BoE to change bank capital rules puts £44bn in SME lending at Risk

A new study warns that plans to overhaul UK bank capital rules could lead to a 25% reduction in lending to small business, which could threaten jobs and economic growth.

Prudential Regulation Authority of the Bank of England announced controversial plans to reform capital treatment for small-business lending. This was part of wider proposals to introduce the final package of Basel regulations in the UK.

The package’s small print includes the removal of a favorable treatment for SME loans (known as the “SME supportive factor”), which was introduced in the EU in 2014. This was in favor of what regulators refer to as a more “risk-based approach”.

Due to the high capital charges for property-backed loans, the BoE proposals also contain a flaw that makes small business lending more expensive than unsecured loans.

According to consultants Oxera, Allica’s SME lender, the proposed changes could lead to a PS44bn decrease in lending to UK SMEs. This is based on the reduction that banks would have to make in loan books if the capital used to support that lending was not increased.

The total amount of banks’ lending to SMEs is approximately £165bn, excluding the government-sponsored bounce back loan scheme.

According to the report, the application of the rules to existing loans and new loans starting in 2025 would require challenger banks to decrease their lending “very materially” from 2024 to 2026. The changes would have a greater impact on larger banks that calculate capital differently.

Oxera stated that SME finance was important for the health of the UK’s economy. SMEs have been called the ‘engine for growth’ of the UK. “Given the UK’s wider economic outlook and the extent that SMEs rely heavily on bank financing, it doesn’t seem like a good time for taking risks by eliminating the SME support element.”

According to Oxera, the market’s impact would be reduced if nonbank lenders increased their activity or if banks choose to allocate more capital.

Martin McTague (chair of the Federation of Small Businesses) stated that the proposals of the BoE created a “real danger that lending to the SME industry may become more expensive, leading in a reduction of credit provision and higher interest rates”.

He said, “If the SME industry finds it harder to access credit and must borrow at higher interest rates, it is likely this will affect the ability of SMEs scale up and create new jobs.”

The National Association of Commercial Finance Brokers urged the PRA not to make changes because many small-business lenders are “small and systemically insignificant”. Paul Goodman, chair of NACFB, stated that the regulator should instead be focusing on its secondary objective of encouraging economic growth and competitiveness through SME lending. This is “without compromising their primary objective of financial stability.”

Oxera stated that the proposals also had a negative impact on lenders’ risk management. “Banks will not become more prudent if they are encouraged by prudential regulation to offer unsecured loans to businesses rather than secured ones.”

It shared the report with the PRA officials, who declined to comment. The PRA will close next month with a consultation about the December proposals.