Lack of awareness drives SMEs to high-cost loans

Asset and equipment finance providers need to become much more proactive in communicating the benefits of alternative forms of lending across the board, after a government report identified a widespread perception amongst SMEs that “debt finance is too expensive, and the application process overly complex and time-consuming”, putting them at risk of stacking up high interest loans.

In its response to a 10-week consultation on small business access to finance the Department for Business and Trade (DBT) acknowledged that the issue of financial awareness and navigating the market was a contributing factor to the comparatively low levels of demand for SME finance in the UK in relation to international counterparts.

The DBT said the evidence reiterated that small businesses are likely to approach their existing bank or main supplier when they do seek finance, rather than exploring a wider range of options such as challenger banks, commercial finance brokers or online lending platforms, noting “this limited awareness or confidence in alternative providers may restrict access to more suitable or competitive finance products.”

Moreover, if their first point of contact declines an application or offers unattractive terms, many SMEs do not pursue other routes, contributing to lower overall uptake of debt finance.

It also singled out the views amongst SMEs that where credit is available, “interest rates and fees often seem prohibitively high.” The DBT pointed out that this increases the total cost of borrowing and strengthened SME’s feeling that the costs outweigh the expected benefits of investment, further suppressing demand.

High-cost lending

More worryingly, the report found evidence of “opaque loan application processes, lack of clarity on assessment criteria, and slow decision-making” which it said “can result in rejection without clear explanations.”

It cautioned that “This may drive businesses toward high-interest online lenders, especially when traditional banks close accounts or delay decisions.” As a result, “high-cost lenders remain a last resort for many businesses, sometimes leading to detrimental impacts.”

One respondent reported that direct marketing and mis-selling of loans have contributed to “unmanageable debts and business failures”.

Moreover, some respondents suggested that rigid, automated lending systems lack the nuance needed to assess the true potential of small businesses which may otherwise be viable. Evidence to the consultation included the example of rejections due to the liquidation of a subsidiary during the COVID-19 pandemic, which led to the use of a high-cost lender that approved their application for finance.

Need for advice

The DBT response emphasised the gap in support for SMEs is growing, with fewer taking professional advice than five years ago. While larger SMEs will have a business relationship manager at the bank, this is not afforded to smaller SMEs so they are unable to access advisory support.

There was an overall sentiment that banks have little appetite to lend, offering only very small or very large amounts which do not always meet the investment needs of such SMEs. This was reinforced by a disconnect between how SMEs view the level of risk in their business in comparison with the way in which this is evaluated by lenders.

Respondents to the consultation were also unhappy about some SME experiences with digital or online only lenders, and noted that in-person support has been replaced by impersonal chatbot services, leaving those with limited staff and expertise struggling to navigate complex application processes.

The report noted: “As such, some respondents suggested that the private sector can also play a role by coupling financial support with advisory services, through which lenders could help businesses become more resilient and adaptable to market trends, which in turn may increase their willingness to borrow.”

Broker experience “mixed”

While the report identified a growing interest in the role of brokers in helping navigate the diverse and complex market for credit provision for SMEs, and found more SMEs were turning to intermediaries, it also concluded that “experiences with brokers were mixed.”

In particular, some small business owners reported difficulty identifying trustworthy, affordable brokers who could secure appropriate finance, while others suggested that “brokers prioritise larger loans and lenders that are easier to work with, driven by commission incentives, which can result in small businesses missing out on better-value options”.

Currently, the evidence showed many businesses unknowingly approach the wrong type of funder for their needs, leading to wasted time, repeated rejections, and further erosion of confidence in the finance system.

To address these issues, the DBT endorsed proposals that broker standards could be improved through accreditation, membership in professional bodies like the National Association of Commercial Finance Brokers (NACFB), and requirements for qualifications, whole-market access, and standardised commission disclosures.

The NACFB’s head of advocacy and communications, Kieran Jones, said:

Regulatory burden

The DBT’s response to the call for evidence noted “substantial feedback” on the impact of the regulatory framework on lending to small businesses, and acknowledged the concern that multiple regulators and public bodies now have remits that touch the sector, but no single body has overarching responsibility.

“In particular, respondents raised the CCA, prudential regulation, financial conduct regulation, the Consumer Duty, Financial Ombudsman decisions and legislation including common law as notable examples of regulations that influence incentives and behaviours,” it stated.

The DBT accepted need for predictability and certainty in the regulatory framework, noting a lack of regulatory clarity, particularly for brokers and lenders operating at the edge of the regulatory perimeter.

The consultation indicated there was agreement that regulatory changes have made securing finance more difficult and technically complicated, and in particular that the CCA has created a barrier to lending below the amount of £25,000 to sole traders and unincorporated entities because such loans are regulated as consumer loans under the CCA.

There were also suggestions that the Consumer Duty acted as a disincentive for lenders as it has made recovery more expensive. As such, it was suggested that the Consumer Duty should be integrated in a way that complements the FCA’s secondary competitiveness and growth objective. One suggestion was that the FCA’s reform of its rules following the implementation of Consumer Duty should consider that Consumer Duty and Mortgage Conduct of Business rules and Consumer Credit sourcebook (and related guidance) apply to in-scope business lending.

Overall, finance respondents to the consultation proposed that less complex and overlapping regulations that strike a different balance between risk, financial stability and customer protection could support lending to SMEs in the UK, and called for consistency in economic policy, regulation and long-term support schemes to create the conditions for more businesses to consider borrowing.

Edward Peck, AFC CEO, said: “At last month’s AFC autumn conference, I pointed out in my keynote speech that for SMEs seeking working capital, loans are not always the answer. There is a real risk of small businesses ending up stacking loan on top of loan, just to keep up with repayments.

“In that scenario, the second and then third loans are like crack cocaine – they get the business owner hooked, only to find there is no easy way to break the habit.

“But we know that there are plenty of other – and better – options. As the DBT’s response to the consultation on small business finance shows, there is a huge gap in the market for clearly explained, appropriately priced lending for the SME market. And it’s up to the asset, equipment and receivables finance market to make that happen.

“But for asset finance providers to provide high quality, cost effective advice and lending to the SME sector, we also need to see a drastic reduction in the red tape of regulation, a point which the DBT also recognises, and for which AFC has long campaigned.”