BoE plans to overhaul bank capital rules put £44bn in SME lending at risk

Plans to revamp UK bank capital rules risk a 25 per cent cut in lending to small businesses, threatening jobs and economic growth, a new study has warned.

The Bank of England’s Prudential Regulation Authority announced the controversial plans to overhaul the capital treatment for small business lending in December, as part of broader proposals to introduce the final package of Basel rules in the UK.

The small print of the package includes removing a favourable treatment for SME loans, known as the “SME supporting factor”, that was introduced across the EU in 2014, when the UK was still a member of the bloc, in favour of what regulators call a more “risk-based” approach.

The BoE proposals also include a quirk that makes lending backed by property to small businesses more expensive than an unsecured loan, because the capital charges on property-backed loans are so high.

A report by consultants Oxera, commissioned by SME lender Allica, found that the proposed changes could result in a £44bn drop in lending to UK SMEs based on the reduction banks would have to make to loan books if they did not increase the capital used to back that lending.

Banks’ total lending to SMEs, excluding the government’s pandemic-inspired bounce back loan scheme, is about £165bn.

The application of 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 in a different way, would be even more affected by the changes.

“SME finance is important for the general health of the UK economy, with SMEs having been described as an ‘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 to be a good time to take risks with eliminating the SME support factor.”

The impact on the market would be mitigated if non-bank lenders increased activity, Oxera said, or if banks chose to allocate more capital.

Martin McTague, chair of the Federation of Small Businesses, said the BoE’s proposals created a “real risk that lending to the SME sector may become even more expensive, leading to a reduction in the provision of credit and higher interest rates”.

“If the SME sector finds it more difficult to access credit and must pay higher interest rates for borrowing, 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 rethink the changes given that many small business lenders were “small and systemically unimportant”. NACFB chair 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 on their primary objective of ensuring financial stability”.

Oxera said the proposals were also bad for lenders’ risk management. “Banks are unlikely to become more prudent if prudential regulation encourages them to offer unsecured rather than secured business loans”.

It has shared the report with officials from the PRA, which declined to comment. The PRA is running a consultation on the proposals put forward in December, which closes next month.