A significant £90 billion “lending gap” in bank financing for small and medium-sized enterprises (SMEs) in the UK is hindering investment, productivity, and overall economic growth, according to a new study.

Research covering lending trends over the past 40 years indicates that a “credit shortfall has emerged, particularly in productive SME lending for growth and working capital,” which may explain the UK’s ongoing challenges with weak growth and productivity levels.

A report by Allica Bank revealed a “heavy shift” towards low-risk lending backed by property, resulting in a distorted business finance landscape.

According to Allica, bank lending to businesses has declined “well below historic trend” levels, with current SME lending down by £90 billion compared to levels seen between 1997 and 2004.

While the growth of non-bank financing has partially addressed the issue, there remains a “substantial SME credit gap of up to £65 billion,” as noted by Allica.

Moreover, there has been a drastic reduction in overdraft services available to small businesses, which fell from 31 percent of SME bank lending in 1998 to just 5 percent today.

Allica Bank, specializing in business banking, highlighted that current SME lending trends are increasingly focused on commercial loans secured against assets, primarily property. It pointed out that the UK economy has shifted toward the service sector, but many SMEs do not possess sufficient tangible collateral, making it challenging for them to secure loans for growth.

The report also identified that slim loan margins have caused banks to concentrate on “low-risk, highly secured” lending.

Consequently, long-term trends have led to an environment where SMEs are “discouraged from borrowing.” In a Bank of England 2024 SME survey, 77 percent of businesses indicated they would prefer slower growth rather than take on debt for more rapid expansion.

Allica Bank emphasized that there is a “clear gap in productive credit supply to SMEs, hindering investment, productivity, and economic growth.”

Richard Davies, CEO of Allica Bank, stated, “Record low numbers of SMEs are seeking finance. The UK stands out as an outlier, both compared to our own lending application rates in the 1980s and 1990s, as well as in comparison to other countries.”

He urged for a revamping of the UK’s SME finance market to fulfill the government’s growth objectives.

Davies noted that the market dynamics have been influenced by regulatory and accounting changes, coupled with business model transformations prompted by digital advances, leading to a persistent move towards collateral-backed loans, mainly in real estate.

He expressed concern that this shift, while beneficial to a mortgage-driven banking model, is fundamentally mismatched with the requirements of Britain’s modern, service-oriented SME sector, which generally lacks asset ownership.

“As a result, the uptake of ‘productive credit’ among SMEs for improving productivity remains alarmingly low. We must escape this long-standing cycle to harness the potential of established SMEs as a driving force for the upcoming wave of economic renewal,” he concluded.

Davies called for reforms to ensure that the Bank of England prioritizes SME finance, preventing regulatory barriers from hindering debt availability, especially for smaller banking institutions.