Government-backed loan schemes have supported businesses of all sizes across the UK, from big manufacturers and exporters taking Coronavirus Large Business Interruption Loans (CLBILS), to mid-sized companies using Coronavirus Business Interruption Loans (CBILS) and millions of small ventures via Bounce Back Loans (BBL).

Treasury data from July 2021 reveals almost £80 billion was borrowed in 1.6 million emergency loans between April 2020 and May 2021. Government-backed but banking sector provided, these loans are beginning to mature – with the recovery uncertain and business assistance from the Job Retention Scheme (JRS) also ending. Banks must pursue full recovery before the government guarantee kicks in. Involving many still fragile companies, and individuals, the process risks being long and messy in both mechanics and public relations for banks.

Who is responsible?

UK Finance is unequivocal about the primary debtor for coronavirus loans, quoting the government’s rulebook. “On CBILS, businesses are liable for 100 per cent, in the event of default lenders are required to seek to recover the full value of the loan from the borrower, using all available security. On CLBILS, businesses are 100 per cent responsible, including interest and fees. On BBLS, businesses are 100 per cent responsible, including interest and fees after the interest free twelve-month period,” says Stephen Pegge, managing director of commercial finance at the trade body.

Holding an £80bn bag of debt, banks want businesses to know the government guarantee is not a loophole to avoid repayment. “In early 2020 when these loans were announced they were sold, or more importantly interpreted, as a government gift,” says Simon Michaels, partner at accountants HW Fisher, but like any other debt, “an active company continues to be liable – until it is no longer a viable business”.

What the costs may be

Bank estimates of the impending cost of defaults vary, depending on the strength of the economic recovery. Once all recovery processes are completed following a default, lenders can make their claim to the government for 80 per cent of the outstanding losses on each Covid loan, and 100pc for BBLs against both capital and interest.

“The government has to take that loss, it’s the only way banks would have made the loans”, says Neil Kadagathur, CEO Credit Spring, though he suggests not to comply would have been hard given taxpayer support for banks during the 2008/9 global financial crisis. Banks may find it is a long road, however, from loan non-payment, via their own recovery process, to successful repayment from Treasury coffers. Borrower protections factored into the schemes mean banks can’t accept a borrower’s primary residence as security on any CBILS loan.

Personal guarantees are not allowed on loans of less than £250,000. Above that, personal guarantees may be required, but lenders may only recover up to 20 per cent of the loan from it. BBL rules do not permit personal guarantees. There is also a risk of political friction.

“Will the Government be assessing the lending criteria throughout this period, will they try and blame banks for inadequate processes and controls and lending to unsuitable businesses?” questions Michaels. “The Government will need to support many of the defaulted loans but I am sure banks will need to ensure they have done all possible to recover these,” he adds.

Bank responsibility

As co-beneficiaries, requiring banks to do their bit first is reasonable, says Kadagathur: “If the government had not stepped in with blanket guaranteed loans, banks would have had big problems with their balance sheets”, he says. Banks aren’t, he points out, profiting from Covid loans, but are getting new customers. Neo banks like Starling have “massively benefited” from an unprecedented boost to their loan book growth: “That would never have happened without the government guarantee, and is worth quite a lot,” he says. Could this be an argument for banks taking part of the loss?

“I don’t think that will happen”, Kadagathur says; with ultra low interest rates, high levels of competition and record debt repayment during lockdown, margins remain constrained at banks. The cost of chasing Covid loan recoveries will be an unwelcome additional burden, “but there really isn’t another better option”, says Kadagathur.

Protecting SMES

Efforts have been made to prevent SMEs, most vulnerable to financial shocks, from getting to the default stage, obviously better for them, banks and the government. For BBLs, targeted at SMEs, businesses can use Pay As You Grow forbearance options; an extension of their loan term to 10 years from six; for six months paying interest only (up to three times during the term); and take one repayment holiday for up to six months. UK Finance’s Pegge says lenders are “committed to supporting all customers in financial difficulty and will consider forbearance options including repayment holidays and term extensions where appropriate”.

Research by the Vulnerability Registration Service (VRS), a not-for-profit, paints an alternative picture.

Despite Financial Conduct Authority’s rules on treating customers fairly, 41% of vulnerable people reported being unfairly treated, including by banks and financial services, in the last 12 months.

