March 27, 2024

Can UK SMEs Surmount the 2024 Refinancing "Great Wall"?

I recently attended a session on global insolvencies and was confronted with a startling projection: the UK's SME debt refinancing requirements in 2024 tower over those of any other country, forming a seemingly insurmountable "Great Wall."

This alarming visual underscores the immense challenges UK businesses face in the coming years as they navigate a landscape of rising interest rates, tightening credit conditions, and uncertain government support.

Interest Rates: From Stimulation to Strain

The global economy has experienced significant fluctuations in interest rates over the past decade. Following the 2008 financial crisis, central banks worldwide adopted policies of low interest rates to stimulate economic growth. This era of low rates persisted for more than a decade, facilitating easy access to capital for businesses, including small and medium-sized enterprises (SMEs).

However, as of 2022 and into 2023, the global economy has seen a sharp rise in interest rates, a response by central banks to combat inflationary pressures that have been building up, partly due to supply chain disruptions and increased demand post-COVID-19 pandemic recovery efforts.

The UK's Refinancing Challenge

The session's revelatory slide showed the levels of SME debt refinancing requirements in a number of countries in 2024, 2025 and 2026, with the UK's towering 2024 projection standing out. It looked to be double anywhere else, and it raised three key concerns:

1. Interest Rate Rises 

If any of this debt was taken out before 2022 and fixed, any refinancing is likely to be at a significantly higher interest rate. Have businesses in the UK been somewhat sheltered from the rate rises with that shelter about to be lifted? Since December 2021, the Bank of England has steadily raised its base interest rate from 0.1% to a 16-year high of 5.25% in August 2023. This series of rate increases poses significant challenges for SMEs in refinancing existing debt at affordable rates.

2. Basel 3.1 Implications 

If the proposed removal of the SME support factor goes ahead, isn't it likely to make it significantly more difficult and expensive to refinance this debt? Basel 3.1, also known as the final Basel III standards, introduces more stringent capital requirements and risk management practices for banks. Key aspects include the introduction of the standardised approach for measuring counterparty credit risk (SA-CCR) and revisions to the credit valuation adjustment (CVA) risk framework.

For SMEs, the implementation of Basel 3.1 could lead to tighter credit conditions. Banks may become more risk-averse, particularly in lending to unrated corporates and SMEs, due to the higher capital charges associated with such exposures. Financial institutions might recalibrate their lending strategies, potentially leading to a reduction in available credit for SMEs or increased borrowing costs.

3. Government Bail-outs 

Supporting the economy (or at least keeping the stock market up) has been a staple of the UK (and other) governments for over a decade. If it came to it, can it bail us out again?

Past economic crises have seen various forms of government intervention to support the economy, including bailouts and stimulus packages. During the 2008 financial crisis, for example, governments worldwide injected capital into the banking system and provided guarantees to stabilise financial markets.

The current economic environment, characterised by high inflation and rising interest rates, has prompted governments to adopt measures aimed at supporting SMEs. These include tax deductions, energy cost subsidies, and targeted government guarantees to strengthen SME lending. However, opinions on government intervention vary, with some arguing that it is necessary to prevent systemic failures, while others caution against the long-term consequences of increased public debt and market distortions.

Preparing for the Refinancing Wall

Given that expectations of materially higher arrears and defaults have been discussed for a few years, it may just be a case of refreshing a plan. However, if not, it might be worth taking some time on this before we run into that refinancing wall.

Finance companies should conduct thorough assessments of their funding and liquidity risks, considering the potential for continued high interest rates and tighter credit conditions. For some lenders, there may also be value in looking at credit insurance, to protect against downside risk and reduce capital requirements.

Developing scenarios that account for various economic conditions can help businesses prepare for uncertainties. This includes considering the impact of interest rate rises and changes in government support measures.

Having diversified funding sources, including non-traditional financing options, can help mitigate the risk of over-reliance on bank financing.

In summary, as we face the potential challenges of rising interest rates, tighter credit conditions due to Basel 3.1, and uncertainty surrounding government interventions, it is crucial for businesses to assess their risks, plan for various scenarios, and explore diversified funding sources.

By taking proactive measures and staying informed about the evolving economic landscape, businesses can better position themselves to navigate the "Great Wall" of refinancing we are facing.

Stockpiling canned goods (and toilet paper of course!) may be a little extreme, but thorough preparation is essential to weather the potential storm ahead.

For more information, contact:

Christian Roelofs, CEO, Finativ

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