At a glance
- High street banks are retreating from SME lending.
- Alternative finance providers are filling the gap.
- Algorithms, not relationships, now drive decisions.
- Strong cash flow is vital for new loan applications.
Britain’s high street banks have been quietly backing away from small business lending, leaving many thousands of firms to find finance elsewhere. According to the British Business Bank (BBB), the proportion of smaller businesses using finance fell to 43% in the second quarter of 2024, down from 50% a year earlier. That’s consistent with other figures pointing to a change in UK SME lending.
The impacts have been particularly acute for younger businesses, sole traders, and companies without property to offer as collateral – precisely the enterprises that once relied on high street banking.
In place of the high street banks has emerged something messier but potentially more responsive – a patchwork of fintech lenders, private credit funds, and other alternative finance providers willing to serve the businesses that banks have abandoned.
How did the previous stewards of British enterprise lending become so risk-averse? And what does this new financial landscape mean for the millions of small businesses that help to power the UK economy?
When banks stopped saying yes
Many causes may have helped shape today’s risk-averse SME lending environment: regulatory changes, economic uncertainty, COVID-19’s lasting impact.
The warning signs were there long before the pandemic. Data from Funding Options suggests that overdraft lending – once a business lending mainstay – slid 42% between 2011 and 2016, from £20.9bn to £12.1bn. One likely cause: banks now tend to avoid holding higher capital reserves against unsecured lending, a tendency encouraged by new global banking rules after the 2008-09 crisis.
COVID-19 accelerated the retreat. Yet even as government safety nets have been wound in – the Term Funding Scheme winds down in 2025 – economic volatility has kept banks cautious. The BBB notes that gross lending to SMEs by all banks in 2024 totalled £62.1bn. That was not only below the 2020 level, which was inflated by government-guaranteed loans, but also below 2022’s £65.1bn.
“Firms tell us every day that they are struggling to pay off debts, some dating from the pandemic…”
There are some signs that the bank retreat may be ending. UK financial-sector trade association UK Finance notes a “gradual recovery” in banks’ SME lending in recent quarters. Its first-quarter 2025 Business Finance Review, for instance, reported that main retail banks’ SME lending rose nearly 14% on the same period in 2024. This was its highest level since mid-2022.
So alternative finance has not vanquished the banks. But they have less territory now.
What this means for business owners
For a business owner, the banks’ retreat from SME finance creates two formidable hurdles.
First, for alternative finance providers, algorithms rather than relationships drive more lending decisions. Computer systems often reject businesses that don’t fit preset patterns. That contrasts with the previous high street model, where banks had more discretion.
In its 2022 report Credit Where Credit’s Due, the Federation of Small Businesses (FSB) attributed declining finance success rates to “application processes being too long and the inability to speak to anyone about the process itself”. And SME confidence in securing bank finance has fallen sharply. According to BDA BDRC’s SME Finance Monitor, in 2019 56% of SME applicants were confident of success. By Q4 2024, that figure dropped to just 32%.
Second, most finance on the market is simply not attractive, with limits down and interest rates up. In 2024, a British Chambers of Commerce (BCC) survey suggested that short-term interest rates were “negatively impacting” 39% of small and mid-sized firms. BCC policy director Alex Veitch recently reported: “Firms tell us every day that they are struggling to pay off debts, some dating from the pandemic, and finding it difficult to take out new loans.”
The widening gap between what businesses need and what traditional lenders will provide has forced many to look elsewhere.
Alternative finance: How challenger banks and fintech fill the void
Where high street banks have retreated, new players have seen expansion opportunities. Challenger banks provided 60% of all small business lending in 2024, the fourth consecutive year they’ve beaten the big five traditional banks.
Revenue-based financing, where repayments scale with sales, appeals to startups with fluctuating revenue or seasonal sales patterns. Invoice financing has boomed, with alternative lender Sonovate claiming 77% of users said it improved their cash flow management.
Private credit funds – investment vehicles that lend directly to businesses rather than through banks – have also moved into the SME space, particularly for mid-market companies. For many, this has proved a lifeline, with 70% of SMEs admitting that alternative finance has been crucial.
However, alternative paths to finance bring their own issues. Higher interest rates reflect lenders’ higher risk appetites. Shorter repayment terms can strain cash flow. And spotty regulatory oversight means fewer protections when things go wrong. For example, peer-to-peer investors have no Financial Services Compensation Scheme (FSCS) protection, and platforms historically have had inadequate wind-down plans in the event of collapse.
Readying businesses for alternative finance
So where does this leave small businesses and their advisers?
Alternative finance providers tend to centralise and automate lending decisions, strong financial fundamentals usually determine application success. Modern cash flow underwriting lets lenders assess creditworthiness from real-time banking data, making consistent cashflow vital.
Open banking means lenders can analyse financial behaviour instantly. Transparent management accounts and a robust business plan still matter. But a business with steady transactions may appeal to some alternative lenders more than one with immaculate paperwork but erratic cash flow.
Accountants must also build relationships with multiple lenders and understand which types suit different businesses. Too many choices can paralyse as much as help.
Ultimately, the rise of alternative finance papers over a deeper crack in the British economy. Business investment remains stubbornly low, a key reason UK productivity lags that of its G7 peers. Policymakers must ensure that access to capital does not become another barrier to innovation. And as the market diversifies, they must also guard against new risks, lest Britain’s most dynamic firms are left dangerously exposed.
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