The government’s recent meeting with senior executives from HSBC, NatWest, and Lloyds confirmed what many in industry and policy circles already know: the UK’s SME finance market remains dysfunctional.
Loan approval rates have dropped significantly since the pandemic, business owners continue to report unresponsive lenders and rigid terms, and challenger banks—those best placed to serve smaller firms — are increasingly constrained by regulatory capital requirements.
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The Minimum Requirement for Own Funds and Eligible Liabilities (MREL), introduced in the UK in 2016 in line with post-2008 global reforms, is a central part of this picture. Designed to ensure that banks can be wound down safely and without public cost, MREL requires institutions to hold substantial volumes of loss-absorbing capital. However, under the UK’s implementation, any bank crossing the £15 billion asset threshold faces a sharp and immediate increase in its capital obligations, regardless of its actual systemic risk.
The effects are clear: challenger banks are discouraged from growing beyond the threshold, limiting the pool of institutions actively competing to serve small firms. While high-level policy discussions have focused on adjusting the MREL framework—either by lifting the threshold, expanding eligible instruments, or extending the glide path—there has been little discussion of a complementary role for the British Business Bank (BBB). This is a missed opportunity.
Paragon Bank, a mid-tier lender, has highlighted the disproportionate impact of MREL on non-systemic institutions. In its submission to the Treasury Committee, Paragon noted that the UK’s MREL threshold of £15–25 billion is significantly lower than in other jurisdictions, such as the US ($100 billion) and the EU (€100 billion). This lower threshold brings mid-tier and specialist banks into a regime intended for the largest, globally significant firms, increasing their funding costs and refinancing risks. Paragon estimates that it could reduce mid-tier bank lending by £62 billion over five years, according to EY analysis. UK Parliament Committees
The BBB has a statutory remit to improve the supply of finance to SMEs. It already operates guarantee schemes, such as the Recovery Loan Scheme, and works through private sector delivery partners. But in the current environment, where regulatory capital rules are interacting with a concentrated banking sector and volatile wholesale funding conditions, the BBB could do more than de-risk loans. It could become a capital access facilitator for non-systemic banks, particularly those constrained by MREL but not classified as globally systemic (G-SIBs).
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By GlobalDataThis would involve developing funding programmes that reduce mid-tier banks’ dependence on wholesale markets, which remain costly and procyclical. The BBB could structure longer-term debt facilities, co-financing tools, or credit-enhanced capital market products to support SME lending. It could also back alternative mechanisms, such as asset finance and leasing, which remain underdeveloped in the UK.
The need for action is clear. According to the Department for Business and Trade’s report ahead of the SME finance review, “loan success rates for companies applying for bank finance are low in the UK at less than 50% on average.” This is down from 67% in 2018, before the pandemic, and reflects not only tighter risk appetites but also structural weaknesses in the finance ecosystem.
The discussion so far has focused largely on risk regulation and capital adequacy. But reforming MREL in isolation will not remove the structural funding constraints that prevent non-systemic banks from scaling. The BBB, if adequately capitalised and empowered, could fill this gap, supporting a more resilient, diversified, and investment-focused SME finance system.
This would not require a wholesale redesign of the financial system. It would mean broadening the scope of an existing institution to play a more active role in market design and funding distribution. It would also align with the government’s stated objective of making the UK the best place to start and grow a business.
As the government weighs its response to the SME lending consultation, the case for MREL reform should consider parallel expansion of the BBB’s mandate and tools, because not doing so risks missing an opportunity to strengthen the infrastructure of SME finance to lay the groundwork for more inclusive economic growth.
