How lenders can better serve SMEs

Summary

UK SMEs are struggling to grow their operations at scale, hampered by difficulties in accessing funding and regulators who do not understand their market. That was the warning from the opening session at AFC’s UK Summer Conference 2024, with Martin McTague, national chair of the Federation of Small Businesses (FSB), highlighting particular problems with what he called the “indiscriminate” use of personal guarantees (PGs).

Speaking to conference delegates McTague outlined how the “chilling effect” of PGs prompted the FSB to bring the first-ever “super complaint” to the Financial Conduct Authority (FCA), after the association found 70% of SMEs would rather grow more slowly than borrow, with external finance viewed as “too risky”.

The FSB wanted the FCA to investigate how PGs are used in the SME market to identify whether or not this is a systemic problem, arguing that high quality research is needed rather than simply anecdotal data.

While the regulator has agreed to collect data on the number of personal guarantees in place for SMEs borrowing less than £25,000 and assess complaints to the Financial Ombudsman Service (FOS) regarding PGs, it will not be looking at the use of PGs in lending to limited companies, stating that this is beyond its regulatory scope. McTague branded this response “pathetic.”

“The relationship between risk and return is unbalanced and that’s because of the indiscriminate use of PGs. They have three characteristics: all monies; the personal home is involved; and there’s no link to interest rates,” McTague said.

Alternative options

Conference panellist Nathan Mollett, head of asset finance at United Trust Bank, agreed a better balance needs to be struck, pointing out that requirements for PGs in the asset finance sector are more selective, and are typically demanded if the SME is a new-start business or there is no asset security.

“It’s a different story when you look at loans to SMEs where there’s more of a blanket approach. But there’s risk it becomes counterintuitive. If the regulator were to impose regulations when lenders can or can’t impose PGs, then the outcome might be to restrict SMEs from accessing credit,” Mollett cautioned.

Fellow panellist Daniel Bailey, managing director of Arkle Finance, pointed out that asset finance agreements are “based on the chemistry of the whole transaction” with PGs only required “to fill a gap”.

But as Graham Lines, head of product at Novuna Business Finance and another panel member, highlighted: “We operate with customers whose businesses are three years old or more, but we know that 50% of business fail in their first five years so you need to put that into the mix. If you get it wrong, the counter effect is less funding available.”

Unintended consequences

Despite PGs’ potential pitfalls, McTague is clear he does not want them banned, saying “it’s the blanket use of PGs in indiscriminate ways that is unjust. We are looking for better practice.”

In response, Mollett said the financial services sector needed to signpost options better, making it clearer to SMEs what is involved in a PG so they make an informed choice, and suggested this could form part of the Finance & Leasing Association (FLA) Code.

Lines made the point that lenders should be careful about viewing SMEs as a single group, given their diversity and the fact that 73% would be classed as “micro businesses”. That has led some – McTague included – to argue that some SMEs should be treated more like consumers and given the protection of Consumer Duty rules.

“The challenge for funders is that regulation isn’t really working and there’s a lack of clarity. It’s very difficult to know where we’re going to land with all this. It’s more expensive to do regulated business, there’s more complex administration and more complex controls, plus you’ve got regulatory risk, reputational risk and financial risk. Lenders could end up thinking ‘why bother?’” Lines said.

McTague said the FSB’s super-complaint to the FCA was motivated by a desire to get a consistent view of the impact of PGs, using the regulator’s powers to ensure that all lenders responded. He argued that solid data could feed into the FCA’s commitment to regularly review its regulatory perimeter.

However, the panellists remained concerned about regulatory creep, voicing worries that expanding the scope of a regulator’s reach could have the effect of making lending to SMEs less attractive.

Claims culture

In the background to that concern is the FCA’s announcement at the start of the year of a review of motor finance agreements going back to 2007 in the wake of two FOS decisions relating to car purchases.

The result of that intervention has been a flood of claims which have prompted at least two auto finance lenders to set aside provision for any future compensation payments.

Some of those claims have been passed on via claims management companies (CMCs) as well as by individuals, and conference delegates heard from Simon Evans, managing director of the Consumer Redress Association (CRA), which is the CMC trade body. While CMCs have sometimes been viewed as an enemy of lenders, Evans was keen to suggest in future they could work with funders to create a better consumer focus and processes for dialogue.

Declaring “I don’t want any CMCs to exist – they should not exist, and there should never have been situations like PPI or undisclosed commissions to the detriment of consumers”, Evans argued that the CRA’s role was to drive up standards, encourage best practice and provide a route for consumers to complain if they felt they had not been treated fairly, acting as a “check and balance”.

“CMC’s value is in identifying where issues have arisen and any potential harms. Then the FCA says we are saving consumers time by giving them knowledge of who or where to go to complain. With some products, consumers know there is an issue but they don’t know who to complain to, so we have an education and information role,” Evans explained.

Recent increases in the fees charged by the FCA and the Solicitors Regulation Authority (SRA) have been designed to reduce the number of non-meritorious claims brought and Evans was adamant that CMCs who put forward claims that have little chance of success are committing “commercial suicide”.

“Our mantra is co-operation, not confrontation,” Evans declared. With regulators sometimes facing a backlog of complaints, CMCs offer a way for consumers to stay engaged with the process and see it through to an eventual conclusion. With some 20,000 claims now lodged with FOS relating to undisclosed commission on car finance, there is some concern that these may take a while to work through, particularly given the judicial review brought by Barclays which has stalled the regulator’s evaluation processes pending a judgment being handed down.

Analysis from David Betteley, Asset Finance Connect’s head of content

Treating SMEs in exactly the same way as consumers actually provides SMEs with even more protection than consumers, on the basis that on average one would expect an SME owner/director to be more aware of what they were signing than the average consumer.

Moreover extending, for example, the Consumer Duty regulations to SMEs could have three unintended and negative consequences for the sector:

• • Firstly less choice as some companies decide to exit the market as it becomes “too difficult” to lend.

• • Secondly, those remaining companies impose a higher hurdle rate making it more difficult for less than prime SME covenants to access credit.

• • Thirdly, a general increase in pricing to cover the costs and risks of additional regulation.

As always in life….be careful what you wish for!