Category: UK

The key chart

Trends in net lending flows to UK SMEs (£bn) (Source: BoE; CMMP)

The key message

How can UK SMEs invest fully in growth and job creation when monthly financing flows have been negative since March 2021?

Most SMEs in the UK rely on bank loans and overdrafts as their main source of external financing. They use loans typically to finance investment and overdrafts for various cash-flow related purposes.

The previous post highlighted the structural challenges faced by SMEs in accessing external finance. This post considers the cyclical challenges they face with a focus on trends in financing flows to the SME sector.

Gross lending flows remain resilient in absolute terms – £63bn in the twelve months to August 2023 – but they are 40% below their peak level in the twelve months to February 2021 (£106bn) and 3% below the level recorded in the twelve months to December 2022 (£65bn).

The spike in gross lending during 2020 reflected the impact of various COVID-19 related schemes while the increase during 2022 reflected the positive impact of challenger banks and other specialist lenders who lent more to the sector than the UKs big five banks in 2021 and 2022.

Repayments of SME loans remain close to record levels, however, driven largely by the ending of various payment holidays. The result, as shown in the key chart above, is that net monthly lending flows to SMEs have been negative since March 2021 – a pessimistic message from the money sector in terms of SMEs’ future investment plans.

Demand for working capital products such as bank overdrafts, which had increased during 2022, has also slowed during 2023. According to the latest Bank of England data, monthly overdraft flows turned negative in the 12 months to June 2023 (-£0.2bn) and August 2023 (-£0.5bn).

In short, current cyclical trends compound the longer-term structural factors that inhibit SMEs ability to invest fully in growth and job creation in the UK. Net lending and overdraft flows are both negative. This is despite the positive impact of challenger banks and specialist lenders over the past two years.

The next post in this series will examine the extent to which these negative trends are exacerbated further but the transmission of the Bank of England’s monetary policy.

How can UK SMEs invest fully in growth and job creation (II)?

This is the second of three short posts examining the challenges faced by UK SMEs in investing fully in growth and job creation. It focuses on the cyclical challenge associated with negative bank financing flows. The previous post focused on the longer-term structural challenges at the micro and macro level. The subsequent post will examine the speed of monetary policy transmission to the cost of SME borrowing.

(Source: BoE; British Business Bank; CMMP)

Gross bank lending flows to SMEs slowed to £63bn in the twelve months to August 2023, down 3.4% from £65bn in 2022 and down 40% from their peak level of £106bn in the 12 months to February 2021 (see table above).

Note that the spike in lending in 2020 (see chart below) was largely driven by government guaranteed COVID-19 loans. These included the Coronavirus Business Interruption Loan Scheme (CBILS), Bounce Back Loan Scheme (BBLS) and Recovery Loan Scheme (RLS). Excluding these three schemes, gross lending was £48.1bn in 2020 and £49.7bn in 2021 (British Business Bank, 2023). Note also that there was also evidence of SMEs substituting loans for overdrafts as a source of working capital financing during the pandemic period.

Trends in gross lending flows to UK SMEs (£bn) (Source: BoE; CMMP)

The increase in gross lending in 2022 has been attributed to increased supply from challenger banks and specialist lending. Gross lending from these sources was £29.2bn in 2021 and £35.5bn in 2022, the highest annual level since records began in 2012 (British Business Bank, 2023). Challenger and specialist banks’ share of gross lending exceeded that of the big five UK banks in both 2021 and 2022. (SMEs recorded less success in obtaining all the financing they need from their finance providers and a greater willingness to use more than one provider.)

Trends in repayments by UK SMEs (£bn) (Source: BoE; CMMP)

Gross repayments of SME loans peaked in January 2023 at £74bn and have slowed to £72bn in the twelve months to August 2023 (see chart above). In calendar-year terms, the £73.8bn repayments in 2022 were the highest since records began in 2012. They were driven largely by the end of the one-year holiday on paying back the principal and interest on BBLS loans and on paying back interest on CBILS loans for those SMEs that had taken the last opportunity to draw them down.

Trends in net lending flows to UK SMEs (£bn) (Source: BoE; CMMP)

Net monthly flows reflect the balance between the gross lending flows and repayments described above. As can be seen in the chart above, net monthly bank lending flows to SMEs have been negative since March 2021 – a pessimistic message from the money sector in terms of SMEs future investment plans.

Trends in overdraft flows to UK SMEs (£bn) (Source: BoE; CMMP)

Demand for working capital products such as bank overdrafts, which had increased during 2022, has also slowed during 2023. According to the latest Bank of England data, they turned negative in the 12 months to June 2023 (-£0.2bn) and August 2023 (-£0.5bn).

