Growth of small businesses held back by 'unfair banking practices', MPs warn
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Posted: Wed 8th May 2024
Actions such as the debanking of legitimate businesses and requiring personal guarantees for small loans is restricting the growth of UK small businesses.
That's a warning by the Treasury Committee following the conclusion of its inquiry into access to finance for small and medium sized enterprises (SMEs).
In its final report, the influential group of MPs said in the wake of falling confidence amongst SMEs for accessing finance and a "significant" reduction in funding acceptance rates, the actions of banks are "disincentivising risk-taking, innovation and, potentially, growth".
Debanking of small businesses
During the inquiry, the MPs received evidence that more than 140,000 small firms have lost access to their bank account, a process known as debanking, in the last year. This has often happened with little to no notice, the report said, with at least 4,214 of the closures "attributed to ‘risk appetite' without a clear and consistent definition within the industry".
The committee found that some legitimate businesses were debanked just because they were classed as operating in 'undesirable' sectors, such as defence, pawnbroking and amusement machines.
In the report, the committee said the National Pawnbrokers Association told it:
"It is virtually impossible to access bank financing, and pawnbrokers live in constant fear of bank account closures. Borrowing from banks is not achievable despite excellent profit opportunities at very low risk and high loan security for the banks.
"This is because banks have made higher level decisions to ban lending to the whole sectors of pawnbroking and also pawnbrokers who supply travel money to the public."
The committee said it "condemned" banks for debanking legitimate businesses and called on the Financial Conduct Authority (FCA) to force banks to be more transparent about why they close accounts. The FCA should also, the report said, compel firms to send them the number of business accounts they've closed each quarter split by reason.
The Treasury told the committee that legislation will be introduced to crack down on the debanking of businesses.
Use of personal guarantees
Another issue the committee highlighted was lenders requiring disproportionate personal guarantees for smaller businesses seeking finance.
One example shared with the committee was a "young working mother" who was asked to put her house up as security for £5,000 loan. She decided not to go ahead, so didn't get the finance and had to grow the business more slowly.
Big Society Capital, an investor focused on tackling social issues, told the committee that personal guarantees was a particular issue for social enterprises, or businesses operating in deprived areas:
"Social enterprises tend to work in the areas of highest deprivation, run by people from historically marginalised communities, who tend not to have assets of sufficient value to use as collateral and less likely to offer a personal guarantee from a director.
"For instance, credit decisions for most bank loans under £150,000 are automated, which means that social enterprises in more deprived areas without adequate collateral (given lower property values) have a lower chance of accessing finance from banks."
Earlier this year, the FCA announced an investigation into the use of personal guarantees by banks to support loans provided to small businesses.
It followed a 'super complaint' by the Federation of Small Businesses which said the requirement for personal guarantees has a detrimental impact on small businesses accessing funding to grow and forces founders to put their homes or other assets on the line.
The committee said:
"Disproportionate use of personal guarantees may be a factor in driving down access to finance, either owing to lack of collateral or simple risk aversion from businesses who do not wish to take them out.
"We support the FCA's investigation into the fair and proportionate use of personal guarantees that fall within its existing remit."
Business Banking Resolution Service
The Business Banking Resolution Service (BBRS) was set up in 2021 as a dispute resolution service for SMEs too large to be eligible for the Financial Ombudsman Service and considered not sufficiently sophisticated to go through litigation. It is funded by seven participating banks.
The committee said that BBRS has only settled 58 cases, despite operational costs of over £40m. It added:
"BBRS has been ineffective and perceived as lacking in independence, and should close as planned. However, SMEs above the Financial Ombudsman Service (FOS) turnover thresholds still need a route to complain about treatment from their bank. A consultation on a new mechanism should take place by year end 2024."
Basel 3.1 reforms
The Bank of England's Prudential Regulation Authority (PRA) intends to remove the SME supporting factor from Basel III, an internationally agreed set of measures developed by the Basel Committee on Banking Supervision in response to the financial crisis of 2007--09.
The SME supporting factor is is a mechanism that lowers capital requirements on lending to smaller businesses.
The Federation of Small Businesses told the committee that this policy incentivises banks to lend to SMEs as the capital requirements are reduced by around a quarter.
The committee said:
"The removal of the SME supporting factor under Basel 3.1 threatens to undermine the UK's SME finance market by increasing capital requirements on lenders to SMEs. This will drive up the cost of finance for SMEs and may restrict the supply of lending as banks shift their loans away from the market.
"At a time when costs are tight and acceptance rates for finance low, anything that unnecessarily damages the availability of finance to SMEs is unacceptable.
"Other jurisdictions like the United States and European Union are not pursuing as strict an interpretation of Basel with regards to SME lending so removal of the SME support factor risks putting the UK out of step with international peers and competitors, with negative consequences for the competitiveness of the UK market."
Dame Harriett Baldwin, chair of the Treasury Committee, said:
"There's no hiding from the fact smaller firms have had a torrid time over the last few years.
"Unfortunately, what we have found over the course of the inquiry is that there are some instances where banks and regulators are making a tough world for small businesses needlessly tougher.
"Banks and regulators can't wave a magic wand and solve all of the problems facing small businesses in this country, but they can certainly do more than they currently are. I hope banks, the regulators and the Treasury take careful note of what we've uncovered."
Enterprise Nation's reaction
Commenting on the report, Daniel Woolf, head of policy and government relations at Enterprise Nation, said:
"It's disappointing to see that the funding options open to small business are being made needlessly complex at a difficult economic moment.
"In line with the MPs' views on this, the Enterprise Nation Small Business Barometer found the economic backdrop and increase in operating costs has meant business owners have had to downgrade their growth ambitions and we can see this trend through a progressively decreasing appetite to invest. That has inevitably meant they have had to personally take a hit by paying themselves less.
"On top of that, many business founders are also still reporting they are being paid late, which means they cannot use cashflow to invest in innovation and their own ambition.
"The golden nugget in our research was that businesses are seeking out more business support to help them grow, including more interest in our funding hub, which offers personalised funding options for start-ups and small businesses from alternative lending to cutting costs and getting paid -- as well as banking solutions.
"We feel this upturn in interest could point to expansion over the coming months -- but we will need to ensure we have our financial act together for when that happens."
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