Lost amid the fallout from the bombshell shake-up of the UK pensions market that finance minister George Osborne dropped in his budget in March was brief mention of a new pilot scheme to provide UK state guarantees on bank lending to SMEs.
The British Business Bank has around £3.9 billion ($6.4 billion) of capital to unlock as financing for SMEs. The new pilot programme, which banks are now being invited to join, might range from £75 million to £250 million in guarantees on new loans extended to micro and smaller SMEs, to growth companies and to SMEs with less than five years' trading history.
Ever since the financial crisis hit, British banks have been claiming that reduced demand from SMEs to borrow money has fuelled the decline in lending to the sector, not the banks’ own inability or reluctance to lend. With recovery now at hand, that will be put to the test.
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| Vince Cable, business secretary |
“The shadow of the credit crunch still looms large and too many small and medium-sized businesses are still not able to get the finance they need to grow,” says Vince Cable, the government's business secretary. “The Business Bank is already supporting lending through alternative providers, but the banks dominate the market; this pilot is looking at new ways that we can stimulate bank lending.”
UK banks’ discussions with the government have pointed to the large amounts of capital consumed by lending to often unrated and below investment-grade smaller SMEs as an obstacle that no credible private insurer now helps them surmount.
Reinald de Monchy, managing director for wholesale solutions at the British Business Bank, says: “Our aim is to incentivize new SME lending by making it a more capital-efficient activity for regulated banks, thereby enhancing its commercial attractiveness. This limited pilot will market-test the use of a government-backed portfolio guarantee to achieve this by covering a portion of the unexpected loss, in return for a fee.”
That fee is still subject to negotiation through the pilot phase. The former bankers now working at the Business Bank have been thoughtful in the programme’s construction. It will not protect banks against expected losses on SME loan portfolios that margin income should provide against.
Rather it will insure against tail risk, the unexpected losses that, being unknown and unquantifiable, require expensive capital to protect against. Even then, it will protect only against a portion of unexpected losses beyond a certain attachment point and after originating banks have identified net losses after counting for earned income.
The new pilot will not apply guarantees to existing loan portfolios. The government does not want to reduce banks’ capital burden on these and then see that capital flow into other assets. It also sees the danger of negative selection. Guaranteed new loans must be retained by the originator and not transferred into any special purpose vehicle for later securitization.
Ambitious deadline
The British Business Bank is setting an ambitious deadline for any originating bank to ramp up a new loan portfolio within six to nine months, eventually comprising at least 250 names with no one obligor amounting to more than 1% of the portfolio and no industry sector more than 20%. The guarantee will start to apply only after the portfolio has already built up to a certain level and the loans are somewhat seasoned.
Rather like the guarantee fee itself, precise attachment points on unexpected losses beyond which the taxpayer will absorb losses and precise loan underwriting criteria are all subject to discussion with bank originators.
Bankers suggest the approach looks best suited to smaller lenders, perhaps following the standardized Basle III approach rather than any of the big-five banks that dominate the SME sector.
Cable says: “In the longer term, if we’re to fix this problem, we need our SME lending market to be less concentrated in a few banks, with more diverse sources of finance for businesses. This is why I set up the Business Bank, and over the coming years its activity will lead to an extra £10 billion being lent to SMEs to help them grow.”
Participants in SME funding suggest that it is often not with long-dated bank loans that companies need help, but rather with very short-term funding and working capital, for example against customer invoices. They take more encouragement from a separate budget announcement of a consultation into whether or not to legislate the banks to refer SMEs they turn down to alternative funding providers.
Louise Beaumont, co-founder of Platform Black, a leading alternative finance provider, says: “The overwhelming impediment to Britain’s small businesses getting the funding they so desperately need has quite simply been that they do not know where to turn if the banks are unable to provide a product that is suitable for them.
“George Osborne announcing that a consultation process will be launched on how to bring this referral process into law is the shot in the arm that the UK’s economy needs – especially as Britain’s small businesses account for over 48% of the UK’s private-sector turnover.”
