Sunday 19 April 2020 10:00 pm

The Long Read: The coronavirus loan scheme risks failing the people it was designed to help

Save our SMEs

When the chancellor, Rishi Sunak, vowed that the government would do “whatever it takes” to keep businesses alive during the pandemic, the immediate reaction from corporate Britain was one of relief. 

The pledge to pay the wages of employees unable to work and the ambition behind the £350bn package of support (combining grants, sector-specific relief and state-backed loans) was praised by employers, industry groups, trade unions, the City and even opposition politicians. 

One of the main elements of the chancellor’s announcement was support for the UK’s six million small and medium sized businesses. His Coronavirus Business Interruption Loan Scheme (CBILS) was set up to offer loans to firms with a turnover of up to £45m. Companies can access the money through more than 40 approved lenders and 80 per cent of the loan is guaranteed by the government.

In the early stages of the pandemic, as the economic implications of the virus (and of the government’s response to it) became clear, comparisons were made with the 2008 crash.

In recent days, however, economists and institutions such as the IMF have suggested that 2008 is the wrong reference point – and that we must go back further, to the Great Depression, to find a comparable shock to the system. 

Another reason why our current emergency is different from the financial crisis is the role of the banks. Put simply, in 2008 they were the villains whereas now they have an opportunity to be heroes.

With a nod from government, they could turn on the taps and pump money into businesses up and down the country. At least, that was the theory.

Getting the coronavirus loan scheme off the ground was never going to be easy. The Treasury’s efforts to devise the details of a contractual understanding with more than 40 lenders would have been made more difficult by the simple fact that banks themselves were also dealing with the disruption and impact of the pandemic.

Despite the difficult conditions, the coronavirus loan scheme went live on 23 March and is being administered by the British Business Bank.

In the first three weeks of the scheme operating around 300,000 businesses made informal enquires. But it didn’t take long for the first cracks to appear, with reports emerging of banks requiring additional security from applicants – despite the government supposedly guaranteeing 80 per cent of any loan. 

This, along with a requirement that companies must first be offered a standard commercial loan before being offered one via the CBILS, was abandoned following an intervention from the chancellor on 2 April. Announcing the changes, Sunak said: “This is a national effort and we’ll continue to work with the financial services sector to ensure that the £330bn of government support, through loans and guarantees, reaches as many businesses in need as possible.”  

Nevertheless, on 7 April, City A.M. revealed that just 2,000 coronavirus loans had been issued – totalling £290m. It was a disastrously low figure and it hasn’t improved much since. As of last week, just over £1bn had been lent to around 6,000 firms. 

There will be another jump in these figures once the banking industry reveals its latest coronavirus loan count in the coming days. But any politician or industry advocate who points to this and hails the rate of improvement is living in fantasy land.

Nearly 30,000 firms have applied for a coronavirus loan under the scheme, but demand is certainly far higher. It’s clear that the first issue is the application process itself. The most common complaint I’ve heard from small businesses is that they can’t get through, or they aren’t called back. 

The process itself is also complicated and time-consuming, requiring the submission of management accounts, cash flow forecasts, a business plan, historic accounts and details of assets. In contrast, businesses in Switzerland seeking an emergency loan amounting to ten per cent of their annual revenue are required to submit a one page form, online.

The Swiss system is also administered via the country’s banks but enjoys a 100 per cent government-backed guarantee, which means the banks are essentially distributing grants. Germany and America have also devised far simpler schemes on more generous and realistic terms.

Another issue for many businesses trying to take advantage of CBILS is that a fatal flaw may have been baked into the foundations of the scheme. The British Business Bank sets out the criteria under which an applicant’s viability for a loan should be assessed:

“The lender has to establish that the business has a viable business proposition assessed according their normal commercial lending criteria – this will vary between lenders based on their risk appetite, lending policy etc. If there are concerns over the short-to-medium term business performance due to the uncertainty and impact of Coronavirus (COVID-19), the proposition may be considered eligible under the CBIL Scheme provided the lender reasonably believes that:

 (a)  the finance will help the SME trade-out of any short-to-medium term cash flow difficulty, and

 (b) if the facility is granted, the SME should not go out of business in the short-to-medium term.

“We also expect banks to treat customers fairly, and to carry out affordability checks.”

