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.