The key chart
Impact of policy tightening on the cost of borrowing for different UK sectors (Source: BoE; CMMP)
The key message
How can UK SMEs invest in growth and job creation when their cost of borrowing is rising so rapidly?
The average cost of new loans for SMEs has increased by 514bp from 2.51% when policy rate rises began in December 2021 to 7.65% in August 2023. This increase is greater than the respective increases in the average cost of borrowing for all NFCs (494bp to 6.97%), secured HH borrowing (324bp to 4.82%) and other HH borrowing (280bp to 9.07%). The spread between the average cost of borrowing for SMEs and the average cost for all NFCs has also widened slightly over the period (although only back in-line with pre-pandemic levels).
In response, some SMEs have been able to pass on the increased cost of borrowing to their customers. They are also more active in switching between funding providers and in considering alternative forms of finance.
Nonetheless, the rapid transmission of the Bank of England’s monetary policy to their cost of borrowing is another reason why SMEs are delaying plans for investment and other business development opportunities.
Returning to the central message of this series of three posts.
SMEs access to external finance is systemically important to the UK economy. They account for c.50% of private sector turnover and c.60% of employment. SMEs cannot invest fully in growth, job creation, innovation and equality, however, if and when:
- their access to external capital is so constrained by LT structural factors;
- flows of financing (both loans and overdrafts) are negative; and
- their cost of borrowing is rising so rapidly
Government-backed institutions such as the British Business Bank and the Scottish National Investment Bank are actively working to make financial markets work better for SMEs and thereby drive sustainable growth and prosperity across the UK. Challenger banks and specialist lenders (e.g. Bibby Financial Services) are making a positive impact too in terms of both the volume of funding and the range of financing alternatives.
In short, the UK government, government-backed institutions and the private sector are combining successfully. That said, the challenges of repositioning the UK finance industry away from largely supporting capital gains (FIRE-based lending) to supporting production and income formation (COCO-based lending) instead, remain considerable. In the meantime, the wider UK economy remains the real loser here…
How can UK SMEs invest in growth and job creation (III)
This is the last of three short posts examining the challenges faced by UK SMEs in investing fully in growth and job creation. The previous posts focused on the structural and cyclical challenges relating to the volume of external financing. This post considers the cost of external financing, and the cost of bank lending specifically.
Trend in the average cost of borrowing for UK SMEs (Source: BoE; CMMP)
The average cost of new loans for SMEs has increased by 514bp from 2.51% when policy rate rises began in December 2021 to 7.65% in August 2023 (see chart above). This increase is greater than the respective increases in the average cost of borrowing for all NFCs (494bp to 6.97%), secured HH borrowing (324bp to 4.82%) and other HH borrowing (280bp to 9.07%), as shown in the graph below.
Changes in the cost of borrowing since BoE tightening began by sector (Source: BoE; CMMP)
The spread between the average cost of borrowing for SMEs and the average cost for all NFCs has also widened slightly from 48bp to 68bp over the period, but is below the recent peak of 119bp in November 2022. The current spread is also in-line with the average spread in the pre-pandemic period (see chart below).
Comparison of trends in cost of borrowing for SMEs and all NFCs (Source: BoE; CMMP)
How are SMEs responding?
According to a recent survey by Close Brothers Asset Finance, 60% of SMEs have been able to pass on the rising cost of financing to their customers. At the same time, 36% of those surveyed have switched funders in order to access more attractive deals and 52% have considered alternative forms of funding e.g. asset finance.
UK Finance research suggests that SMEs are utilising existing facilities while also drawing down on deposit holdings. That said, their survey also concludes that, “plans for investment or other business development opportunities appear to be on the back burner.” (UK Finance, October 2023).
Conclusion – the central message of this series
SMEs access to external finance is systemically important to the UK economy. They account for c.50% of private sector turnover and c.60% of employment. SMEs cannot invest fully in growth, job creation, innovation and equality, however, if and when:
- their access to external capital is so constrained by LT structural factors;
- flows of financing (both loans and overdrafts) are negative; and
- their cost of borrowing is rising so rapidly
Government-backed institutions such as the British Business Bank and the Scottish National Investment Bank are actively working to make financial markets work better for SMEs and thereby drive sustainable growth and prosperity across the UK. Challenger banks and specialist lenders (e.g. Bibby Financial Services) are making a positive impact too in terms of both the volume of funding and the range of financing alternatives.
In short, the UK government, government-backed institutions and the private sector are combining successfully. That said, the challenges of repositioning the UK finance industry away from largely supporting capital gains (FIRE-based lending) to supporting production and income formation (COCO-based lending) instead, remain considerable. In the meantime, the wider UK economy remains the real loser here…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.