United Kingdom Interest Rates Discourage Small Businesses From Lending: Report

By Kekeletso Nkele, small.news Assistant

(small.news) — Stephen Dial, co-founder of Charles Grey Menswear, recently expanded his business to supply 90 retailers across the UK and Ireland in just over two years, according to The Times. But fueling that growth came at a cost.

Dial turned to online brokers and lenders, where he was charged interest rates of up to 50%, repaying £56,000 on a £38,000 loan. “It wore me thin,” he said, describing the strain of financing rapid expansion.

Eventually, he discovered the government-backed Business Enterprise Fund and secured a £75,000 loan at a “much more affordable” rate. Dial’s experience reflects a wider shift in the UK lending landscape.

A Changing Lending Market

Small business owners are increasingly turning to alternative providers—now estimated at more than 300 across the UK, including challenger banks and non-bank lenders.

According to the British Business Bank (BBB), these providers accounted for 60% of new SME lending in 2024, surpassing the UK’s big five banks for the fourth consecutive year. That marks a dramatic change from 2008, when around 90% of SME lending came from high street banks such as NatWest, Lloyds Banking Group, HSBC, Barclays, and Santander UK.

At the same time, loan approvals have tightened. Research in the 1990s suggested that high street banks rejected only 5–10% of SME loan applications. The BBB now reports that closer to 40% are turned down.

Data from UK Finance shows that although gross lending to SMEs has risen, net lending remained negative at minus £7 billion in 2024 — meaning repayments, many tied to pandemic-era support, are still outpacing new loans.

Meanwhile, NatWest reported annual profits of £7.7 billion, its strongest performance in years.

Why Banks Pulled Back

Banks reduced their exposure to SME lending after the 2008 financial crash, when small business loans were seen as higher risk and less capital-efficient. Post-crisis regulations required banks to hold more capital against potential SME loan losses, making this segment more expensive to serve.

Last year, Lloyds closed its invoice-factoring service for small firms, citing regulatory costs that made it uneconomical to continue.

“Capital requirement regulations penalise lending into the space,” said Justin Parr of Treyd, which has provided more than £200 million in funding to British businesses.

Instead, many banks now lend large sums to alternative lenders, who then distribute smaller loans to SMEs. While this spreads risk — with the alternative lender typically taking the first loss — it often results in higher interest rates for small businesses.

Lisa Jacobs, CEO of Funding Circle, said SME lending is “important for the economy,” but acknowledged that it represents only a small portion of major banks’ balance sheets and therefore may not receive the same strategic focus.

Speed Versus Cost

The main banks maintain that they are still committed to the sector. Lloyds has pledged to lend £35 billion this year, including £9.5 billion for SMEs, both higher than in 2025.

Borrowing directly from a high street bank remains relatively inexpensive, even accounting for increases in the Bank of England base rate. Loan margins are still lower than they were in 2016.

However, alternative lenders often offer what banks cannot: Speed. Funds can arrive within 24 hours, a lifeline for businesses managing short-term cash flow gaps.

But the lack of Financial Conduct Authority (FCA) regulation in business-to-business lending has, some say, created a “wild west” environment. A government review in December found that gaps in mainstream banking are steering some small businesses into high-cost loans, locking them into cycles of debt driven by steep interest rates and broker fees.

The Broader Economic Impact

The consequences extend beyond individual businesses. If borrowing costs remain high, SMEs may delay hiring, product upgrades, or expansion. The BBB reports that 58% of SMEs cite the high cost of credit as the primary reason for deferring investment.

None of this diminishes the importance of alternative lenders, which have become essential in helping businesses navigate short-term challenges. But Britain’s small business engine—more diversified and arguably more resilient than before — is now running on more expensive fuel.