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SME financing tightens as rising rates and weak growth limit appetite

Date Published: 19/10/23

Finance liquidity for SMEs in the UK are dwindling over the course of this year. Elevated inflation, diminishing government support, and banks’ ongoing loan book rationalisation have combined to constrict access to financing for SMEs.

It has created a much tougher environment for refinancing, new lending and restructuring, but not impossible. In this article, we outline the macro context for the SME financing market, the impact on borrowers across various sectors, what SMEs can do to improve their probability of success, and the outlook from here.

Macro context for SME lending

Since the Covid-19 pandemic ended and Russia’s invasion of Ukraine began, UK banks’ lending capacity has substantially reduced. Multiple factors have contributed to a complex liquidity environment:

  • The Bank of England’s (BoE) liquidity programmes, dating back to the global financial crisis, are unwinding;
  • Increased regulatory requirements for risk-weighted assets (RWA) necessitate higher capital buffers, which restricts banks’ balance sheet capacity;
  • Rising interest rates have elevated UK banks’ cost of capital as higher bond yields make it more expensive for banks to fund their lending from debt capital markets, other banks and the BoE;
  • Loan impairment charges soften banks’ lending appetite; and
  • Heightened ESG reporting requirements, which have increased upfront and ongoing administrative burdens on borrowers.

The outlook for growth, inflation and interest rates is also weighing on bank lending. The IMF predicts UK GDP will rise by 0.5% in 2023 and by 0.6% in 2024. These weakened forecasts reflect the expected lag effect of rate rises weighing on activity, influencing banks’ views on which sectors they are willing – and unwilling – to lend against. Annual CPI for the 12 months to August came in below expectations, at 6.7%, according to the Office for National Statistics (ONS). September’s CPI print released on 18 October. While the IMF predicts the BoE may need to rise another 25 basis points above the current 5.25%, some economists believe rates have already peaked. The upside risks to inflation relate to higher oil prices in international markets, and these have heightened since the recent onset of the Middle East conflict. Overall, the UK’s inflation problem is considered more persistent than its G7 peers, which is expected to influence the BoE to maintain higher for longer interest rates than US and EU central banks.

Table 1: CPI 12- month rates, Jan to Aug 2023

Jan Feb Mar Apr May Jun Jul Aug
10.1% 10.4% 10.1% 8.7% 8.7% 7.9% 6.8% 6.7%

Taken together, it has become increasingly challenging for banks to lend profitably, narrowing both their lending capacity and appetite, especially in sectors such as leisure, hospitality, and development, while they are more selective in retail and offices. Investors have also reacted to market volatility by pausing transactions, reducing the flow of loan prepayments and further limiting banks’ capacity to support new financing deals.

What SMEs should expect

For UK SMEs, the scarcity of liquidity is likely to persist in the coming quarters. Banks are becoming more selective, leading to extended credit analysis and due diligence processes. Borrowers should prepare for longer processing times and anticipate additional information requests, particularly related to ESG requirements. Some SMEs may even be asked to secure new Energy Performance Certificates (EPCs), which can introduce unexpected additional remediation requirements.

Successful borrowers must adjust their expectations. They should be prepared for lower leverage, higher margins, and lower asset valuations, as banks de-risk overall SME exposure. These changes may come as a surprise to some SMEs. For example, strong-performing non-branded UK hotels now struggle to secure refinancing, as the sector has been downgraded to reflect the headwinds affecting discretionary spending as the economy weakens.

Another challenged sector is offices, where the impact of hybrid working trends continues to unfold unevenly. In the financial services sector, firms are taking a tougher stance on in-person working, leading to some signs of improved demand for London office space. However, long-term forecasts for the broader UK office market suggest a challenged outlook, with predictions of a 20% contraction in London office usage due to post-pandemic hybrid working and occupier preferences for greener buildings in suburban areas. As office utilisation trends take time to find a new equilibrium, bank appetite will remain limited.

Pockets of liquidity persist

Despite these challenges, there are pockets of liquidity available for diligent borrowers with robust business plans. The longer-term outlook for SME financing liquidity is tied to interest rates, growth prospects, and the impact of macroeconomic and geopolitical events. SMEs requiring finance in the near term should heed the most critical message: prepare early. If loans are coming up for refinancing, SMEs should anticipate longer timelines, increased due diligence, and potentially lower valuations. Early preparation and adaptability are key to navigating these changes successfully.

To enhance your chances of securing financing in this evolving landscape, do not hesitate to contact our team at BTG Advisory. We have a large network of banks and alternative lenders and can help you prepare a bank-ready financing business plan, positioning your firm more favourably in the eyes of lenders.


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