Conclusion

In short, current cyclical trends compound the longer-term structural factors that inhibit SMEs ability to invest fully in growth and job creation in the UK. This is despite the positive impact of challenger banks and specialist lenders over the past two years.

The next post in this series will examine the extent to which these negative trends are exacerbated further but the transmission of the Bank of England’s monetary policy.

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

The key chart

Trend in the outstanding stock of SME loans since 2013 (£bn) (Source: BoE; CMMP)

The key message

How can UK SMEs invest fully in growth and job creation when access to external financing remains so constrained?

SMEs play a vital role in supporting economic growth and job creation in the UK. They account for c.50% of private sector turnover and c.60% of employment.

SMEs’ access to finance is systemically important, therefore, to the UK economy.

SMEs enjoy access to a variety of funding options, at least in theory, and increased supply from challenger banks and specialist lenders, in practice. Nonetheless, access to external finance remains one of their biggest challenges.

Over the past decade, for example, the outstanding stock of loans to SMEs has grown by only 1.1% CAGR in nominal terms, even after the boost in bank lending associated with government guaranteed COVID-19 loans.

There are a number of structural factors at play here (analysis of additional cyclical factors will follow). At the micro level, these include low levels of financial literacy among SMEs, limited knowledge of the full range of funding options and the mismatch with banks’ lending criteria, risk appetite and the financial history of SMEs.

At the macro level, the challenge is more fundamental. UK finance is not geared to support production and income formation (so-called “COCO-based” lending). Only 22 pence in every pound lent in the UK is for this purpose, with lending to SMEs an even smaller sub-segment of this (c.7 pence). UK finance is geared instead towards supporting capital gains largely through higher prices for real assets (mortgages) and financial assets (so-called “FIRE-based” lending).

The aim of the British Business Bank and other specialist lenders (and brokers) is to make UK financial markets work better for SMEs and thereby drive sustainable growth and prosperity across the UK. The structural challenges here are large and enduring. The next two posts in this series, will examine shorter-term cyclical trends to see if their job is becoming easier or harder still.

How can UK SMEs invest fully in growth and job creation – Part I

This is the first of three short posts examining the challenges faced by UK SMEs in investing fully in growth and job creation. It focuses on the structural challenges involved in accessing finance.

The following posts will focus on the cyclical challenges relating to financing flows (Part II) and the cost of finance (Part III).

To fulfil their role in supporting growth and job creation, SMEs need access to external finance to (1) fuel growth, (2) fund working capital, and (3) invest in new assets/equipment. They enjoy access to a variety of funding options including:

• Bank loans and overdrafts
• Government grants and support programmes (e.g. COVID-19 loans)
• Venture capital and angel investments
• Leveraged loans
• Crowdfunding
• Peer-to-peer lending
• Property/commercial mortgages
• Asset finance and refinance
• Commercial loans
• Invoice financing
• Asset-based lending

Most SMEs typically rely on the first of these options. According to a recent Bank of England study, bank overdrafts and credit cards are used primarily for various cash flow related purposes and short-term funding gaps, while bank loans and various forms of asset-based lending are used for business investment (e.g. capex expansion, R&D etc).

Trend in the outstanding stock of SME loans since 2019 (£bn) (Source: BoE; CMMP)

The outstanding stock of loans to UK SMEs was £188bn as of the end of August 2023, down 13% from its March 2021 high of £216bn (see chart above). More significantly perhaps, this stock has only grown by 1.1% CAGR over the past decade, even when the impact of government guaranteed COVID-loans is included (see key chart above). In the six years between August 2013 and August 2019, the stock of loans fell by -0.2% on a CAGR basis and less than half of SMEs made use of external finance. Unsurprisingly then, access to finance is seen as one of the biggest challenges facing SMEs along with rising costs.

Why is this the case?

At the micro level, levels of financial literacy among SMEs are relatively low. According to a recent Ipsos UK study for the British Business Bank, 70% of SMEs lack awareness of their available financing options and another survey suggested that 85% of them borrowed exclusively from banks. On the supply side, almost 60% of SMEs and their brokers agree that finding funding has become more challenging over the past five years. A 2023 Praetura study, highlighted the mismatched lending criteria, risk and financial history as the most likely reasons why an SME is turned down for funding from an institutional level.

M4L broken down by contribution of COCO-based and FIRE-based lending (£bn) (Source: BoE; CMMP)

At the macro level, the reason why access to financing is so challenging is more fundamental. The UK finance industry is not geared to support production and income formation – so called “COCO-based” lending. Only 22 pence in every pound lent in the UK is for this purpose, with lending to SMEs an even smaller sub-segment of this (c.7 pence in every pound lent). UK finance is geared instead towards so-called “FIRE-based” lending. Almost 80 pence in every pound lent supports capital gains largely through higher prices for real assets (mortgages) and financial assets (see chart above).