Helen Lord, CEO of VRS, said: “It simply isn’t good enough that so many vulnerable customers feel they are being unfairly treated.” Around 17.7 million people in the UK consider themselves vulnerable – 34% of the population. Nine million struggled with their finances in the last year. From SME owners to employees of mid-sized CBILS borrowers, jobs and livelihoods will go in the event of Covid loan defaults, scenes unlikely to play out well in public. Yet, under the terms of the schemes lenders must follow their normal recovery processes to the full extent before they can claim on the government guarantee – an undesirable PR rock a hard place.

Loan enforcement

Government will likely be very keen for banks to play bad cop on loans, however, while its hands are full trying to clawback other money. The Public Accounts Committee reported fraud and error around the Covid support schemes are likely to cost the taxpayer £25 billion a year.

“This is likely to be an ongoing area of enforcement focus for some time,” says Andrew Sacker, partner at law firm Pinsent Masons. HMRC, a tax administration and a law enforcement agency in one, will look to civil recovery where it can, or criminal action against egregious and systematic abuses, says Sacker.

A 1,265 strong HMRC Taxpayer Protection Taskforce was funded with £100m in the March Budget 2021 to recover misappropriated Covid support scheme funds, from loans to the Job Retention Scheme.

In May 2021 a woman in Yorkshire was arrested in an HMRC investigation into a suspected £3.4m JRS fraud. “This is likely to be only the tip of the iceberg,” says Nicola O'Connor, legal director at law firm Bird & Bird, who has been working on coronavirus-related fraud claims, “over the coming months we certainly expect to see many more arrests and investigations”. A whistle-blowing hotline for employees to report bosses has, she says, “been widely used”, from JRS grants when employees are still working, to grants for ‘ghost employees’ who do not exist, and inflated claims.

Claims even if made in good faith may face sanctions if mistakes were made at application or in ongoing compliance. Criminal investigations are being pursued “with ever increasing force”, O’Connor adds, pointing to arrests in 2020 and 2021 for fraudulent BBL applications.

“Over the last six months I have seen an escalation in the number of clients seeking advice and assistance with criminal investigations by HMRC and the National Crime Agency relating to Covid payments,” O’Connor says. This includes freezing orders made where officers believe proceeds of fraudulent applications have been received into bank accounts, and identity theft where those details have been used to apply for loans and grants. O’Connor has “also seen investigations where professionals such as accountants have been arrested”. She expects an “unprecedented number of criminal investigations and prosecutions” in the very near future.

Legal powers

Under the UK Finance Act 2020, HMRC also has powers to claw back Covid-19 support payments, including under the JRS, where recipients were not properly entitled. The mechanism applies not just in cases of deliberate or fraudulent conduct, but also where genuine errors have been made.

Failing to notify HMRC of mistakes risks clawbacks of up to 100%.

“Businesses that have failed to keep adequate records have found it difficult to deal with audits and requests by HMRC for further information,” says O’Connor. Businesses that have availed themselves of furlough grants found later not to be legitimate and requiring repayment to HMRC, are very likely going to struggle repaying their Covid loans to banks.

Judgements on success

Hindsight is always 20:20, but rising defaults and prosecutions will trigger questions about the success of the Covid support schemes. “These measures were done quickly in a crisis to get money into the system asap, and they achieved that goal,” says Kadagathur. “I believe the net effect is many good businesses were saved, which is still very positive compared to if they did nothing and let businesses die from liquidity restraints,” he adds.

HW Fisher’s Michaels is more circumspect: “I personally feel it is too early to assess the final outcome. Of course borrowings need to be repaid, so businesses need to work doubly hard to cover both interest and capital repayments, but without the support will this be the demise of many businesses who simply cannot make up the shortfall needed to service their debt?”

The government’s Recovery Loan Scheme, through which businesses can borrow up to £10 million through accredited lenders, is open until the end of this year to help ease the transition.

But to qualify for the RLS – likewise, if as has been mooted, the current Covid loan scheme was extended – businesses would need to prove ‘affordability’ to lenders.

“Borrowers will still need to demonstrate their financial strength as well as satisfy the lender's affordability criteria. Of course, the big question is how long do you keep ‘kicking the lending can down the road’,” says Michaels, “are we simply delaying the inevitable?”