SMEs at risk from bank de-risking, says FCA

Start-ups and small firms more likely to be de-risked than larger companies in the same sectors, finds wide-ranging report

Overt caution from banks striving to comply with financial-crime regulations is damaging access to finance for UK start-ups and SMEs, according to a new report from the Financial Conduct Authority (FCA).

Compiled by consultants John Howell & Co, the report – Drivers & Impacts of Derisking – explores the impact that measures in the anti-money-laundering (AML) and combating the finance of terrorism fields have had upon the lending environment.

It finds that SMEs in the defence and fintech sectors have been particularly affected by either service denials, or service withdrawals, amid heightened concerns over illicit use of the UK financial system.

“SMEs are more likely to be de-risked in many cases than larger firms in the same sectors,” it says. “This may arise from either a revenue requirement for customers in certain sectors… or use of size as a proxy for compliance effectiveness.”

In terms of how this has affected defence SMEs, the report notes that the sector is in a “difficult position”, with financing for legitimate needs and contractors often overshadowed by controversies over controversial contracts and countries – creating a climate in which banks “fear to be conspicuous”.

The report explains: “A recent survey carried out for the industry found that banks appear unwilling to provide banking services, including letters of credit, to defence-sector SMEs, particularly those involved in munitions. In the past, this had caused some SMEs to relocate overseas.

“Further, some cases of account closure were attributed to de-risking. Dialogue between the industry and the British Bankers’ Association is now said to be improving access, and the situation is being kept under review by the defence industry via one of its leading associations.”

On the fintech side, the report points out that – like all payment systems – novel and innovative solutions are “a potential vector for illegal activity, and thus liable to trigger de-risking decisions”.

It stresses that industry group the electronic money association (EMA) – which represents 44 fintech companies with a total of 85 million customers – has made several submissions to the FCA, indicating that its members have seen a decline in ease of access to accounts, partly attributed to de-risking.

The report says: “EMA has suggested that, while electronic money institutions and/or payment institutions may be viewed as particularly risky clients by banks, refusals are often by letter with no explanation or remedial action being offered, reducing the scope for discussion.”

Those problems, the report adds, are compounded by two attendant issues:

• SMEs underreport incidence “Because of the perceived and actual damage done to businesses by the news that they have lost or been refused an account – or will soon – businesses are reluctant to speak out.”
• SMEs underreport costs “Few of those reporting problems had considered the time involved resolving [them] as a cost, or considered the opportunity value of the distraction… They were mostly concerned about the emotional impact of the hard and unjustified way, in their eyes, that they were treated and the uncertainty of continuing in business.”

John Howell & Co acknowledged: “We have found enormous frustration at the actions of banks, even among those customers fully supportive of the risk-based approach to financial crime.”

Despite that, though, the FCA has concluded that there is no ‘silver bullet’ for mitigating the problem. Instead, it has issued a series of recommendations, calling for improvements in…

1. How firms identify money-laundering risk Through coordinated efforts with the government and the Joint Money Laundering Intelligence Taskforce, the FCA will reduce barriers to information sharing and urge banks to focus on customers who genuinely present the highest risk.
2. Effectiveness of AML supervision The FCA will continue to work with the government and other AML supervisors to explore how supervision procedures could be made more consistent.
3. How banks communicate with their customers In roundtable talks with lenders, the FCA will encourage them to brush up their customer relations for times when they exit or reject banking relationships, and see what more could be done to help customers in those situations.

Find the full report here.