Tim Vine, Head of Credit Intelligence at Dun & Bradstreet
The closed doors of businesses have become a sadly familiar sight on the high street. With social distancing in force, many of the small and medium-sized enterprises at the heart of the economy have been lockdown was enforced. Unfortunately, it looks like we’re a long way from returning to business as usual.
Access to finance is critical for many small and medium enterprises (SMEs) right now. The government has recognised this with loan schemes that seek to inject much needed cashflow into smaller businesses, and financial services providers are equally looking to offer support.
However, in recent years SMEs have had a tricky relationship with borrowing, lacking confidence with the types of finance and options available. In 2018, nearly half of the UK’s small business owners viewed themselves as permanent non-borrowers (47%). Equally, lenders have sometimes struggled to access the information needed to make robust loan decisions.
Understanding the full range of lending options available will be critical for smaller businesses to make informed borrowing decisions in the coming weeks. Credit reference agencies (CRAs) can play a key role in supporting SMEs, as they secure the finance they need to weather the current storm.
The double-edged sword
The borrowing decisions taken now will impact the financial health of SMEs for many months to come. However, even before the coronavirus outbreak, there were signs that these businesses didn’t always have the awareness or the information needed to make confident borrowing decisions.
A survey commissioned by Dun & Bradstreet in late 2019 found that 46% of SME respondents seek business loans from the bank, with 25% turning to private investors and 23% to family members or friends. According to research from the British Business Bank in 2019, small business owners had misgivings about the cost (29%), strict conditions (26%) and difficulty (25%) of securing finance – that put them off applying for loans. This left many SMEs facing a double-edged sword when it came to finance: put off by the terms offered by their bank, but not willing to look elsewhere.
Perhaps as a result, finance has been used as a way to keep the doors open, rather than developing the business. Where SMEs were borrowing, it was most often for working capital to continue trading (56%) – rather than to invest or expand. In Dun & Bradstreet’s survey, over half (52%) of respondents believe there is a lack of financial support available to help small businesses grow and succeed. Today, the challenge to survive is tougher than ever in the wake of COVID-19, so it’s vital that SMEs can look beyond one provider to find finance on the best terms possible.
Lack of information
Importantly, in 2019 small and medium-sized enterprises were most likely to rely on their own knowledge – rather than external sources – when considering access to finance. When asked about their most common source of guidance, small business owners pointed to themselves – both for choosing the type of finance (35%) and the specific provider (30%). Right now, this could result in SMEs limiting their borrowing options and missing out on the best choice for the business.
On the other side of the fence, banks historically struggled to approve loans to SMEs due to a lack of information about the risk they represent. Unlike larger businesses, SMEs haven’t been required to register at Companies House or publish annual accounts.
However, since the Small Business, Enterprise and Employment Act of 2015, credit reference agencies (CRAs) have had access to information on how banks lend to small and medium-sized businesses. This means that CRAs can act as an independent intermediary between SMEs and lenders, offering information to support robust lending decisions during this critical time.
Linking SMEs to lenders
Credit reference agencies can act as an important link between SMEs and lenders. CRAs can provide banks with the depth of data needed to make qualified decisions about offering loans to SMEs, as well as providing greater clarity on how to handle marginal decisions. In other words, CRAs help lenders to say yes as much as possible, to the right business at the right time.
On the business side, credit reference agencies can link SMEs to a wider range of sources for finance, suggesting alternative options and providing clarity over declined applications, to help as many SMEs access finance as possible. Solutions offered by CRAs can help smaller and medium-sized businesses to get a holistic view of their options to make informed decisions – and secure finance on the best terms for them.
Importantly, many CRAs are also taking steps to avoid unfairly discriminating against SMEs due to special measures taken during the pandemic. For example, rating systems will draw distinctions between where SMEs have negotiated approved payment freezes with suppliers and payment defaults, without an impact on credit ratings. This will support smaller businesses’ recovery in the long term.
In everyone’s interests
With strict social distancing rules in place, many of the UK’s SMEs may have to face this period of hibernation for a while longer. Access to finance will be vital for meeting financial commitments, protecting jobs and ultimately staying in business until more normal times return.
Right now, it’s vital that SMEs are able to make informed decisions about the finance that they access, including the lender that they choose and the form that it takes. Equally, lenders should be able to make qualified lending decisions, providing crucial cashflow to SMEs that can afford it. By opening up data on both sides, credit reference agencies can act as a critical intermediary and help to keep SMEs in business.