A sustainable approach to SME lending can help the economy thrive

19 Jun 2019

While large, household-name companies dominate the media, it is small and medium-sized enterprises (SMEs) that keep the global economy turning. A look at how responsible lending to the UK’s SME sector can contribute.

  • With banks pulling out from the market, SMEs have been hard-pushed to secure financing
  • Institutional investors are increasingly filling the lending gap to the SME segment
  • A sustainable approach can achieve long-term growth and development

The overwhelming majority of the world’s companies employ just a handful of people – and the UK is no exception. According to the latest figures from the Department for Business, Energy & Industrial Strategy, in 2018, 99.9% of all UK private sector companies were SMEs. In fact, SMEs account for at least 99.5% of the businesses in every main industry sector. Together, their annual turnover was estimated to hit GBP 2 trillion in 2018, making up 52% of all private sector revenue. Not only that, these companies were staffed by 16.3 million people, meaning they provided some 60% of all private sector employment in the UK.

But despite their crucial importance to the UK economy, SMEs are often overlooked when seeking to borrow to expand or fund their working capital requirements. According to the Bank of England’s statistics on corporate lending1, after a spike in 2013, there has been no significant rise in the level of money being made available to UK companies to borrow. This is despite more than 800,000 new companies being launched in that time.

 

Filling the lending gap left by banks

This lack of available funding is an issue for companies of all sizes, but while those at the larger end of the scale can enter the international capital markets and issue bonds to global investors, this is not a viable option for SMEs with much smaller headcounts and cashflow. Instead, asset managers, including BNP Paribas Asset Management, have been working with partners to seek out these companies and make the funding previously provided by banks available to them.

Our clients, including pension funds and insurance companies, need to make their assets  work hard to produce an income. Over the last few years, traditional investments have failed to offer the returns they need in order to service their liabilities. As a result they have turned to lending to SMEs as a new opportunity offering potentially attractive returns. Both we and our investment clients know that accessing finance is vital for businesses to grow and flourish. This is something that has been recognised by the United Nations, which has taken a focus on the smaller end of the scale.

 

Positive impact for society

In its Sustainable Development Goals (SDG)2, published in 2015, the UN cites lending to SMEs as a key target within SDG 8, which aims to “promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all”. The UN realises that SME lending bring huge benefits to the real global economy; without it, many of these companies would not survive. Allowing such companies to expand delivers a positive societal impact by creating jobs and moving people up the social scale. A wealthier, empowered workforce can more easily educate and provide for their families and ensure a more secure future.

Also, promoting an environmental, social and governance (ESG) agenda to the companies we lend to can help these businesses address their long-term sustainability and allow them to expand further as the years go on. However, unlike other lenders, who try to unduly influence management on strategic matters, we believe it is critical for companies to retain control. Small businesses are usually borne out of an idea to fill a gap in the market and we do not want to quash these ideas or entrepreneurial spirit.

But we do need to undertake a comprehensive analysis of the balance sheet before we lend – and this can be a challenge. While companies listed on a public exchange are subject to rigorous regulation and frequent disclosure obligations, private SMEs are under much less scrutiny. This means there is less publicly available information about the nature of their businesses – and their financial success – which in turn means we need to carry out significant due diligence on each company to ensure its business strategies make sense. The lender also needs to check and recheck that the financials are robust and do not present any significant default risk.

 

Responsible lending at fair rates

With all this in mind, we strive to be a responsible lender. While we will price interest rates according to the risk we are taking, we ensure they are fair and suitable for the borrower. We know that lending to companies at excessive rates can be damaging to both sides of the deal. Far from boosting our return on investment, lending at very high rates can actually undermine it by making it harder for enterprises to turn a profit.

That is why we aim to strike a firm balance between being rewarded for the risk we take and ensuring SME borrowers are able to pay. We have a responsible duty to the borrowers as well as to our clients. As a signatory of the UN’s Principles for Responsible Investment and having committed to the UN’s SDGs, it is our duty to ensure SMEs have access to stable, sustainable funding that will see them grow on into the future and continue to provide a return for our clients.


1 Source: Bank of England, “Credit Conditions Survey – 2018 Q4” as of 17/01/2019

2 Source: United Nations, “2030 Agenda for Sustainable Development” as of September 2015

Unless otherwise stated, all facts and figures come from the Department for Business, Energy & Industrial Strategy 2018 statistical release: Business population estimates for the UK and region