of the prudential framework.
Finally, there needs to be cross industry action to solve the problem of how SMEs can more easily navigate the SME finance market and how their lending options can be hyper-personalised. We believe generative AI will play a key role in this, alongside renewing traditional local relationship models (from brokers, banks, and CDFIs).
We must break out of the long-term cycle we’ve found ourselves in. Established SMEs are the critical force in driving the next wave of economic renewal.
The prize for getting this right is enormous: a more dynamic, innovative and inclusive economy that benefits every region of the country. Let’s seize this opportunity.