Billions in lending, yet little growth – What’s holding UK SMEs back?

By Gloria Methri

Smaller businesses in the UK are increasingly turning to non-traditional lenders as they seek financial support in a challenging economic climate. While the UK’s big five banks have historically dominated business lending, a new trend has emerged—challenger and specialist banks are now taking centre stage.

Their growing market share highlights a shifting financial landscape, but despite increased access to funding, investment among smaller firms remains worryingly low. This reluctance to invest is a major factor behind the UK’s sluggish productivity growth compared to other G7 nations.

Recent findings from the Small Business Finance Markets 2024/25 report by the British Business Bank reveal that in 2024, £62.1 billion was lent to smaller businesses, with challenger and specialist banks providing £37.3 billion. Their share of gross lending has now reached 60%, up from 59% in 2023, marking the highest level on record. This shift suggests that alternative lenders are increasingly filling the gaps left by traditional banks, offering SMEs the capital they need.

However, the report also highlights a concerning trend—despite this influx of finance, many businesses remain hesitant to reinvest in growth, constrained by economic uncertainty and high borrowing costs.

Low Investment Hinders Productivity Growth

Despite the availability of finance, business investment among SMEs remains worryingly low. The proportion of smaller firms accessing finance declined from 50% in Q3 2023 to 43% in Q2 2024, indicating a persistent lack of business confidence despite modest economic growth.

The UK GDP grew by 0.9% in 2024 yet remains just 3.2% above pre-pandemic levels—the second-lowest among G7 nations. The report highlights that small businesses invested £12.3 billion, significantly lower than the £27.7 billion invested by larger firms, despite SMEs contributing 52% of the economy’s turnover.

A key factor behind this disparity is the high cost of credit and risk aversion. Many SMEs struggle with capital constraints, while lenders perceive them as riskier due to limited financial transparency, resulting in higher borrowing costs.

SMEs cite the high cost of credit as major barrier to investment. Among businesses that felt they had underinvested:

• 58% stated that credit was too expensive
• 55% reported an inability to borrow at a reasonable rate
• 77% preferred slower growth over taking on debt

Louis Taylor, CEO of the British Business Bank, emphasised the importance of business investment in driving economic growth, wages, and living standards. He noted that the rise of neobanks and asset finance was a positive sign but stressed the need for improved access to finance across all UK regions.

SMEs Shift Away from Short-Term Credit Options

Traditional forms of SME lending, such as credit cards and overdrafts, saw a decline in 2024:

• Credit card usage fell from 15% (Q1) to 13% (Q3)
• Overdraft usage declined from 14% (Q1) to 9% (Q3)

This indicates a gradual shift away from high-interest, short-term financing options, suggesting that SMEs are seeking more sustainable funding solutions.

Green Finance Gains Traction Among SMEs

Environmental sustainability is an increasing priority, with 53% of SMEs prioritising green initiatives in 2024, up from 50% in 2023 and 46% in 2022. While 88% of SMEs funded sustainability efforts using internal sources, more businesses are now considering external finance for green investments:

• 16% plan to use loans or finance agreements
• 21% aim to secure grants
• 9% intend to rely on credit cards or overdrafts

Equity Investment Reflects Pre-Pandemic Levels

The equity investment landscape in 2024 resembled pre-pandemic years, stabilising at 2019–2020 levels after the boom in 2021 (£20.3 billion) and 2022 (£17 billion). Deal volumes declined by 24% in the first three quarters of 2024 compared to the same period in 2023, yet total investment value rose by 7% year-on-year.

Encouragingly, venture capital exits doubled in value, reaching £10.4 billion in 2024 compared to £5.2 billion in 2023, indicating a potential rebound in investor confidence.

Ethnic Minority-Led Businesses Struggle with Finance Access

The report highlights ongoing disparities in access to finance for ethnic minority-led businesses. While entrepreneurs from Black, Asian, and Other Ethnic Minority backgrounds are more willing to use external finance (45%) than White business owners (31%), they face significant barriers:

• 43% of ethnic minority-led businesses report difficulties accessing finance
• 59% of Black entrepreneurs say securing finance is particularly challenging

These figures underscore the need for greater inclusivity and targeted financial support to ensure equitable access to growth capital.

The increasing focus on sustainability and signs of recovery in equity investment are promising. Still, greater financial inclusivity and more accessible lending frameworks will be crucial for fostering SME growth and strengthening the UK’s economic future.