“The only gig in town came with 60% interest, because we were considered subprime lending. It meant that every payment of £15,000 included £9,000 interest.”
When it comes to high-cost credit, most of us think of personal borrowing and payday loans. But the quote above comes from a business owner.
More than a decade after the Financial Conduct Authority (FCA) took over regulating consumer lending and introduced the cap on payday loans, there’s a new high-cost loan story unfolding. Up to one in four loan enquiries to Community Development Finance Institutions (CDFIs) now come from small businesses seeking to escape unsustainable high-cost loans. It rarely makes headlines, but it is leaving some firms fighting to survive.
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The 2008 financial crisis triggered an explosion in payday lending as households locked out of mainstream credit turned to quick cash. The impact was well covered in the media and public outrage led to FCA intervention.
Fast forward, and businesses are experiencing a parallel crisis. After five turbulent years marked by the pandemic, rising costs, political and economic instability, and late payments, the cost of doing business has soared. At the same time, recent research has highlighted a £65 billion gap in credit for SMEs and a rise in loan rejection rates over the last thirty years from 5-10% to around 40%. Banks’ lending practices have increasingly focused on tangible capital, which many small businesses typically lack.
In some cases, banks are seeking to support SMEs in other ways like this initiative from Lloyds Bank. However, slick online lenders are stepping into this gap. They offer quick decisions and immediate cash – which can be enticing. This type of finance has its place and can be useful, but growing evidence suggests that these practices are causing harm – to small businesses and the economy. Without intervention, the problem will continue to grow.
David Reynolds, quoted at the start of this article, is the Managing Director of Baillie Reynolds Maintenance. Launched in 2019 to serve social housing landlords through home improvements required by law, the business has grown from covering a 30-mile radius of Somerset, to stretching from Devon to Leicester. But Covid-19 hit them hard, and after exhausting all his own funds, David had to seek out external finance. Unfortunately, after his bank wasn’t able to help, the only option David was aware of was high-interest business loans. David was then caught in a cycle, needing to take on expensive short-term borrowing to manage his cashflow.
Small businesses are vital to the UK’s economy and growth. They create jobs, circulate wealth in local communities, and drive innovation. Responsible Finance has heard examples of small businesses – from sectors ranging from manufacturing to health and social care – approaching CDFIs to refinance high-cost, unserviceable loans. When taking out high-cost loans, these businesses often:
- Faced challenges accessing finance through traditional banks.
- Lacked awareness of alternative funding options or had insufficient capacity to shop around.
- Needed rapid access to cash to address urgent demands.
- In some cases, had limited financial expertise.
The appeal of these loans is clear; they are fast and perceived as easy to access. But CDFIs are seeing the following conduct:
- Unserviceable repayments: large unaffordable loans over short terms – typically one or two years – creating repayments that hamper cash flow.
- Excessive interest rates: sometimes exceeding 60% APR for a term loan, and instances of up to 300% APR.
- Loans being stacked on top of loans: there have been cases of businesses who have taken out 15 high-interest loans, each new loan being taken out to cover the unaffordable repayments on previous loans.
- Lack of transparency: unlike consumer lenders, business lenders aren’t required to clearly display the total cost of borrowing or accurate representative rates. These lenders often advertise attractive introductory rates – such as “from 1.5% per month” or “6.9% per annum” – that may not reflect the actual rates most borrowers receive.
- Aggressive marketing and customer acquisition: online lenders invest heavily in SEO, meaning they are often the first option visible to businesses in need – particularly those unable to access bank funding.
- Broker misaligned incentives: high-cost lenders may pay brokers excessive commissions to repeatedly refer businesses to them.
This has a negative impact on businesses, communities and the economy. Instead, businesses could benefit from coming to a CDFI first because:
- Transparency is central to CDFIs’ lending.
- Their relationship-based approach means speaking to their customers, and ensuring they understand the cost and terms of the loan and how that will impact their business’ finances.
- This also includes challenging the business – asking the question ‘is this loan right for you?’
- They will not lend if the loan will make the business worse off or not improve their trajectory.
- They signpost to other types of support such as specialist advice or grants.
Refinancing with CDFI SWIG has enabled Baillie Reynolds Maintenance to be on track to meet its business’ goals by 2026. With projected year-on-year growth of 25%, David’s new target is to achieve £10 million per annum by 2031. The company has also been able to expand, with five new jobs taking the total headcount up to 54. You can hear about their story in David’s own words on SWIG’s LinkedIn page.
“Overnight we were saving £80,000 to £90,000 of interest a year. We could put that onto the bottom line. Rather than being caught in a series of 12-month loans, we could finance over a sensible 5-year period. It allowed us to clear everything and get our cashflow back in sync. We were not living on a week-to-week basis, we could make investment plans…I wish I knew SWIG existed before.” David Reynolds, Baillie Reynolds Maintenance.
Unfortunately, CDFIs aren’t as widely known of as firms with much greater marketing budgets, so many businesses don’t have the same positive outcome as Baillie Reynolds Maintenance. CDFIs are not-for-profit institutions and can’t compete with well-financed online lenders. At the same time, some CDFIs’ funding restrictions mean they cannot make loans for refinancing.
But when a business burdened with high-cost unaffordable finance finds a CDFI and reaches out at the right time, sometimes they can help them to escape their cycle of unsustainable repayments by refinancing the one- or two-year loan over a longer term. Some other real-life examples include:
- A transport company which was repaying £26,257 per month to an online business lender was supported by a CDFI to refinance and reduce its payments by 86% to £3,728 per month, freeing up £22,529 per month of cash flow.
- A service business was repaying £8,000 per month to a high-cost lender. A CDFI reduced their payments by 81% to £1,500. This freed up cash flow giving the business the stability to manage costs and plan for growth with confidence.
- A manufacturing company which was paying £20,500 per month refinanced with a CDFI to bring its repayments down by 76% to £4,975 per month – a monthly saving of £15,525.
These savings help businesses return to a position where they can grow, employ new staff, invest in productivity gains or new product innovations, enabling them to contribute to economic growth.
But CDFIs cannot always help, such as when the business’s financial position has deteriorated too far. CDFIs have reported that in the worst cases, businesses approach them with their working capital completely depleted by high-cost loan repayments. At this point, the business can face closure. The ripple effect – on owners, families, employees and communities – is devastating.
This is a significant challenge, and one of the most effective solutions is ensuring businesses become aware of their options earlier. To support this, we recommend:
- The Government fully investigates the high-cost business loans market and considers targeted interventions around pricing transparency, affordability checks and awareness raising for business owners.
- The Government rapidly launches its consultation on the Bank Referral Scheme to enable more small businesses who are declined by their bank to connect with a CDFI.
- Banks consider partnering directly with Responsible Finance to support CDFIs to scale and invest in technology to better compete with online lenders and ensure their declined customers are referred directly to CDFIs.
We also encourage industry bodies to implement standards on affordability, transparency and financial promotions to ensure better outcomes for small businesses.
The warning signs are here, and it is vital that action is taken to stop this becoming a greater drag on communities and the economy’s growth.