Main headline in the Financial Times today “Sunak bends to pressure for 100% guarantees on small business loans“. HMT is apparently considering 100% state guarantees of loans up to £25,000 to the very smallest “micro-businesses” in the UK. This is a consequence of sustained lobbying, including from many Conservative MPs, concerned about the slow roll out of funds from the CoronaVirus Business Interruption Loans Scheme (CBILS).
CBILS offers loans of up to £5mn for loan periods of up to 6 years to firms with a turnover of up to £45mn, providing an 80% state guarantee on each loan and the government paying the costs of the first 12 months of interest.
A number of practical questions about how this extension for the smallest businesses will work.
- What is the criteria for qualification? If I was advising the government I would suggest minimizing complications, offering this guarantee on the first £25,000 of all CBILS loans, i.e. these 100% guarantee should be available to any firm with turnover of less than £45mn. I fear the government instead imposes arbitrary and unnecessary rules, e.g. these may only be available for firms with less than £0.5mn turnover. My own analysis underpinning my NIESR policy paper suggests that there are many firms with turnover in the £0.5mn- £5mn turnover range who could avoid failure through a small loan of £25,000.
- How much should be loaned? The analysis underpinning my NIESR paper suggests sector by sector ratios based on turnover. So for example (in order to cover a 6 months business interruption, which is what we should be thinking of) in retailing I think the gap in cash flows can be 6.2% of annual turnover. So I would limit the lending to retailers to the lower of £25,000 or 6.2% of turnover (the £25,000 would only bind for a retailer with annual revenue of less than £400,000). If a single ratio to turnover for all businesses, then I would set this at 5%.
- What is the term of the lending? Not easy questions to answer since the future landscape is so uncertain. If the loans are amortizing over a short period of time e.g. 1 year then they will not do all that is needed to alleviate the cash flow problems that can trigger failure of sound businesses. But longer term exposes the government to greater credit risks. Again in the interests of simplicity I would suggest these are two year loans.
- What is the interest rate on the loan? This is government guaranteed lending. The government is the marginal source of funds to the banks. So the loan rate should be current two year borrowing rate for government. i.e. 0.06%. We can call this 0.1% for simplicity allowing a (very small) turn for the lenders.
- What about potential fraud? This is a major concern. The identity of the borrower must be accurately determined and (if my suggestions here are followed) turnover checked. What if the borrowing turns out to be fraudulent? Then there must be some sharing of loss between government and lender, to ensure they have incentive to undertake their role responsibly. I would suggest 50:50 share of the resulting loss.
- What about administrative costs to the banks and non-bank lenders to check information and avoid fraud?. I would recommend the government paying the banks a fixed administrative fee, what the lenders say they need to cover their costs but set at a maximum of £125 per loan. (why £125 per loan? This corresponds (roughly) to the costs of getting loans out the door for highly efficient small business lenders such as Funding Circle).
Will this solve all the problems of smaller business? Yes it will, in terms of numbers of businesses. £0.5mn turnover apply to the smallest firms. There are 1.9 million companies in the UK with turnover of less than £0.5mn. This scheme can reach all of these who are in real need. There could be £15bn going out the door, but this will be money well spent (on my calculations in my NIESR paper will generate a 5 time payback to the economy, generating £75bn).
These scheme, if it is not made excessively complicated, will do a lot of good. It will not though solve all the problems of threatened failure of viable companies. There are a further 50,000 companies with turnover in the range £0.5mn to £50mn, and around half of these have experienced a major collapse of revenue that threatens failure. Many of these are still struggling to access the CBILS scheme. My calculations suggest that the total borrowing needs of these 50,000 somewhat larger companies are as great as those of the 1.9 million businesses who can benefit from Sunak’s new scheme.
What to do to help these firms? Here I think the key is to announce a program of future relief, money to be paid out in 2021 to cover essential costs of recovery based on revenue loss in 2020. This in turn will greatly facilitate the access of these companies, those in the £0.5mn to £50mn turnover range, to access the existing CBILS loans.