Increasing financial inclusion for SMEs: What commercial lenders need to know

The extent of SME commercial borrowing

Commercial finance can help small businesses grow from family concerns to multi-million-pound enterprises. But in today’s uncertain economic world, financial support may not feel accessible to many borrowers.

Though access to loans isn’t a key issue, high interest rates, waning consumer demand and cashflow issues are squeezing the size of lenders’ customer bases.

It can be more challenging to demonstrate affordability and viability in a higher interest rate and uncertain economic environment. We are also seeing some businesses discouraged from borrowing due to these factors.

Mike Conroy, Director of UK Finance

John explained that lenders are working out how to support businesses, who have changed their borrowing habits after facing the Covid-19 pandemic, supply chain issues, high energy prices and rampant inflation.

“We are still seeing demand for commercial finance increase, but there’s been a shift in the types of products businesses are using to borrow – such as asset finance and revolving credit.”

To understand the concerns of diverse clients, John explained that lenders need to take a segmented approach when working with SMEs. A micro business in e-commerce and a medium business in hospitality are likely to need different kinds of finance.

Taking an individualised approach will allow lenders to better understand borrowers’ priorities, their commercial affordability and concerns – potentially making them feel more comfortable with accessing lines of essential credit. For example, a well-resourced business may benefit from a loan to help it expand, while another struggling with cash flow from late client payments would be better off with products that boost liquidity.

To borrow or not to borrow

Commercial lenders in the UK have a large potential customer base, but a lack of understanding around the benefits of responsible borrowing could be limiting their reach. Around 50% of the UK’s estimated 5.5 million SMEs are using some form of external financing to support or grow their operations. Surprisingly, around 31% of businesses have no debt at all.

They are characterised as “permanent non-borrowers” – meaning they have never applied for any form of commercial credit.

Mike says some small business owners can be averse to any debt, even if it has a low interest rate. He also outlined a significant knowledge gap when it comes to business owners and their finances. For lenders, this could limit how business customers use credit – even if it could be in the business’s best interest. It’s important that the commercial finance industry shows successful, stable businesses the value of products like agreed overdrafts or business credit cards, even if they never need to use them.

Finding the right products

Over the past decade, legislation such as 2016’s Bank Referral Scheme has been introduced to help SMEs obtain finance. The UK’s nine biggest lenders are obligated to refer SMEs that they decline for finance to government-backed online platforms which can connect SMEs with lenders. Unfortunately, 94% of businesses turned down by the leading lenders also fail to secure due to the creditworthiness of the applicants.

While the changes had great intentions, Mike suggests that they have done little to improve accessibility in commercial lending.

“The NACFB (National Association of Commercial Finance Brokers) has around 150 lenders on their panel, so there is a good supply in the market. However, SMEs are time poor and typically don’t shop around to consider their options.”

As today’s digital tools come without the oversight and advice of a bank manager, or even a broker, they’re unable to capture the aspirations of applicants and redirect them to a more appropriate option. So what should lenders be helping small businesses do to present themselves as strong candidates for essential finance?

Helping businesses borrow confidently

SMEs can make a difference to their likelihood of obtaining finance by taking a number of simple steps. For example, a lack of commercial financial education is likely to be the biggest one. As many as 20% of small business owners use their own personal current accounts for their business’s finances. Even though it’s simple and free, not opening a business bank account means their data footprint presents them as a consumer rather than a business.

“Something as basic as a business account lets credit reference agencies and lenders see that a business is actively trading,” said John. “Without it, it’s easy for a lender to misconstrue a successful business as an inactive pipe dream.”

Mike explained that the lack of data can be compounded if business owners open a dedicated account, or incorporate their operations, a few years down the line – making them look like a start-up, rather than an established, successful business. He shared some advice to help improve business owners’ commercial credit score, such as:

• Paying suppliers on time, every time.
• Avoiding entering an unplanned overdraft by closely managing cash flow, or taking out an agreed overdraft as a safety buffer.
• Avoiding making too many hard credit searches for products they’re not seriously interested in, such as credit cards.
• Managing personal finances well, particularly if they are a sole trader. Personal arrears, missed payments and more serious strikes such as CCJs will reflect poorly on a small business.
• Diligently banking cash payments so lenders get a true picture of the business’s turnover.

John added: “From a credit reference agency perspective, there’s a clear profile of a business that’s in financial trouble. It’s wise for small business owners to avoid being careless, and quickly rectify any genuine mistakes, so they don’t show those tell-tale signs of a business in poor financial health.”

He concluded with a note to lenders, explaining how they can paint the most accurate picture of their potential customers.

“It’s also necessary for lenders to ensure they use the full range of data available from credit reference agencies and Experian Commercial Bureau, such as CCDS, which includes commercial CATO data, other credit data sharing schemes like Experian’s Commercial CAIS, and the latest risk scores including Commercial Delphi Generation 6. Painting a full picture of business’s health allows them to be as inclusive as possible and give businesses that deserve credit the best chance of securing it.”