Credit risk assessment for SME lenders: FCA expectations
The FCA-regulated SME lending market — covering peer-to-peer lenders, specialist business lenders, and the consumer credit-adjacent products used by small business owners — occupies a complex regulatory position. SME borrowers are not protected by the Consumer Credit Act 1974 for most business lending above £25,000, and many business lending products fall outside the FCA's consumer credit regime altogether. However, where individuals act as personal guarantors, or where lending is to sole traders or small partnerships, the FCA's consumer credit rules and, increasingly, the Consumer Duty's principles may apply. Lenders operating at this interface must map their products against the applicable regulatory framework carefully.
For FCA-regulated SME lenders, the credit risk assessment framework must satisfy the obligations in CONC (Consumer Credit sourcebook) where applicable, and in all cases must meet the overarching SYSC requirements on systems and controls. The FCA's expectations on affordability assessment for business borrowers — while less prescriptive than the mortgage affordability rules — require lenders to conduct an assessment of the borrower's ability to repay without undue difficulty, to obtain and verify relevant financial information, and to stress-test repayment capacity against plausible adverse scenarios. The FCA's 2023 thematic review of SME lending found that some lenders were placing excessive reliance on security (including personal guarantees) as a substitute for adequate affordability assessment — a practice the FCA has indicated it considers inconsistent with its consumer protection mandate where personal guarantors are involved.
Forbearance obligations for business borrowers in financial difficulty are less extensively specified in the FCA's rules than for consumer borrowers, but the FCA's principles require firms to deal fairly with customers in difficulty regardless of whether specific rules apply. For lenders whose SME borrowers include personally guaranteed facilities, the Consumer Duty's consumer support outcome may require firms to proactively identify businesses in difficulty and offer meaningful support options — including payment deferrals, restructurings, or referrals to business debt advisory services. Firms that automatically move to enforcement without exploring forbearance options where there is a personal guarantor are at risk of FCA supervisory engagement.
Credit risk modelling for SME lending poses specific challenges. Unlike consumer credit, where large historical datasets and standardised product structures allow sophisticated statistical models, SME credit involves heterogeneous businesses, thin credit files for many applicants, and significant reliance on qualitative assessment by credit managers. Firms using AI or algorithmic models for SME credit decisioning should apply the model risk management principles discussed in our guidance on AI in financial services, and should pay particular attention to potential bias against borrowers from underrepresented groups — a concern highlighted in the FCA's research on financial exclusion.
Climate risk and SME lending portfolios
Climate-related credit risk is an emerging consideration for SME lenders. PRA-regulated banks have been required under SS3/19 to embed climate risk into their credit risk frameworks since 2021. FCA-regulated specialist lenders are not directly subject to these PRA requirements, but should consider whether their lending portfolios have material concentrations in sectors with high transition or physical climate risk — and whether their credit risk assessment processes adequately capture these risks. Investors and institutional funders are increasingly asking these questions, and lenders that cannot demonstrate a credible approach to climate risk in their portfolios may face funding or capital cost consequences.