SME debt has ballooned during the pandemic – Bank of England figures suggest the stock of bank lending to companies with turnover below £25m has jumped from £160bn in early 2020 to more than £200bn today. For many SMEs, this is an unwelcome position – they are not normally borrowers and avoid debt wherever possible.

Mike Conroy, director of commercial finance at the banking industry body UK Finance, says that around 70% of the 1.4m Bounce Back Loans approved by his organisation’s members to date went to small companies that had no other debt with that lender. This chimes with the SME Finance Monitor’s finding that the UK’s SMEs have historically included a large rump of ‘permanent non-borrowers’ – companies that do not use debt and, until Covid, had no wish to.

“A lot of them will be facing debt management for the first time,” says Conroy, adding that the latest default estimates for the Bounce Back Loan Scheme, including those by the Bank of England and the Office for Budget Responsibility, range from 15% to 80%, depending on the UK’s economic performance.

Paul Thwaite, chief executive of commercial banking at NatWest, told the Treasury Select Committee in mid-December 2020 that around half of the money his bank had lent under the Bounce Back Loans Scheme remained in borrowers’ bank accounts. But he added that there were signs businesses in the worst-hit sectors such as hospitality and accommodation were starting to spend it.

Even so, it is clear many businesses took out the loans as a precaution – knowing they would pay nothing for a year – and have not so far had to spend the money. A lot of future borrowing demand among the smallest businesses, therefore, has already been met at the exceptionally low interest rate of 2.5%. Even though the Bounce Back Loan Scheme has been extended to March 31 this year, the growth rate of total lending has slowed markedly since the summer and remains far below its level in the early part of the crisis.

Other companies, particularly larger SMEs taking out loans under the Coronavirus Business Interruption Loan Scheme (CBILS), used the cheap government funding to replace existing borrowing that carried commercial rates, David Oldfield, chief executive of Lloyds Commercial Banking, told the select committee: “I think the great majority of that is replacing what would have been business-as-usual lending this year.”

The crucial question, therefore, is whether to try to keep these companies in ‘suspended animation’ until economic conditions start to return to normal, in the hope that they will be able to recover and return to profitable trading.

On the face of it, there are reasons to try. Deprived of opportunities to spend money during the pandemic, many better-off consumers have instead increased their savings. Interviewed in the Daily Mail in December, Andy Haldane, the Bank of England’s chief economist, pointed out that the household savings rate had rocketed during the early months of the pandemic, leading to “around £100bn of excess savings”.

Once opportunities to spend this money return, demand in the hardest-hit sectors could rebound rapidly. “You are not going to go to the pub twice as much when they’re open again, but there will be some catch-up in social spending,” Haldane said. “There is plenty of scope there for the vaccine to release more of that pent-up demand.”

But the Bank of England’s biannual survey found that “only 10% of households that had increased their savings (less than 3% of the whole sample) planned to spend the money they had saved”. In a post from November, the Bank Overground blog adds: “About 70% said they planned to continue to hold the savings in their bank accounts. Others planned to use their savings to pay off debts, invest or top up their pensions.”

“Certain sectors of the economy are now permanently suppressed relative to where they were,” he argues. “And the flip side of the demand-supply equation is where do people spend their money if they’re not spending it over there? So if the government wants to avoid growing unemployment, it needs to ensure it has solid funding lines into growth companies that are positively impacted by the virus.”

The government has signalled that it will continue to support SME lending. A new state-backed loan scheme is in the works, mirroring many elements of the pre-crisis Enterprise Finance Guarantee. It is likely to give banks an 80% government guarantee on new loans to viable companies that have tried and failed to borrow on commercial terms. It may allow banks to take personal guarantees from borrowers on top of the state guarantee.

Its impact would be less distorting than the emergency loan programmes because these state-backed loans would be more expensive than standard commercial debt, reflecting the premium, of perhaps 2% to 3% over Libor, that banks would have to pay the government to access the 80% guarantee. The new scheme is likely to be essential if lending to viable companies in the worst-hit sectors is to continue, says Jenny Clayton, financial services partner at EY.

Given the changed economic landscape, banks are likely to do more manual underwriting of loan applications to ensure credit risks are fully assessed. “When the coronavirus loan support schemes as they currently stand come to an end, it will be important that there is capability within the market to tailor financial help for different sectors and individual businesses to ensure that the support for viable companies is available as they look to the future,” Clayton adds.

There may be implications for bank lending to microbusinesses because the automated credit assessment models widely used for this segment are calibrated on “normal” economic conditions. Greater use of manual underwriting might be required, or having access to more in-depth or real-time data to obtain a more accurate view of a business’s performance and ability to pay, says Conroy. “That’s where I would anticipate a greater challenge,” he adds.

As a result, lenders will have to be much more careful in deciding whether to agree unsecured loans to small businesses and will have to establish whether their VAT and payroll taxes are up to date. This is likely to increase demands from lenders for direct access to borrowers’ accounting software packages via application programming interfaces. That would let them monitor the borrower’s financial position in real time. A widespread shift towards this way of operating would deliver a big boost for “open finance”, in which IT systems exchange data automatically, once permission has been given.

If open finance does move into the mainstream, banks will require software tools to enable them to monitor thousands of borrowers’ management accounts automatically and flag developing problems. “You’ll need middleware doing that for you,” says Law. “With the HMRC adjustments and the more precarious nature of business, I think 2021 is probably the year it really takes off.”

For companies serving that corner of the market, at least, perhaps there is light at the end of the tunnel.