Allica Bank is calling on the Prudential Regulatory Authority (PRA) to make changes to proposed new bank capital rules to ensure small businesses have access to finance and to prevent damage to the UK’s SME challenger bank sector.

In November 2022, the PRA published a consultation paper outlining its proposed approach to implementing the final elements of the Basel international banking standards, known as Basel 3.1. The consultation contains proposals to materially increase the level of risk-weighting banks would need to apply to SME lending.

New research commissioned by Allica, a fintech SME challenger bank, suggests the PRA’s current proposals could put up to £44billion of SME lending ‘at risk’.

The analysis, conducted by economic and finance consultancy Oxera, also found that challenger banks using the so-called Standardised Approach would see an increase of over 30 per cent in the risk weighting assigned to loans made to SMEs.

Research published by the British Business Bank in February showed that challenger and specialist banks accounted for 55 per cent of gross lending to small firms in 2022. This record share compared to the traditional ‘Big 5’ banks demonstrated the important role challenger banks now play in providing finance to SMEs across the UK.

Suggested changes

Allica has provided its own detailed evidence to the PRA on the risk of different types of SME lending. It has also proposed changes to the PRA’s current proposals to achieve a more risk-sensitive capital regime without materially increasing the capital required.

Richard Davies, CEO, Allica

Richard Davies, CEO of Allica Bank, said that the PRA has been instrumental in helping establish a more diverse and competitive banking market.

“This transformational change in the UK banking market has helped to create a more robust, diverse and responsible SME finance market for Britain’s army of small business owners, the engine room of our economy,” said Davies.

“With a more risk-based approach to new capital rules, aligning the PRA’s proposals to the actual risks associated with lending, the regulator could avoid a really negative impact on the SME economy in the next two to three years. It’s really a golden opportunity to continue to cement the gains made in increased competition in the SME banking market while meeting the PRA’s prudential objectives.”

Supporting the new analysis

Both the Federation of Small Businesses (FSB) and the National Association of Commercial Finance Brokers (NACFB) have also called for the PRA to provide a more detailed assessment of how their proposals could impact the SME finance market and the real economy.

Martin McTague, national chair of the FSB, said that the PRA has an opportunity to pursue their secondary objectives in terms of supporting the UK’s economic growth and competitiveness. “We would welcome the PRA publishing empirical evidence and cost benefit analysis specific to SME lending, as it isn’t clear that the proposed changes are justified.”

While Paul Goodman, chair of the NACFB, said that “now is not the time to hinder smaller players and hold back their evolution. Market plurality and competition are central tenets of what has become a vibrant SME lending community.”

Allica’s suggestions
  • Remove the PRA’s proposed 100 per cent minimum risk weight floor for SME business loans secured on property. This would be substantially higher than international standards and would mean unsecured SME loans would have lower risk weights than secured loans, potentially incentivising banks to favour riskier lending.
  • Introduce a new risk weight for equipment and invoice finance lending to SMEs at 69 per cent, which is equal to the current average of the SME Support Factor and also the PRA’s own benchmark risk weight for SME lending in its Pillar 2A guidance
  • Put unsecured SME lending in line with the current proposals, applying 75 per cent risk weights for smaller loans and 85 per cent risk weights for larger loans to SMEs

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