A goldmine for enterprising criminals. Even legitimate borrowers face sky-high default rates. Taxpayers to eat the losses.
By Nick Corbishley, for WOLF STREET:
Demand continues to surge for the UK’s Bounce Back Loan (BBL) program, which provides cheap emergency lending to small and medium-sized businesses. On Wednesday, HSBC announced it was having so much difficulty processing the deluge of new applications that it has decided to halt pandemic lending to new business customers.
The BBL program was first launched in May. Since then, £38 billion has been lent to 1.26 million businesses — in a country of roughly 5 million businesses. SMEs are able to borrow up to 25% of their revenues to a maximum of £50,000 under the program. The loans, interest-free for 12 months, are administrated by private-sector banks, but are 100% backed by the government.
Besides the Bounce Back Loans, banks have also lent £15.5 billion to 66,600 mid-sized businesses (with revenues up to £45 million) through the Coronavirus Business Interruption Loan Scheme (CBILS), and £3.5 billion to 566 large businesses (with revenues over £45 million) through the Coronavirus Large Business Interruption Loan Scheme (CLBILS). Both loan programs are 80% guaranteed by the State.
In total, £58 billion has so far been disbursed across the full gamut of the UK’s coronavirus emergency lending programs — the equivalent of 2.6% of GDP. That’s relatively low compared to some countries. In France, for instance, companies have received €106 billion — the equivalent of roughly 4% of GDP. In Spain, the state-owned bank ICO has guaranteed over €100 billion in business loans — almost equivalent to 10% of GDP.
Before the BBL program was launched, very little emergency lending was actually reaching small UK businesses, partly due to voluminous red tape but also because 80% of each loan was guaranteed by the state, meaning that banks had to assume 20% of the risk of non-payment on loans that they knew had extremely high risk of non payment. Hence the decision by the government to provide 100% backing for the Bounce Back Loans.
The loans are also self-certified, making them quick and easy to process. Because banks are not liable for any unpaid debts, they are quite happy to release the funds with little in the way of background checks. This has created a goldmine for enterprising criminals.
The UK government was repeatedly warned about the risk of fraud before launching the program, it was revealed this week. In early May, just two days before the program was launched, the chief executive of the state-owned British Business Bank, Keith Morgan, warned that the program was at “very high risk of fraud” from “organised crime.” The bank, he said in a letter to Business Secretary Alok Sharma, could not guarantee “robust controls”:
“The scheme is vulnerable to abuse by individuals and by participants in organised crime. Alongside the fraud risk, there will be considerable credit risk in the current economic environment, which will be exacerbated by removing significant elements of the credit checks that would otherwise have been undertaken.”
Fake businesses have been set up to access the cash, the National Crime Agency (NCA) said on Friday. Here’s how it works: Gangs get hold of a victim’s personal details using phishing emails or by purchasing them online. They then set up a fake company in his or her name. After opening a business bank account, they apply for a Bounce Back Loan through the same bank. Although the rules state that firms set up after March 1, 2020 are ineligible for the program, applications have been successful for companies created as late as June, reports the BBC.
There’s also the growing risk that many of the loans will end up in default. According to the Chancellor of the Exchequer, Rishi Sunak, taxpayers could face losses of up to £23 billion in bad loans across the state coronavirus emergency bailout schemes. That’s the equivalent of 40% of all the money lent out.
That could prove to be on the low side. In June, a report from the Recapitalisation Group, a task force assembled by The CityUK, one of the UK’s most powerful financial lobby groups, and EY forecast that up to £36 billion worth of government-backed business loans — 62% of the current total — could become toxic by March of next year.
One of the problems is that many of the small businesses that have taken out emergency loans in the wake of the lockdown have no history or experience of borrowing or repaying debt. Lenders estimate that up to 70% of BBL borrowers have never borrowed before, equating to over 700,000 small- and medium-sized enterprises (SMEs), according to The Financial Conduct Authority (FCA).
These companies have taken on large volumes of debt for the first time ever, merely to weather the virus crisis while, in many cases, generating a lot less in revenues. Many of them, particularly those in the sectors most affected by the crisis, now have much weaker cash flow — hence the need for the debt.
Emergency business loan borrowers do not have to begin paying back the loan in the first year of its duration. It’s when the first year is over, which in many cases will be in June or July next year, when the real pressures will come to bear.
“Month 13 is going to be an interesting moment,” says Metro Bank PLC CEO Dan Frumkin. “It is the moment when people need to start paying back the [Bounce Back Loan Scheme loans], and we fully expect there will be a significant amount of defaults.”
In the UK, forbearance is scheduled to end at the end of this month, as, too, is the government’s job retention program. The ending of these two programs at exactly the same time is likely to heap a whole lot of extra pressure on struggling businesses and their owners. Old debts, including mortgages, will once again come due, at the same time that companies will have to start paying their staff’s full wages, for the first time in seven months. More than a third say they plan to lay off staff over the next three months, according to a YouGov survey.
Attention is now turning to how to deal with the fallout, including the anticipated surge in non-performing loans. It’s a problem all European countries will soon have to face, especially those where emergency lending to distressed businesses has been provided on a much larger scale than in the UK.
UK Finance, a lobby group representing UK-based banks, is weighing up creating a debt collection entity to be used by all British banks faced with recovering unpaid coronavirus loans. The European Commission is looking at ways to securitize bad loans at the EU level and offload them to global investors, as was recently done, with a certain degree of success, in crisis-hit Italy.
Other policy suggestions include a straight “state debt for equity” swap; forgiving all coronavirus small business debt (and probably later all coronavirus business debt), as recently proposed by former UK Chancellor George Osborne; and lastly, converting coronavirus debt that can’t be paid back into an income contingent loan collected as a share of trading profits. The debt would come due only when a company begins turning a profit. All of these proposals have one thing in common: the government, whose debt is already soaring, will essentially foot the bill. By Nick Corbishley, for WOLF STREET.
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