Small and medium-sized enterprises (SMEs) can be defined by the number of employees or annual turnover – small businesses are those with 10-49 employees and a turnover of €10 million, whereas medium enterprises have 50–249 employees and annual turnover of €50 million. SMEs make up 99.8% of all of the 5.98 million private businesses in the United Kingdom (UK). Using AMPLYFI’s AI-driven Insights Automation Platform, DeepInsight, we have surfaced unique insights on the UK SME lending landscape. The technology leverages machine learning to analyse structured and unstructured content to uncover previously hidden insights, trends and opportunities in the UK SME lending space. Analysing the connections between UK SMEs and financial service providers reveals the extent to which COVID has dominated the financing landscape over the past 18 months. The prevalence of COVID-related loans since the UK’s first official recorded cases in early 2020 and its series of restrictions and lockdowns, dominates anything that had preceded it (see Figure 1 below). Whilst Big Banks retained their association, their role changed from direct lending to helping to administer the UK Government support schemes alongside the British Business Bank.
Until the advent of COVID-19, the relationship between UK SMEs and access to funding had been experiencing fundamental change with private enterprise and government initiatives seeking to change the financing landscape. In essence, three main factors give impetus to the success of a small and medium-sized enterprises (SMEs) – a commercially viable business proposition, financial resources, and talent. Talent in the context of this article means the technical capacity to manage all aspects of a company, and develop and market its products or services. All other success factors, such as the use of appropriate technology, the capacity to navigate the regulatory environment and customer service become increasingly important once all three main factors are in place. Until this time, adequate and timely financing is the lifeline of a business. Financing flows backwards to establish and then enhance the viability of a business idea and forward to facilitate the securing of the appropriate talent to execute on the idea.
Small and medium-sized enterprises (SMEs) in the UK contribute up to 52% of its GDP, account for over 60% of all private sector jobs, and contribute 47% of all revenues. However, despite the value that SMEs add to the economy and the importance of finance in determining the success of early-stage ventures, a £56 billion funding gap for SMEs still exists in the UK. Data shows that SMEs face a significant challenge in accessing finance compared to their larger business counterparts. The main challenges of access to finance are rooted in ripple effects from key events, such as the 2008 financial crisis that shrank funding options available to SMEs and the COVID-19 pandemic that rapidly expanded the demand for financing. Since the financial crisis, the value of bank loans issued to SMEs through the enterprise finance guarantee scheme for small businesses hit a record low of £55.6 million in the final quarter of 2018, from its height of £255 million in 2009. According to the British Business Bank, of the businesses surveyed, 45% applied for an external loan in 2020 as a result of COVID-19, with 42% of them opting for a bank loan.
The UK coronavirus containment measures forced many businesses to shut down their operations during successive lockdowns with a national job protection furlough scheme available. Those that were able to remain open were often subject to strict government health and safety requirements that increased their operating costs. The restrictions, and resultant reduction in activity across the entire economy, placed severe financial strain on SMEs with limited balance sheets and reserves to fall back on.
To help businesses try to survive the COVID pandemic, the government introduced measures such as the Coronavirus Business Interruption Loan Scheme (CBILS) and the Bounce Back Loan Scheme (BBLS). Launched on 23rd March 2020, the CBILS immediately faced criticism over eligibility requirements and general lack of preparedness that saw a slow uptake. Consequently, it rapidly underwent a number of revisions to widen its appeal. The BBLS (operating between 4th May 2020 and 31st March 2021) was subsequently launched to offer a simplified application and approval process and specifically targeted SMEs. It eventually saw an average approval rate of 79.2% of applications, with the best week seeing an 82.5% approval rate. Designed to deliver loans to businesses within 72 hours, the UK Government paid the interest and associated fees for the first 12 months, and provided a 100% repayment guarantee. After 12 months, the interest rate was fixed at 2.5% per annum. However, to achieve such a fast turnover, the scheme overlooked checks required by the Consumer Credit Act. The House of Commons Public Accounts Committee criticised the scheme for failing to have appropriate safeguards to protect taxpayers against the risk of fraud or loans to borrowers unable to service their debts. The committee also reported that the government failed to put forward a compelling business case for the scheme. The committee noted with concern that there were no indicators in place to measure the impact of the scheme, especially in terms of the number of insolvencies prevented.
Even before the pandemic only five of the major banks, Royal Bank of Scotland, Santander, Lloyds Banking Group, Barclays and HSBC, provided 80% of the business loans to small businesses. In 2014, HM Treasury made public plans to match SMEs whose loan applications were rejected by mainstream banks by working with challenger banks and alternative finance options. At this time, 50% of first time loan applicants were rejected on the basis of not meeting the risk requirement of the big banks. Consequently 40% of the rejected applicants give up on their quest to seek financing. HM Treasury investigations determined that most of the loan applications were from viable businesses and that they were not aware of alternative financing options. In addition, the providers of these options such as peer-to-peer lenders and challenger banks were not aware of the SMEs needing their services.
To address the identified shortcomings across the lending landscape, the Small and Medium Sized Business (Finance Platforms) Regulations 2015 placed a legal duty on participating banks to provide the relevant applicant information to designated alternative financial providers whenever an SME made an unsuccessful application for finance. The participating banks included First Trust Bank, Bank of Ireland, Clydesdale Bank, Danske Bank, and the five aforementioned major banks. Designated alternative finance options included Funding Option, Funding Xchange, and the Alternative Business Funding (ABF) Platform, all of which are still active.
The regulations require the designated banks to share applicant information after first securing their express consent. Further, applicants are eligible for referral if the value of the facility rejected is above £1,000 and the facility is sought for a period exceeding 30 days. A business does not qualify to benefit from the programme if the bank has information that the entity is subject to a statutory demand for payment owing to an existing finance facility.
The other measure in place to encourage competition in the SME lending space is open banking. By December 2019, over 3.5 million SMEs were virtually invisible because they lacked the historical data to determine their credit score. The so-called invisible SMEs had not been in business long enough to generate the kind of data that banks would use to determine their credit score or they would submit balance sheets without a profit and loss statement. With initiatives such as open banking, banks are now statutory mandated to share information among a pool of approved lenders. The relevant credit information provides a basis for different lending institutions with models different from banks to use while making lending decisions.
However, with upcoming presence from companies like PayPal and Amazon making entries into the SME lending space, the landscape is starting to shift. FinTech lending is also changing significantly with new entrants causing disruption. E-Commerce companies, over the course of providing their service, access data that helps them predict an SMEs capacity to repay loan facilities. PayPal’s business loan with one affordable fixed fee, known as the PayPal Working Capital, for instance, has issued over £400m in short term loans to SMEs in the UK. The company offers loans to merchants transacting over eBay and makes payment through PayPal.
The other emerging trend in the space is peer to peer lending that enables high net worth individuals to lend to small businesses. Institutions like MarketInvoice enable individuals to purchase business outstanding invoices.
With the policy interventions and the increasing entrance of Tech Giants into the lending space, the dynamics are changing in favour of SMEs. The small and medium-sized business regulations encourage competition in the space by placing a legal obligation on participating banks to refer viable loan applications to a pool of other potential lenders. On the other hand, tech companies target the clients who utilise their services and use the data such clients generate to determine their probability of repaying a loan facility.