SME finance in the UK: An interview with Professor Michael Mainelli

Michael Bickers, Managing Director of BCR Publishing, spoke with Professor Michael Mainelli (pictured)—Chairman of the Z/Yen Group, President of the London Chamber of Commerce and Industry, and Lord Mayor of London (2023–2024)—about SME finance in the UK, the funding gap, and the role of alternative finance.

Michael Bickers: Why have banks largely withdrawn from funding SMEs in recent years? This is a trend we have certainly observed in the UK, and possibly beyond. There has been a noticeable shift towards funding larger businesses, particularly through receivables and payables finance, which has been developing for some time. 

Professor Michael Mainelli: The history of bank funding for SMEs is complex and, frankly, difficult to analyse with precision. Numerous theories have been advanced regarding how to channel more lending to businesses. One prevailing notion is that a good business should naturally attract capital and generate satisfactory returns. Yet, across many countries – though not all – there is a widespread perception that banks are failing to support SMEs adequately. I would attribute much of this to two primary factors. The first, which is often overlooked, is the scale of banking concentration. The second, more frequently cited, is the regulatory system.

Let us begin with concentration. In several countries, competition among banks means SME lending is not perceived as problematic in the way it is in the United Kingdom. Germany, for instance, has approximately 1,800 banks, while the United States has just under 5,000. This level of competition fosters local lending, where institutions are closely embedded in their communities and possess a nuanced understanding of local businesses.

By contrast, the UK exhibits intense concentration. Over the past ten years, the top four UK banks have gone from accounting for approximately 90 per cent of the SME lending market to 40 per cent.  But that’s still quite concentrated. Furthermore, in 2009, some 52 per cent of the market effectively collapsed with the failures of RBS and Lloyds, and Barclays was far from healthy. Although there are around 100 deposit-taking banks in the UK, roughly 40 of these are building societies, many aligned with Nationwide. This does not constitute a vibrant or diverse lending ecosystem. Consequently, banks in such a concentrated market have limited incentive to prioritise SME lending.

Turning to regulation, supervisors understandably seek to ensure that lending is well-secured. Lending against future cash flow is often regarded as the domain of equity markets, while bank lending is expected to be secured against tangible assets – most notably property. As a result, SMEs frequently find that access to finance is contingent upon providing personal guarantees. What is the personal guarantee? The personal guarantee is your home. In other words, it’s really just a mortgage. SME owners are encouraged to mortgage personal property to support business borrowing.

These two factors – concentration and regulatory emphasis on property-rich asset-backed security – substantially constrain banks’ willingness and capacity to lend to SMEs.

Michael Bickers: Do you believe that over-regulation in Europe and the UK, compared to the United States, is contributing to this issue?

Professor Michael Mainelli: It is important to define what we mean by regulation. The financial crash was, in many respects, poorly analysed in the UK. Leverage ratios among the UK’s top banks in 2009 reached as high as 42:1, compared to a historic average of 10 – 12:1 and a current average of around 15 – 16:1. This excessive leverage, combined with high market concentration, was central to the problem.

Similar patterns emerged in Iceland and Ireland, both characterised by highly concentrated banking systems. In Iceland, three banks had the entirety of the market, a small market of 350,000 people. And Ireland had about four and a half million people with two banks controlling most of the market. Concentration and high leverage ratios are really what led to the financial crises of these three island nations.

By contrast, the United States experienced a steady churn of bank failures even prior to 2009 – approximately 150 per year, rising to 300 in 2010 – within a system then comprising around 8,000 banks. This level of turnover reflects a dynamic banking environment, something we have failed to replicate in the UK, where challenger banks have struggled to scale effectively.  Although, the departure of some 3,000 US banks over the past decade and a half, combined with little new bank creation, is leading the US down a similar path to the UK.

While the US has historically been more successful in fostering new banks, Europe too presents a diverse landscape and a rich mixture, with models ranging from the Spanish Caixa banks to the French banking system and Germany’s large network of regional banks (1,800 German banks). It is therefore unhelpful to treat Europe as one clump.

Could we do more on the regulatory front? Most definitely. A more progressive approach would involve enabling banks to lend against future cash flow or intellectual property. NatWest, for instance, introduced an intellectual property-backed product in an attempt to facilitate unsecured lending, i.e. unsecured against property. This type of innovation is promising, but it is not yet evident at scale. That said, banks are not the only solution; alternative finance mechanisms offer additional pathways of achieving the funding of SMEs.

