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The Real Reason Banks Deny Loans to Small-Business Owners

15 June 2017
Written by Jason

Banks, ironically, often struggle with notion of ‘business lending’. Most banks won't lend to a business unless it has a perfect credit record. We explore the real reason banks don't like lending to small businesses and why the answer often lies in seeking an alternative: unsecured business loans.

The Problems Already Facing Business

There are a number of reasons why small businesses struggle to get their enterprises off the ground and then go on to grow them, and while the issue of finance might be their number one priority, it isn't the only issue they face:

Operating costs: Energy prices have increased by 43% since 2010 which has proven very damaging for the UK's small business sector. While energy costs remain high, business rates have also been on the increase and with it the continued stagnant drift on the UK's high street has continued. It means that many business are now paying more in business rates than they are in Corporation Tax, which is also set to rise over the next five years, placing them at even more disadvantage from both online competition and retailers from abroad.

Wages: There is a very real danger that many small businesses are still struggling to cope with the implementation of the National Living Wage which was introduced in April 2016. It has almost certainly contributed to a large number of enterprises either scaling back expansion or closing up shop for good. A by-product of increased wages is reduced overtime, fewer bonuses, decreased productivity and increased costs to customers, which mitigate a business's ability to expand and grow in their market.

Brexit: The continuing uncertainty of Brexit remains a looming shadow, especially for the UK's import and export community but also for any business trading under the fluctuating economic conditions that this uncertainty brings with it.

Property: The value of the UK's commercial property is rising at a rate that precludes many small businesses from buying and forcing them to rent. Purchasing is viewed as an unjustifiable option.

What these problems create for small businesses is a reluctance to both borrow further and expand their operations, fearing a big downward spike in their cash flow and damaging the day to day running of their businesses. Higher wages and operating costs (business rates and tax hikes) are high on the reasons for businesses failure to expand as rapidly as they want to and uncertainty in the economic conditions have impacted both raw material purchase and the ability to buy assets like property.

Small Business Credit Scores Aren't High Enough

Financial reasons, i.e., the ability to generate finance when a business needs it, is perhaps the biggest reason of all. However before a business can even consider the notion of obtaining credit, it needs to understand the fundamental way in which traditional lenders, like banks, view their applications for finance.

Understanding how credit scores are calculated, what they mean and their importance in matters related to gaining business loans are among the chief reasons small businesses either don't apply for small business loans or are knocked back when they do.

Either having a bad credit history or having an insufficient credit rating, perhaps being new start-up or a business with limited trading history, can be enormously detrimental in terms of small business loan applications.

Traditional lenders have also been very slow to react to how they view small businesses and their financial needs. Their credit scoring has been stoic and set in stone since the economic crash almost a decade ago which makes their lending criteria very conservative in its outlook.

One of their biggest fundamental decisions is requiring security. Nearly all high street banks demand security (on their funding) provided by the borrower. Yet the biggest source of funding in the alternative lending industry comes from unsecured business loans.  

It is a fact that both personal credit and business credit scores are essential for a business to secure and exercise their option for external finance, but the high street banks aren't quick to change their practices. While alternative lenders are quick to seek positive reasons for extending their funding arms, banks highlight only the negative.

How The Banks Assess Your Credit Score

Credit scoring is used by creditors to determine how much of a risk lending to you really is. Every time you apply for credit, your application forms an impression of both you and your business capabilities. Add into the mix your history of applying for and repaying credit and you get a business credit score.

If your score is below the lender's threshold then your application gets rejected.

Lenders can use different ways of working out your score and go to different lenders to get it too. Your lender won't be able to tell you what your score is but they can tell you which credit reference agency they have used - which is handy if you want to check that the information they are using is correct or not.

The three credit agencies that the banks use are:

  • Equifax
  • Experian
  • CallCredit


What this means is that even if one lender decides to refuse you, another, using the same information, might actually accept your application for credit.

The information held on your credit file will contain the following:

Account information - How you manage your existing accounts including your bank account and other credit account payments.

Public records - These include any county court judgements, bankruptcies or debt relief orders.

Electoral roll - Verification of who you are and where you've lived.

Mortgage - Any information held by the Council of Mortgage Lenders about your home and business mortgage payments and defaults.

Financial associations - Shows anyone you have a financial association with or you are connected to whether it is a joint account or any jointly held credit and business accounts.

Credit searches - Highlights any companies or organisations that have accessed or looked at the information on your file within the last twelve months.

Information on your credit file is usually kept for up to six years, longer if you have court judgments against your name. For any other information still on your file, you can look to get it removed.

What Business Owners Need To Know About Their Credit Score

When a business is rejected by the banks, it is imperative that they understand the reasons for it. The banks don't have to offer an explanation for their rejection so it is up to the business owner to understand what potential credit issues might be standing in the way of a successful application.

If a business owner understands how their credit rating is built up and, more importantly, is able to take steps to ensure that, over time, it is improved, then they will find their ability to experience successful credit applications are significantly improved.

The Five Biggest Reasons Why Your Small Business Loan Was Rejected

It's no secret that the banks are not very easy to sway if you have anything on your credit file that indicates a less than perfect lending proposition and these are usually highlighted in these five most common reasons for a credit application to be rejected:

1. Your Business Credit Score: Having a low business score ensures that the banks have a pretty good reason to say no. It might be because of previous payment issues, high levels of debt, multiple credit applications or that your company performance just isn't strong enough to warrant the risk of lending to you.

2. New Business: Every new business has the same problem: being able to establish that they are not a high risk to the lender. Having little or no credit history at all can mean that your personal credit will be looked over in more detail and as with most applications based on personal credit, they will either require high levels of asset security or will reject you outright.

3. Poor Personal Credit: Your personal credit rating is very important if you are applying for credit for your business. Even if your business is new, or you are applying for a small business loan you may well find yourself being asked for a personal guarantee to back it up. Either way, your personal financial situation is an important criteria for accessing small business credit.  

4. Bad Credit History: It certainly isn't unusual for small businesses to have experienced times of bad credit and inability to make payments. This is especially true when considering the shrinking of many supplier credit accounts when the economic recession hit and these supplier accounts have never really rebounded to the same levels since.

5. High Risk Industry: Some sectors are considered to be riskier than others and the banks are inherently risk-averse organisations. If they view your industry sector as not being stable, and this can change for any given bank, your finance application isn't going to get through - regardless of how good your financial projections are or how sound your trading history.

The reasons for the banks to reject a considerable amount of loan applications, can usually be reduced down to a combination of credit scoring and security. If you have security, then credit is available. Without it and you will struggle to convince any traditional lender.

Being able to negotiate with a lender that doesn't take such a black and white view of your business assets and credit history is the number one reason why the banking industry has been forced to adopt the 'bank referral scheme'; essentially forcing them to realise that the alternative lending industry’s unsecured business loan products are a much better fit than those offered by the high street banks themselves.

Originally published Jun 15, 2017 8:23:21 AM, updated June 15 2017
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