Banks pocket more profit from SME loans than mortgages

Banks pocket more profit from lending to SMEs than they do from residential mortgages, according to a report released this week.

The report comes despite claims from SMEs they consistently struggle to secure loans from the banks, with recent research showing half of small business are knocked back on loan applications.

Yet the latest report from research firm Digital Finance Analytics says the business of lending to SMEs is more lucrative for banks compared with the residential mortgage business, despite a higher risk and a lower volume of business.

Martin North, principal of Digital Finance Analytics, told SmartCompany interest rates on small business loans rose after the global financial crisis due to greater risk as more businesses failed in the face of economic hardship.

“The fact is that the interest rates that the banks charge on small business lending are higher than a mortgage,” says North.

“It’s also true that SMEs have less negotiating power,” he says. “They are less likely to switch banks. They are in a less advantaged position. So what tends to happen is if an SME finds a bank that’s prepared to do business with them, they tend to stick with them.”

North says banks also place extra demands on SMEs, such as providing accounts and other information on an ongoing basis.

“We’ve also seen an increase of compliance requests, so if you’re an SME, not only are you paying more, but you’re also spending extra time keeping the bank up to date,” says North.

“There is considerable discounting going on in the mortgage sector at the moment because lenders are desperate to get a share of the relatively benign growth of mortgage lending, whereas there is no discounting in the SME sector at all. So overall banks will be making more from the SMEs,” he says.

North says banks make it difficult for SMEs to secure lending because they are conscious of the higher risks involved, including higher write-offs and up to a 50% rate of failure of small businesses.

“Quite often, banks will only lend against security,” says North. “That could be the house of the business owner or the commercial premise or some sort of guarantee. But many SMEs don’t have security they can offer, and therefore in an unsecured environment, banks are less likely to go with them.”

North also says many SMEs go to banks with a cash flow problem, rather than to expand their business, which also presents a higher risk element to banks.

“Banks will lend to SMEs, but at a higher premium rate and they’ll be very selective,” he says.