Business Lending in the UK

 As the Bank of England continues to raise interest rates in order to bring inflation back down to their 2% target. I thought it would be a good idea to discuss the business lending market and if rising rates or inflation matter. 

Forecasting business lending growth rates is tricky business. There are no clear correlations between business lending growth and obvious variables such as GDP, Inflation, Unemployment, or last but not least interest rates. While they all play a factor, I have found that business lending is determined largely by business strategy. Business lending forecasting at best is an attempt to accumulate several microeconomic formulas which in turn result in often counterintuitive macroeconomic results. The reasons why I believe this is the case are the following. 

1. Fragmentation between SME and PNFC lending conditions

2. Shocks and solutions to supply chain disruptions vary across industries

3. Government support/intervention for SMEs is different to PNFCs

4. Firms do not always display profit maximising behaviour, they may try to increase market share, employee satisfaction (attracting best human capital), or longevity and this may change with respect to the size of the company and industry in which it operates

5. As firms have different numbers of years in operation or scale, newer industries and older industries have different debt profiles

The list can go on as to all the factors that influence different firms' balance sheets. Even now we can see the vastly different needs of the travel industry in contrast to the tech industry. We can see the amount of debt outstanding by industry. It is difficult to get even more granular data than the below as this is taken from the Bank of England, however we can see that the largest industry is 'real estate, renting, computing or other business service activities'. It does seem a random selection of industries to group together. However, the computing industry is in this mix and it would be interesting to see what percentage of this box can be attributed to it. The latest headlines mention the difficulty in the tech sector as companies with extremely high projected valuations were able to leverage this to raise capital (debt) to expand operations. The recent pressure and scrutiny placed by investors on tech companies that have underperformed in their yearly financial statements is starting to place question marks on the basis of these valuations and quality of debt. Furthermore, the Tech sector is one that is consistently seeing a reviews in best practices for accountancy as concepts such as 'stock/inventory', 'raw material' and 'works in progress' translate differently than the did in more traditional industries like manufacturing combined with fewer precedent and comparable firms that you would find in the traditional services sector.

Nonetheless, we are seeing cost cuts and more profit maximising strategies in the tech sector starting to emerge than we had seen previously. When we look at lending growth in the tech sector we may see companies want to cut costs, reduce debt and borrowing. However, for other industries such as the energy sector who is receiving a windfall tax and investment incentives borrowing is likely to increase as there is no spare capacity and increased consumption in the industry requires faster expansion of supply. Even looking back, when Brexit was announced, the need to increase stock of goods as border disruptions were expected led to various sectors taking out loans to cover the costs of stockpiling in anticipation of future disruption.

In the chart below, we can see how during lockdown lending growth differed greatly between different sectors, public administration and defence saw the largest growth but was also the sector that was experiencing the highest growth and was projected to increase in size post-Covid however this year borrowing in this sector has remained very limited. On the other hand in this year so far the sectors to see the most growth are transport, storage and communication companies for which we know there is a labour shortage that needs to be met due to what is expected to be consistently higher demand volumes in a post-Covid world. We also see that borrowing has increased for development of buildings as post-Covid society is rethinking use of space in what is expected to be a more long-term shift in how and the purpose with which shared spaces are designed. I would expect the electricity, gas and water supplying companies to have increased borrowing for 2022 however the weak figures do suggest there needs to be further research done into this industry. For example it may not be as simple for an expansion in energy supply to be provided regardless of finance being available or not. As pointed out in number two of my list explaining why lending growth rates might appear counterintuitive is due to shocks and solutions to supply chain disruptions varying significantly across industries.

In summary business lending in the UK is very much a fragmented task even more so now with the myriad of supply chain disruptions all impacting sectors in different ways. To further add to the visual understanding that interest rates do not directly influence business lending rates in an economy I include a chart below which shows lending growth rate alongside bank rate. While there is no clear correlation between the two, a rising base rate does feed into increased cost of borrowing at a relatively equal rate for all industries however what determines a firm's propensity to borrow is how much revenue they expect in return, when they expect to receive the revenue and from where the revenue will come all of which vary widely across sectors and industry.