A debt holiday could make all the difference for small business

With streets in lockdown and markets in turmoil, we are told the answer for small businesses is new loans; debt to tide them over. But the opposite is true. What is needed is a year off debt — a moment of escape from onerous interest rates and overhanging debts.

The Coronavirus Business Interruption Loan Scheme (CBILS) is the UK response to the risk of mass business failure in the context of the pandemic. The initiative covers lending of up to £5m in value, with the first 12 months interest free. CBILS has been adapted, extended but is still criticised for being opaque, slow and run in the interests of the banks. One in five small businesses are reported as likely to close within a month. So far, only 16,000 loans have been agreed – a paltry 0.3 per cent of the 5.9 million small- and medium-sized enterprises in the country.

The scheme can be accelerated. Bank of England Governor Andrew Bailey has suggested that the state provides a 100% guarantee for the smallest firms, simplifying the process for the largest number of applicants. These are the businesses that tend to be started with personal savings or credit cards and have no assets or even future revenue streams to offer up as security. In uncertain times, cash is king, so it is natural for businesses short of money to turn to banks for credit to tide them over challenges of liquidity and volatility.

But what about the burden of the existing £167bn of loans to UK business? Raising the financial gearing of already indebted enterprises gives them no freedom to be entrepreneurial. Instead they are tied into a prison sentence of future repayments. 

One remedy may be switching focus to cutting the burden of existing debt, through an old-fashioned banking remedy, forbearance; a debt payment holiday.

What is needed is a year off debt — a moment of escape from onerous interest rates and overhanging debts.

There is a lesson to be learned here from the mortgage ​‘crisis’ in the recession of the early 1990s. Rising interest rates and soaring unemployment ensnared millions of people in a liquidity trap, where they were at risk of losing their homes. As unemployment climbed towards 3 million, with interest rates doubling to 15%, the property bubble burst and the result was widespread arrears. Those more than six months behind on repayments rose from 43,000 in 1988 to more than 200,000 by 1992. Repossessions soared on the back of this, jumping from a level of around 16,000 in 1989 to over 75,000 in 1991.

The challenge was exacerbated by negative equity, where the loan outstanding on a property was greater than its market value. The fall in house prices made it impossible for people to trade out of their circumstances by moving down-market into smaller homes or rental properties. In the end, the economy turned, but what helped to make the difference was an industry-wide and government backed programme to avoid repossessions and keep householders in their homes.

The same set challenges face us when we emerge from a lockdown. This time it is foreclosing businesses rather than repossessing houses. If the demand for credit increases at the same time as the risks, then the results are likely to be the bank door closing or remaining open at what could be prohibitive rates. The results will be mass closures. Despite proposed changes around insolvency, businesses don’t have the right to go into negative equity like homeowners. Small firms may look to borrow at a personal level to keep the business alive. In this case home repossessions, if listed as collateral, may come back onto the table in a more serious way.

On current trajectories, the financial services sector will be the transmission mechanism for failure across the business population, particularly those small businesses that tend to be employment-rich and embedded in their local economies. Government action can help to reflate the economy, but that won’t prevent the UK’s dominant shareholder-owned banks from charging more for credit and closing down small businesses that could be viable in time. 

These businesses are proving to be the bedrock of resilience at a time of shock and will be needed again for uncertain economic times ahead

One solution is to require appropriate ​‘forbearance’ by the banks. This means holding back by not enforcing all of the contractual rights of the lender, on the grounds that both parties will benefit if the borrower has more favourable treatment with time and opportunity to recover. It is not about forgiving debts, but about action to make the repayment of debt more likely in time. This could include extending the loan term, reducing the interest rate, offering a payments holiday, capitalising arrears or allowing the borrower to access new and additional finance.

But just because this is an option, doesn’t mean that UK banks will promote it. They have done the opposite for years when it comes to alternatives to expensive overdraft financing for small business. So, there is a need for a policy or regulatory intervention that operates across the banking sector to make forbearance a more viable option. One way to achieve this is giving small businesses a ​‘debt-free year’ with the promise of zero loan payments.

Alongside this, it would also be possible to make foreclosure more difficult through codes and guides, which is what happened in the mortgage crisis of the early 1990s. Within the remit of UK Finance, there could be a ​‘Foreclosure Code’, tightening up on the processes around decisions that would prompt business closures – in the same way that any bank branch closures are now subject to clear and more transparent steps.

The more radical ways to achieve the same outcome would be to explore the principles that could underpin not just payment forbearance but debt forgiveness. The Jubilee Debt Campaign calls for cancelling the stock of debt and not just the burden of interest. We need more human and ecological principles, such as debt reduction in sunrise sectors like renewable energy and green jobs, and in the more local and regional businesses — co-ops, employee-owned and local firms, social enterprises. These businesses are proving to be the bedrock of resilience at a time of shock and will be needed again for uncertain economic times ahead.

The number of UK companies entering administration had risen to a five-year high even before the lockdown started. Let’s not wait to see how high it will go or who is still standing. A year off debt could make all the difference.

Ed Mayo is a Fellow of the New Economics Foundation. Currently Secretary General of Co-operatives UK, Ed moves in June to become Chief Executive of the social enterprise Pilotlight.

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