Plans to reform UK bank capital rules risk a 25 per cent cut in lending to small businesses, putting jobs and economic growth at risk, a new study has warned.
The Bank of England’s Prudential Regulation Authority announced controversial plans to change capital treatment for small business lending in December as part of wider proposals to introduce a final package of Basel rules in the UK.
The small print of the package includes removing favorable treatment for SME loans, known as the “SME support factor”, which was introduced across the EU in 2014, when the UK was still a member of the bloc, in favor of what regulators call A more “risk-based” approach.
The BoE proposals also include an irony that would make property-backed lending to small businesses more expensive than unsecured loans, as capital charges on property-backed loans are much higher.
A report by consultant Oxera by SME lender Alica found that the proposed changes could result in a £44 billion reduction in lending to UK SMEs based on the reduction in loans banks would have to book if they did not raise capital. Pay back that loan.
Banks’ total lending to SMEs, excluding the government’s pandemic-induced bounce back loan scheme, is around £165bn.
Applying the rules to existing and new loans from 2025 would mean challenger banks would have to reduce their lending “very materially” between 2024 and 2026, according to the report. Larger banks, which calculate their capital differently, will be more affected by these changes.
“SME finance is vital to the general health of the UK economy, with SMEs being described as the ‘engine of growth’ for the UK,” Oxera said. “Given the broader economic outlook in the UK and the extent to which SMEs rely on bank finance, this does not seem like a good time to take risks with the elimination of the SME Support Factor.”
If non-bank lenders increase activity, the impact on the market will be less, Oxera said, if banks choose to allocate more capital.
Martin McTague, chairman of the Federation of Small Businesses, said the BoE’s proposals “created a real risk that lending to the SME sector could become more expensive, leading to reduced credit provision and higher interest rates”.
“If the SME sector finds it more difficult to access credit and has to pay higher interest rates to borrow, it is likely that this will compromise the ability of SMEs to scale up and create jobs,” he added.
The National Association of Commercial Finance Brokers called on the PRA to reconsider the changes because many small business lenders were “small and systemically unimportant.” NACFB chairman Paul Goodman said the regulator could instead focus on its new secondary objective of supporting economic growth and competitiveness by nurturing SME lending “without compromising its primary objective of ensuring financial stability”.
Oxera said the proposals are also bad for lenders’ risk management. “Banks are unlikely to be any wiser if prudential regulation encourages them to offer unsecured rather than secured business loans.”
He has shared the report with PRA officials, who declined to comment. The PRA is running a consultation on the proposals put forward in December, which will close next month.