Michael Bickers: Are you confident that banks will address the SME financing gap?

Professor Michael Mainelli: No, I am not particularly confident.

Michael Bickers: What role, then, can challenger banks, fintechs, and alternative providers play? To provide the funding to SMEs that the banks seem to have pulled away from.

Professor Michael Mainelli: Several challenger banks established over the past decade do provide commendable service levels to SMEs. However, they largely replicate the traditional lending model – primarily funding against property, equipment and machinery, or other physical assets. While service quality may be superior, the underlying products remain conventional.

Moreover, their growth rates remain modest. Reports suggest that even over several decades, their market share may only reach around 10 per cent. Operating under the same regulatory constraints as larger banks, but without comparable scale, they face significant limitations. While their contribution is valuable, this is not truly alternative finance; it is simply a more customer-friendly iteration of traditional banking product.

Once these institutions reach a certain size, they are subject to the same capital and balance sheet requirements as major banks, which further restricts their flexibility.

Michael Bickers: Does this imply a bleak outlook for SME support?

Professor Michael Mainelli: If reliance remains on banks alone, then yes. However, numerous alternative mechanisms exist. There are models that we have stubbornly ignored here in the United Kingdom. Examples include the covered bond market, widely used across continental Europe, and the Swiss WIR system, which has operated successfully for over 90 years and represents around 2.5 per cent of Swiss GDP. They are not banking models. So there are models out there that work.

Michael Bickers: So a shift in mindset is required.

Professor Michael Mainelli: Yes. In the receivables market, challenges persist due to the difficulty of preventing receivables from being pledged to multiple lenders.

One solution might be the introduction of a national registry for receivables, akin to mortgage registries. Similarly, capacity markets and barter exchanges – particularly for perishable goods such as hotel rooms and food – have been problematic, often due to governance failures. However, previous scandals should not deter exploration of these models; rather, they underscore the need for robust frameworks.

Michael Bickers: Yes, we have seen registries used successfully in some markets, in Turkey for example, where they have a central registry for receivables. And that seems to have brought down fraud almost to zero from a very high level before they had the registry.

Professor Michael Mainelli: This receivables registry might be achieved through intelligent application of Tax Office eInvoicing (TOeInvoicing), where all business invoices would go through HMRC.  Several countries, including Italy and Russia, have implemented systems where invoicing is routed through tax authorities. This has been talked about here in Britain, and it is on HMRC’s radar.

At first glance, TOeInvoicing feels like another layer of government oversight, wrapped reassuringly in phrases like “it won’t hurt a bit.”  The last thing many SMEs want is HMRC closer to things, but variants of such systems now operate in over 100 countries and could significantly improve the securitisation and transparency of receivables.

Beyond fraud reduction, TOeInvoicing could bring two substantial business benefits: improved economic insight and better SME financing.  First, granular data on monetary obligations and flows could transform forecasting and decision-making around interest rates, public spending, taxation, trade balances, and exchange rates.

Second, on receivables lending, HMRC, through TOeInvoicing, would effectively hold a definitive register of invoices. A modest extension of TOeInvoicing to confirm payments made would give the government the data to enforce late payment legislation and interest on late payments, as well as improve macroeconomic management data.  A public register of ‘pledged’ invoices being used as collateral for loans could unlock major growth in factoring and discounting – an enormous boon for small businesses.  The government would be here to help national cashflow.

Finally, I might point out something that has always perplexed me. I’ve been advising SMEs in the United Kingdom professionally since the 80s. And I have long questioned why some banks just do not lend against an option on equity. Most SMEs fiercely resist surrendering equity. But if it does fall into other hands, then one of the things that the lender would have recourse to is to actually buy and own the business outright. Getting equipment by taking ownership doesn’t go through the receiver capital extraction process, which is another weakness in our system.

Somewhat tangential to the alternative finance, but slow receivership processes is one area where a lot of finance is locked up unnecessarily for periods of time when it could be released.

A structured lending model – based on sustained revenues and profitability – could allow banks to lend against a proportion of future revenues, with equity as a last-resort recourse. For example, above a cutoff point, say, ‘a minimum of three million in revenues, and you’ve had that revenue level for more than five years, and you’ve been profitable for three of the last five years, and we can lend against a proportion of your future revenues with an equity takeover option’.

This approach would unlock capital while preserving business ownership and improve the efficiency of debt recycling. A healthy economy must be able to recycle its debt efficiently.