Small and medium-sized enterprises (SMEs) comprise over 99% of the UK economy, according to government statistics from 2023. These firms – having fewer than 250 employees – make up the backbone of our economy, but most will need access to external funding from banks. Not all of them are getting it, and it’s not always for the reasons you’d expect.

“A non-negligible proportion of SMEs in need of external finance, albeit credit-worthy, voluntarily choose not to apply for any because of fear of rejection,” says Dr Weixi Liu. “Those SMEs are termed ‘discouraged borrowers’.”

Weixi, a member of the Centre for Research on Entrepreneurship and Innovation, focuses on the impacts of ‘credit rationing’ – when SMEs are denied the financing they have applied for – and the knock-on effects this has.

Some of his recent work examined data from a longitudinal survey of UK small businesses, spanning a five-year period. He and fellow researchers looked at the types of finance sought by firms, whether they were approved and whether they went on to apply for further credit.

They found that smaller firms were more likely to face credit rationing and that an average of 4.1% of SMEs simply stopped applying for finance altogether, often following a denied application.

In total, this meant an average of 230,000 UK SMEs withdrawing from credit markets per year, impeding their growth and ability to create new jobs. What’s more, the effect was more pronounced in regional areas of the UK, such as the East Midlands and the North East.

However, the Covid-19 pandemic had an unexpected impact. SMEs with ethnic minority owners have historically tended to be more reluctant to apply for traditional lines of credit – potentially due to concerns around perceived discrimination in finance markets – and in times of crisis, banks usually increase their lending standards and approve fewer loan applications. But Weixi’s research has shown that this wasn’t the case, particularly in the wake of the three loan guarantee schemes implemented by the UK Government during the early stages of lockdown in spring 2020.

The researchers examined data around bank loan applications and approvals in the run-up to and during the pandemic. Their conclusions were that in the absence of access to their preferred, more informal sources of credit, loan applications from minority ethnic-owned SMEs did surge more sharply than other SMEs – but that approval rates were the same as or higher than those for other SMEs. This suggests that racial discrimination plays less of a role than might have been assumed.

Weixi explains: “With generous government guarantees that de-risk bank lending, and as more UK commercial banks adopt transactional lending technologies such as automated credit scoring systems, there is clear evidence of narrowing ‘funding gaps’ for traditionally disadvantaged small business owners.”

Still, this doesn’t mean access to finance is entirely equal. Further research from Weixi and his fellow academics has gone on to explore whether gender stereotypes may also play a role, comparing entrepreneurs’ confidence levels with the credit rationing they faced from banks.

At moderate confidence levels, women’s loan applications were more likely to be approved than men's. However, female entrepreneurs were punished far more harshly for overconfidence than male counterparts – an effect the researchers attributed to lenders seeing egotism as a deviation from their expected gendered attributes.

“Although it remains unanswered whether this increase of credit supply reflects a longer-term alleviation of financial constraints, we suggest that banks should continue to engage with asset-poor SMEs to consolidate this improved situation,” says Weixi.

“On the other hand, banks could engage more with the business and seek to understand its true potential, and explore alternative lending technologies or communication styles to increase financial inclusiveness in lending decision-making.”