• What’s happening?

The Bank of England is looking to remove something called “The Supporting Factor” from financial regulations which could put nearly £45bn of SME lending at risk, according to research from economic and finance consultancy Oxera and Allica Bank.

• Where has this come from?

Last November, the Bank of England’s Prudential Regulation Authority (PRA) published a consultation paper setting out its response to the Basel III standards, the final part of a framework that set international requirements for bank capital adequacy, stress testing, and liquidity following the 2008 financial crash.

The aim of the requirements was to improve risk management practices in the banking sector, with the aim of negating the need for another massive industry bail-out by UK taxpayers.

• So how did this become a problem?

Despite its honourable intentions, the strict regulations laid down by the wider Basel framework lacked a little nuance. For example, they shackled the banks when it came to lending in riskier areas. This may seem like a good thing but, unfortunately, one riskier area was deemed to be SME lending. SMEs are obviously integral to any economy, let alone the UK’s where there are over 5.5 million of them, and access to proper funding options is vital.

With this in mind, in 2014 the EU introduced the “Supporting Factor”, enabling banks to lower the amount of capital held as a buffer against losses when lending to the riskier SME sector, thus freeing up funding.

It is this “Supporting Factor” that the Bank of England is now looking to remove.

• What is the Bank of England’s thinking? Why are they looking to do this?

Alexei Garan, Partner – Business Funding, Shaw & Co: “It is understandable that the Bank of England and the Prudential Regulation Authority are looking at ways to prevent any risky lending from contaminating the UK banking system. Brexit has given the UK regulator an opportunity to consider removing the SME Supporting Factor to reduce systemic banking risk.”

• If the Bank of England was to remove the “Supporting Factor”, how and why would this impact lending to SMEs?

AG: “Since the 2008 crisis, traditional high street banks have significantly retrenched from SME lending, which is still seen as being a much riskier undertaking despite the Supporting Factor.

“It is envisaged that this latest move could make matters even worse as it would force both traditional and the new challenger banks, both of which are subject to the same regulatory requirements, to hold more capital against loans to SMEs, subsequently reducing these institutions’ appetite for SME lending.

“Banks, both traditional and challenger, would also need to increase the cost of any new loans made. An increase in the cost of borrowing and a reduction in bank credit appetite will encourage SMEs to look to the alternative lending market for support, accelerating a trend we have seen gaining ever increasing momentum since 2008.”

• What can SMEs do to prepare?

AG: “Although no final decision has been made, SMEs can put themselves at an advantage, by getting comfortable with all of the funding options from alternative lenders sooner rather than later.

“High street banks stopped being a one-stop-shop for SME funding when the financial crash happened some 15 years ago. Since then, we have seen many growing SMEs – having been turned away at the high street - benefit not only from greater availability of capital from alternative lenders, but also from:

- More flexible repayment terms, including full interest-only loans;

- Security arrangements more aligned to a modern SME that lacks tangible assets, including fully unsecured lending;

- Pragmatic covenant arrangements;

- More streamlined approval processes and other such administrative benefits.

“Quality independent advice for SMEs is readily available to help navigate this market with its numerous and ever-increasing providers and products. Bringing such advice on board and doing so early, enables SMEs to secure the necessary capital and to transform their funding from a problem into a source of competitive advantage.”

Alexei Garan is a Partner – Business Funding at Shaw & Co.

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