The latest initiative in Cable’s crusade for UK SME lending looks to take the risk away from the high street banks and place it on the Government. This will be achieved by guaranteeing challenger banks’ loans to small businesses, that the high street banks don’t want to lend to, in order to stimulate the economy. The programme would enable smaller lenders to “expand their scale considerably” and compete with the country’s biggest banks.

The question is will it work?

There are some issues with the scheme that might make its success questionable. First, for this scheme to work we need to trust that high street banks are willing to pass along leads to the smaller challenger banks on a large enough scale to make a difference. Even when hard pressed, high street banks might fear losing more than just lending (e.g. current account, payments) to the challenger bank; there is a risk they might not comply. 

In addition, the scheme has a danger of adverse selection. It seems that the plan essentially creates the incentive for the challenger bank to loan to businesses they wouldn't loan to themselves, effectively bypassing their credit processes and putting a large chunk of risky debt on the government, and ultimately on the tax payer.

Not one, but two separate things need to happen for the policy to be effective. The scheme will only work if the high street banks and challenger banks are willing to cooperate and the pilot is not too affected by adverse selection.

Will we see a drastic change in the SME lending landscape? Hard to say, but it will certainly not be easy to achieve.

The scheme might create a subsidised source of lending but not one that is going to dramatically alter the industry as we know it. To do that, the government needs to focus on supporting the younger fintech lenders who have strong origination abilities and are able to reach SMEs in a much more innovative and effective way.