British SMEs exposed to substantial debt stress

British small and medium sized businesses are exposed to substantial debt vulnerabilities as a result of the Covid pandemic, according to the UK financial system’s watchdog.

The Financial Policy Committee said in a report published today that though UK corporate debt vulnerabilities have only increased modestly, they have “been more substantial… among small and medium-sized enterprises.”

The warning was flagged in the FPC’s latest Financial Stability Report, which is published every six months and is intended to identify possible threats to the UK economy’s health.

Sectors of the economy that have absorbed the worst revenue hits as a result of restrictions on economic activity to curb the spread of Covid and SMEs “may be more vulnerable to increases in financing costs”, the FPC said.

Read more: British businesses sell-off assets to offset Covid debt stress

Firms in the leisure and hospitality sectors have been at the sharp end pandemic prevention measures. Many have taken on debt through government emergency Covid loan programmes and used the furlough scheme to plug cash flow shortfalls to stay afloat.

SMEs may have also been under strain from being highly leveraged even before the pandemic. Small businesses often finance early development years through debt in an effort to reach profitability.

UK economy still faces strong headwinds

The FPC highlighted that the UK economy is still facing strong headwinds despite the success of the vaccination rollout and the lifting of Covid restrictions.

“Risks to the recovery remain. Households and businesses are likely to need continuing  support from the financial system as the economy recovers and the Government’s support measures unwind over the coming months” it said.

The Committee also pointed to fragility among UK corporates, noting that “the proportion of corporate bonds issued that are high‐yield is currently at its highest level in the past decade.”

The FPC added: “There is evidence of loosening underwriting standards, especially in leveraged loan markets. This could increase potential losses in a future stress, and highly leveraged firms have also been shown to amplify downturns in the real economy.”

However, the Committee did note that household high-indebtedness is below pre-global financial crisis levels.

“UK businesses’ aggregate interest payments as a proportion of earnings did not increase over 2020, and are around historic lows” it said.