Rising interest rates: SMEs need small business debt relief to grow

Britain’s small businesses are hobbled by debt and pressed by the challenges of recent years— as a result, they are failing at record numbers.

The Centre for Economics and Business Research expects business insolvencies, which averaged 4100 per quarter in 2019 and reached 6700 in the second quarter of 2023, to skyrocket to 7000 per quarter in 2024. 

Borrowing burden

Britain’s economy needs vibrant businesses to power its economy forward, but that will be a challenge with their current burden of debt. The facts are daunting.

When Margaret Thatcher became prime minister in 1979, business debt totalled only 25% of GDP, today it is triple that level at 77% of GDP, and one of the highest levels in the world. Succeeding in business is challenging in the best of circumstances, but it is never more challenging than when heavily indebted. 

Making payments on that debt was already problematic before 2022, but in 2023,  the Bank of England increased short-term interest rates from zero to 5.25%. This is one of the sharpest and most abrupt interest rate increases in British economic history. So not only is it costing British SMEs paying more to service their debts, they’ve also had almost no time to prepare or adapt. 

Bank of England not budging

Business borrowers should not expect relief from high rates anytime soon, with the Bank of England wedded to the belief that high interest rates are the necessary antidote to today’s high inflation. It has mattered little to policymakers that inflation is more tied to Brexit, the Ukraine War, and the lingering effects of the pandemic than monetary policy, and that high interest rates will do nothing to overcome the impact of those ills. Nor has it mattered to them that high interest rates make things more expensive and contribute to higher inflation. 

It’s not just that the debt of Britain’s businesses has skyrocketed—the debt of its households has too. Since 1970, Britain’s total private sector debt, the sum of its business and household debt, has also tripled as a percentage of GDP. The total is now 163%, up from 58% in 1970. So not only are British businesses saddled with too much debt, but their customers are as well, which impacts purchasing power. 

How can the government help?

To bring relief to its small businesses and vibrancy to its economy, British policymakers need to think of structural and innovative ways to help those businesses overcome high debt. 

One area of focus should be insolvency itself. If our aim is to help troubled businesses regain their financial footing, insolvency laws should be streamlined and modified with the objective of getting distressed small businesses through the process more quickly and in better financial health.

Policymakers should also consider a program of debt relief for small businesses, whereby, at those small businesses’ option, they could cede equity in their business to the lender in exchange for a reduction in their loan principal and monthly payments.

For small business loans where the enterprise or collateral value has fallen below the loan value, a lender could write down all or part of the difference, as long as they immediately restructured that debt to reduce principal and payments by the borrower by that same amount. To make it feasible for the lender, they would be allowed to recognise that loss over a span of several years.

In exchange, the borrower would give the lender a negotiated portion of the gain on the sale of the business or its key assets. The lender could take the loss in the current year for tax purposes, and the deferred accounting loss would not be counted against that lender in the calculation of capital and reserve adequacy until it is recognised.

Final thoughts

Though it has been ignored by policymakers, the bedrock truth regarding the British economy is that it is struggling under the heavy load of far too much private sector debt, and as a result its economy will be hard-pressed to return to true vibrancy.

Faced with an acceleration in business insolvencies, the time has come to face this issue.

Richard Vague - author of new book, The Paradox of Debt

Richard Vague is the author of new book The Paradox of Debt, he is an investor and entrepreneur. He has served as the Secretary of Banking and Securities for the Commonwealth of Pennsylvania and co-founded two US banks – First USA, which was sold to Bank One and Juniper, which was sold to Barclays.

The Paradox Of Debt