The aim of the British Business Bank and other specialist lenders (and brokers) is to make UK financial markets work better for SMEs and thereby drive sustainable growth and prosperity across the UK. The structural challenges here are large and enduring. The next two posts in this series, will examine shorter-term cyclical trends to see of their job is becoming easier or harder still.

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

The key chart

Trends in average cost of borrowing for SMEs, PNFCs and HHs since December 2021 (Source: BoE; CMMP)

The key message

Who are the real losers in the BoE’s policy tightening race – UK SMEs or the wider UK economy?

The transmission of monetary policy to the cost of borrowing for SMEs has been rapid (+514bp) and faster than for average corporate borrowers (+494bp) and for households (+324bp). Monthly financing flows to the sector have also been negative since March 2021.

On the face of it, not good news for UK SMEs…

Looking behind the headlines, however, gross lending flows to the sector have been relatively stable so far this year (£4.9bn average YTD). They are slowing however on a cumulative 12-month and 3-month basis and, more importantly, they remain below the flows of monthly repayments.

In short, in the face of subdued demand and higher financing costs, SMEs are adopting prudent financing strategies. They are “utilising existing facilities and diverting some deposits to secure higher returns” (UK Finance, September 2023). Hence the subdued demand for new credit.

Why does this matter?

The key message from the money sector is that UK SMEs’ plans for future investment appear to be “on hold”. Given that they account for c.50% of private sector turnover in the UK and c.60% of employment, this suggest that the real loser here is the wider UK economy…

Who are the real losers in the BoE’s policy tightening race?

The transmission of monetary policy to the cost of borrowing for SMEs has been rapid and faster than for larger corporates and for households.

Trend in average cost of new SME borrowing (%) (Source: BoE; CMMP)

The average cost of new loans for SMEs has increased 514p from 2.51% when policy rate rises began in December 2021 to 7.65% in August 2023 (see chart above).

As shown in the key chart above, this increase is greater than the respective increases for average corporate borrowing (494bp), secured household borrowing (324bp) and other household borrowing (280bp).

Monthly net lending flows (£bn) (Source: BoE; CMMP)

Monthly financing flows to the SME sector have been negative since March 2021 (see chart above). Note that these trends reflect a balance between gross lending flows and repayments.

Monthly and 12m cumulative monthly gross lending flows (£bn) (Source: BoE; CMMP)

Looking behind the headlines, we discover that gross lending flows to UK SMEs have been relatively stable so far this year – £4.9bn average YTD (see chart above).

On a cumulative 12-month and 3-month basis they are slowing however, and they remain below monthly repayments (see chart below).

Monthly gross lending, repayments and net lending flows (£bn) (Source: BoE; CMMP)

In short, in the face of subdued demand and higher financing costs, SMEs are adopting prudent financing strategies. According to UK Finance analysis they are “utilising existing facilities and diverting some deposits to secure higher returns.”

Conclusion

The key message from the money sector is that UK SMEs’ plans for future investment appear to be “on hold”. Given that they account for c.50% of private sector turnover in the UK and c.60% of employment, this suggest that the real loser here is the wider UK economy…

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

The key chart

Trends in cumulative financing flows to the UK private sector (12 months, £bn) (Source: BoE; CMMP)

The key message

The latest “Money and Credit – August 2023” data release from the Bank of England shows financing flows to the private sector collapsing in the UK – this story is not unique to the euro area (see “Choke Point?”).

Cumulative monthly financing flows to UK corporates and to households have fallen from £66bn in the 12 months to August 2022 to only £17bn in the twelve months to August 2023. If we include relatively volatile flows to non-intermediate financial companies, positive flows have become negative, net repayments of £42bn (see key chart above).

The average cost of borrowing for corporates has increased 494bp from 2.03% in December 2021 (when BoE rate increases began) to 6.97% in August 2023. In response, they have repaid loans in six of the past ten months, and cumulative 12-month financing flows have been negative for the past eight months. Behind the headlines, UK SMEs also face the extra “dual challenge” of lower lending volumes (negative YoY growth since August 2021) and even higher borrowing costs (7.65% average, up 514bp since December 2012).

The average costs of secured and other household borrowing have increased by 325bp (from 1.58% to 4.82%) and 280bp (from 6.27% to 9.07%) respectively over the same time-period. Households have repaid loans in two of the past five months and cumulative 12-month financing flows have declined from £64bn in the 12 months to August 2022 to £23bn in the twelve months to August 2023.

