A banker friend put it well to me recently. Half of his small and medium sized business customers, the SMEs, were awash with cash, mainly as a result of having taken advantage of government backed Covid loan schemes but did not quite know what to do with it. The other half would normally be borrowing but did not have the confidence to do so.
This unusual situation, which reflects the reality across the economy, makes interpreting what is happening to SMEs more difficult than usual. Even so, something is happening. Figures from the Bank of England showed that Small and Medium sized non-financial businesses (SMEs) repaid £0.2 billion of bank loans in May after a net repayment of £0.5 billion in April.
More significantly, this was the 15th consecutive month in which outstanding bank loans amongst SMEs have fallen. How worried should we be by this?
A bit of context is necessary. SME lending is down by around 5% on a year earlier, which is worrying. However, the level of outstanding loans, £206.9 billion at the end of May, remains above pre-pandemic levels. At the start of the pandemic, SMEs had £167.2 billion in outstanding loans.
The various government-backed loans introduced for the pandemic were seized in hungrily by SMEs, lifting the total to a peak of £216 billion at the end of the third lockdown in March 2021. It is from that peak that the past 15 months of falls has occurred.
That does not, however make everything OK. In fact, it fits in with the way that my banker friend described it. SMEs which took on large loans during the pandemic appear to be running them down, but businesses which should be borrowing for expansion are not doing so.
Everybody in finance is familiar with the lending gap for SMEs, sometimes described as the “Macmillan Gap” after the report of the Macmillan Committee, formed in 1929. The committee, under Hugh Pattison Macmillan, included such luminaries as John Maynard Keynes, Ernest Bevin and Reginald McKenna among its membership. The gap was in the financing of business, particularly SMEs, which compared badly with Germany and America.
To that longstanding gap can be added another one. Exceptional Covid support, some of it in the form of loans, has enabled SMEs which might otherwise have gone under to survive. But those who need to borrow to expand either cannot or are not doing so.
That is concerning on two fronts. It suggests that amid rising costs, an uncertain outlook for demand and labour shortages, SMEs are battening down the hatches. This was supposed to be a year in which the economy would be supported by investment from businesses large and small. So far it is not happening.
The sectoral breakdown of the fall in SME lending is also interesting and in some respects is the story of the UK economy in miniature. The amount of loans to real estate and related businesses is close to the pandemic peak and has barely fallen. Loans to hospitality firms are, however, down by more than 10% and there has even been a fall in outstanding bank borrowing by manufacturers.
The second concern is that loans could soon become even more difficult to come by. On July 5, the Bank published its latest Financial Stability Report, warning that for businesses as well as households, things were set to become “more stretched” in coming months, and that both are vulnerable to further shocks.
The Bank is concerned that this could be compounded by a credit crunch, with lending to businesses, and particularly SMEs, inhibited by lenders’ caution. Banks, it said, had the resilience to cope with a further deterioration in economic conditions.
But it warned: “Banks are likely to manage prudently their lending activity, commensurate with changes in credit quality in the real economy. Setting lending terms to reflect the new risk environment is appropriate. Restricting lending solely to defend capital ratios or capital buffers would be counterproductive and could prevent credit-worthy businesses and households from accessing funding. Such excessive tightening would harm the broader economy and ultimately the banks themselves.”
This, sadly, appears to be the reality. The Recovery Loan Scheme, extended by the former chancellor Rishi Sunak to June 30 in his October Budget last year, was expected to be extended, but amid the current political turmoil, firms are still waiting.
According to the Federation of Small Businesses: “FSB figures show finance application approvals drying up. If we see a credit crunch following, as we did in 2008, having a scheme like this from the British Business Bank already up and running could be crucial, to combat the recession and protect small businesses from going under through a lack of cash. The Bank of England recently used the word stagflation in connection to the current economic crisis, which is noteworthy and deeply worrying. Low growth coupled with high inflation will be a death knell to countless small businesses.”
A survey from Manx Financial Group, coinciding with the end of the Recovery Loan Scheme, found that 22% of SMEs that needed external finance over the past two years were unable to access it, and that 27% had had to pause or close areas of business. More than a third of SMEs expected that lack of finance would prevent their businesses from growing over the next 12 months.
The SME financing gap has not gone away. Indeed, it appears to be getting worse.
