Bank of England plans to change the capital treatment for small business

These changes are included in a series of broader proposals to introduce the final package of Basel rules in the UK. According to delphix.com, Basel III represents a set of international banking regulations developed by the Bank for International Settlements in order to promote stability in the international financial system. Basel III regulation is designed to minimise the damage done to the economy by banks that take on too much risk. 

The BoE proposals include the removal of favourable treatment for SME loans or the ‘SME supporting factor’ that was implemented in the EU in 2014 when the UK was still a member of the bloc. Instead, the regulators now call for a more risk-based approach. According to the Financial Times, the BoE proposals include an anomaly that makes lending backed by property to small businesses more expensive when compared to unsecured loans. This is due to the current state of capital charges on property-backed loans.

How would banks be affected by the new rules?

According to an Oxera report cited by ft.com, applying these rules to existing and new loans from 2025 will prompt challenger banks to reduce their lending considerably between 2024 and 2026. In the case of larger banks, they could become even more affected by the changes as they calculate their capital differently. The report also indicates that market impact could be mitigated by increasing the activity of non-bank lenders. 

The National Association of Commercial Finance Brokers urged the PRA to reconsider these changes in the context of many small business lenders being 'small and systemically unimportant.' NACFB officials suggested that the regulator could instead focus its efforts on its new secondary objective of supporting economic growth and competitiveness by propping up SME lending. 

The Oxera report concluded that the proposed changes could potentially cause a GBP 44 billion drop in lending to UK SMEs based on the reduction banks would have to make to loan books if they did not increase the capital used to back that lending. Oxera also highlighted the proposals’ potential to disrupt lenders’ risk management efforts, as it’s unlikely that banks would become more prudent if prudential regulation encourages them to offer unsecured rather than secured business loans. The proposals are currently being reviewed by the PRA, with consultations scheduled to end in April 2023.