So what – why does this matter?

The BoE and the ECB lack playbooks for such aggressive periods of monetary tightening. Financing flows to the UK and EA private sectors are falling sharply and reaching a potential “choke point” for growth and much-needed investment. Central bankers may argue that this suggests that the transmission of monetary policy is working. Others might view such as rapid pace of adjustment as an indicator that the risks of policy errors and risks to future growth are rising very sharply…

Financing flows to the UK private sector are collapsing too

The latest “Money and Credit – August 2023” data release from the Bank of England shows financial flows to the private sector collapsing in the UK (see chart below).

The collapse in cumulative 12-month financial flows to the UK private sector (12 months to August, £bn) (Source: BoE; CMMP)

Cumulative monthly financing flows fell from £77bn in the 12 months to August 2022 to net repayments of £42bn in the twelve months to August 2023 (blue bars in chart above). This data includes volatile flows to non-intermediating financial companies. Excluding these, financing flows to corporates (PNFCs) and households (HHs) fell from £66bn to £17bn over the period (maroon bars in chart above).

Trend in the average cost of new loans to UK PNFCs (%) since August 2018 (Source: BoE; CMMP)

In response to the 494bp increase in the average cost of borrowing from 2.03% in December 2021 (when the BoE rate increases began, see chart above) to 6.97% in August 2023, PNFCs have repaid loans in six of the past ten months.

Despite two consecutive months of positive flows to PNFCs in July 2023 (£1.3bn) and August 2023 (£0.5bn), cumulative 12-month financing flows have been negative for the past eight months. In the 12 months to August 2023, PNFCs repaid £6.2bn in loans (see chart below).

UK PNFCs have repaid loans in six of the past ten months (Source: BoE; CMMP)

Note also that, behind the headlines, the average interest rate on new loans to SMEs has increased by 514bp from 2.51% in December 2021 to 7.65% in August 2023.

Trends in growth rates in corporate loans since August 2018 (% YoY) (Source: BoE; CMMP)

The annual YoY growth rate in lending to SMEs has been negative since August 2021 (see chart above). In short, SMEs face the dual challenge of lower lending volumes and higher borrowing costs.

Trend in the average cost of new loans to UK HHs (%) since August 2018 (Source: BoE; CMMP)

In response to a 324bp increase in the average cost of new secured HH lending (the largest segment of HH borrowing) and 280bp in the average cost of other HH lending (see chart above), HHs have repaid loans in two of the past five months. Despite a recovery in HH financing flows in July 2023 (£0.9bn) and August 2023 (£1.3bn), cumulative financing flows have fallen from £64bn in August 2022 to £23bn in August 2023 (see chart below).

Cumulative flows to UK HHs have fallen to £23bn in August 2023 (Source: BoE; CMMP)

Conclusion

The BoE and the ECB lack playbooks for such aggressive periods of monetary tightening. Financing flows to the UK and EA private sectors are falling sharply and reaching a potential “choke point” for growth and much-needed investment.

Central bankers may argue that this suggests that the transmission of monetary policy is working. Others might view such as rapid pace of adjustment as an indicator that the risks of policy errors and risks to future growth are rising very sharply…

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

The key chart

Forty year trends in UK debt “relative growth factors” (3Y CAGR in debt versus 3Y CAGR in nominal GDP) (Source: BIS; CMMP)

The key message

The two sources of UK money creation – government spending and bank lending – are being squeezed at the same time. This does not bode well for future growth prospects (or for the re-election prospects of the current government).

Turning both taps off at the same time

UK government and private sector debt are growing at a slower pace than nominal GDP, and at the same time.

According to the latest BIS data release, government debt has declined by -2.4% on a rolling 3-year CAGR basis to the end of 1Q23. Over the same period, nominal UK GDP has increased by 3.8%, resulting in a “relative growth factor” of -6.0ppt.

Household (HH) and corporate (NFC) debt have risen by 3.1% and 0.2% on the same basis, but again at a slower rate of growth than nominal GDP, resulting in relative growth factors of -0.6ppt and -3.5ppt respectively (see key chart above).

So what?

Some economists draw the analogy between debt to GDP ratios and the relative growth factors described above and the speed of a car and the rate of acceleration or deceleration respectively. In this context, the “UK car” is not only travelling slower, the rate of growth is also decelerating at the same time.

Why do economists often overlook (or underestimate) these trends?

For the simple season that traditional macro frameworks typically ignore private sector debt and its impact on aggregate demand.

When aggregate demand is viewed correctly as being equal to income (GDP) plus the change in debt, these dynamics become far more concerning, however – especially for an incumbent government seeking re-election.

Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.