This in itself is ambiguous. How, for example, should a lender assess whether a company could go out of business in the short-to-medium term? 

Some banks are clearly nervous about lending given that the government could turn around in years to come and refuse to honour the state guarantee for a loan issued to a business deemed subsequently to have been unviable. City A.M. has seen correspondence from one high-street lender in which they tell the applicant:

“It is fair to say very stringent conditions are being imposed on the banks by the British Business Bank { BBB } who are administering the scheme on behalf of the government. The BBB will be auditing a cross section of applications in due course & because of this, our internal auditors are themselves undertaking in-depth due diligence with all loan requests the bank is receiving.”

The British Business Bank says it has to protect taxpayers’ money and that the public would expect them to keep a close eye on the scheme. While this is understandable, it remains the case that whether by accident or design some banks are using the threat of an audit to put yet more stress on an applicant who, let’s not forget, is only applying for a coronavirus loan because they see their life’s work in mortal peril. 

To compound the problem of viability/eligibility, the British Business Bank has passed on further guidance to lenders, requiring that eligibility for funding be based on EU Commission Regulation No 651/2014 of 17 June 2014.

Known as the General Bloc Exemption Regulation, it governs EU state aid law. In particular, section 187/19 Article 2 (18) sets out rules concerning an “undertaking in difficulty” and outlines specific circumstances or corporate characteristics which may disqualify a company from aid.

It was designed with large-scale bailouts in mind and, according to James Weber, a partner at Shearman and Sterling specialising in state aid law, should never have been applied to the CBILS.

A Treasury spokesperson insisted last night that the regulations had to be included in the CBILS in order to comply with European Commission’s Temporary Framework on State Aid. The spokesperson acknowledged that the EU rules pre-date the coronavirus crisis, but said “it is impossible to take this condition out [of the CBILS framework]”. 

However, according to Weber, the CBILS categorically “does not need to fall under the terms of existing legislation such as the General Block Exemption Regulation…as [Treasury] officials designed the scheme under great time pressure they have taken elements from existing rules – such as definition of ‘undertaking in difficulty’….the problem with this is that existing rules may be too complex for banks to apply to such a large number of companies.”

Weber is confident that if the Treasury asked the European Commission to authorise an amendment to its CBILS rules, officials would grant the change in as little as 48 hours:  “If the scheme is not working as intended, the UK can readily amend it. Any reasonable amendment notified to the European Commission is very likely to be approved within one to two days.”

If banks are indeed nervous about granting loans to a business it is at least in part because the government has required them to assess the firm’s viability against EU regulations that some feel should never have been included in the guidance. The issue of EU state aid rules hampering the loan scheme is a slippery one. It is cited by some Treasury sources but denied by others; referred to by some banks but not by others; and acknowledged by industry groups and the British Business Bank without anyone being able (or willing) to take ownership of the issue. There is ambiguity where there should be clarity.

If the scheme was working as well as its architects hoped, there would be a much more even distribution of loans among the 40 accredited lenders. Instead, the vast majority of loans are being made by just two banks. According to the Sunday Times, by 18 April NatWest, 60 per cent taxpayer-owned, has approved just over 5,000 loans while HSBC has approved just over 2,000. An urgent inquiry must be launched to determine the issues holding up lending at other institutions.

It’s now clear that the coronavirus loan scheme needs another review. There are growing calls for the government to guarantee 100 per cent of the loan, making banks more of a delivery mechanism for grants.

The viability criteria needs an urgent overhaul, as does the application process itself. The chancellor shouldn’t fear these modifications and nor should he be criticised if he makes them. Sunak is meeting the heads of major lenders this week to look at the scheme, and we must hope that he doesn’t shy away from making the changes needed.

It would be simplistic, and wrong, to blame the banks for the failure of this scheme. The government is asking them to use their own liquidity to issue loans on a six year repayment term, and with the government’s guarantee (assuming it even holds) banks face being on the line for a fifth of all such lending.But when one bank, out of more than 40 lenders, is responsible for the vast majority of loans, questions must be asked about the confidence banks have in the scheme. If they detect flaws in the system, they must speak up – for all our sakes.

These are extraordinary times and the Treasury innovated at speed to provide reassurance to businesses. But now it’s cash that businesses need, and the longer they go without it the deeper the scars will be.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.