Coronavirus Loan Scheme Risks

At a time of great crisis, with many businesses closing down, people asked to stay at home, protect the NHS and save lives, taking an 80% government-backed business loan offered by the chancellor of the exchequer will naturally feel like an olive branch. After the treasury used taxpayers’ money to bail out the banks in 2008, bailing out businesses and bailing out the people sounds like justice. However, after investigating this as a business owner, I found that the way it works in practice is very different to how the chancellor presented it, and very little has been said on the matter.

The initial interpretation is that if you borrow £100,000 to support your business, and despite best efforts, you were unable to pay back the loan, the bank could claim £80,000 from the government and potentially lose £20,000. Understandably, the bank would need to exercise some due diligence to mitigate this risk. People will believe this is how it works because this is what Rishi Sunak implied when he announced the scheme to help businesses. Now let’s move on to how it works in practice.

An application is made for £100,000 to keep your business up and running during the coronavirus lockdown. The first thing the banks want to know is how much property the company owns, how much you own personally as the business owner and any other assets available as collateral against the loan – expected, given that the bank will take 20% of the risk. On borrowing £100,000, understandably, you will need to offer £20,000 assets to secure the loan against it, or credible cashflow projections which offset this risk to the bank. However, missing if you don’t ask, is the process followed in the event of your business defaulting on the loan.

Again, back to the £100,000 loan example. The bank asks the applicant about assets, and the applicant reports that his business has no property at all, and very little in the way of valuable equipment with any resale value. However, the applicant has £50,000 equity in his home. The bank accepts the loan application with the home as collateral – more than adequate to cover the £20,000 after the government pays the 80%, but this is NOT how it works.

If your business defaults on loan payments, the bank will start by coming after you for the £50,000 equity in your home. Then, and only then, they will go to the government and claim 80% of the outstanding £50,000 of the loan; the £40,000 leaving a loss of £10,000 to the bank. Several journalists and politicians have brought up the subject of why should it be an 80% loan guarantee scheme, and why not 100% with the government taking all the risk. The fact is, changing it from 80% to 100% is useless for businesses and their owners. An increase from 80% to 100% will ONLY take away the remaining risk to the banks. Essentially, it is a loan guarantee for lenders, not a loan guarantee for borrowers.