04 Jul 2017

Small businesses are likely to be hit hardest by Brexit disruption

Europe has 23m small and medium-sized enterprises. They are the backbone of the European economy, accounting for 99pc of all companies in the EU and 67pc of employment. That amounts to approximately 58pc of gross value added in the non-financial economy.

And yet, as a Boston Consulting Group (BCG) report commissioned by AFME reveals, however much disruption Brexit may cause, it won’t necessarily be big business which suffers the most, but rather the small and medium businesses who will be propping up our post-Brexit economy. This applies to SMEs in the rest of the EU as well as in the UK.

We came to this conclusion after analysing how companies and investors in the current EU28 could be affected by the impact of a hard Brexit on the wholesale banking services they consume. BCG’s researchers spoke to more than 62 chief executives and treasurers of corporates, investment firms and SMEs, along with 10 industry associations which represent a wide range of companies and sectors. What was striking from the responses was that SMEs could find themselves the hardest hit unless they take action now. There are three reasons for this.

First, the banking-related effects of a hard Brexit could lead to a higher cost of capital for SMEs and more restricted access to wholesale banking services. While the exact figures will vary, there is a real risk of fragmentation unless industry and policymakers can work together for a solution that benefits EU businesses and consumers.

Secondly, while the scale and bargaining power of individual large corporates and investors mean that many of them would be able to navigate the wholesale banking impacts of a hard Brexit, SMEs would undoubtedly find it harder. That’s because not only are SMEs more likely to find their access to wholesale banking services restricted, but the cost of making adjustments – such as forming new banking relationships – can be material for them. SMEs tend to choose a local bank and stay loyal to them. In fact, 60pc of SMEs currently only use one bank for their business banking because of higher costs and greater difficulty than large corporates when building new relationships.

In the event a local UK bank chooses not to establish a subsidiary in the EU27, or that a hard Brexit results in banks having to change their services for existing customers, developing a new banking relationshipcould be time-consuming, taking anywhere from six months to replicate what SMEs currently do in the UK.

Thirdly – and crucially given the above – 55pc of the SME participants who commented in the report admitted that they had made no plans so far for Brexit. Worryingly, the assumption from corporates – small and large – is that their banks will continue to provide financing and be there in the same guise. Some 44pc of the SMEs interviewed expect their banks to absorb any additional costs caused by Brexit.

However, this may be overly optimistic. The loss of passporting may cause some banks operating through a UK banking licence to withdraw from the EU27, reducing the capital available to companies and investors. Other banks are likely to use subsidiaries to maintain cross-border operations, but this could be costly. We cannot presume that the plumbing underpinning the banking system will continue to function seamlessly. The most likely result is that the European financial and banking markets become less integrated – ultimately limiting access to markets and raising costs.

To mitigate such adverse effects of Brexit on end users, our interviewees made a number of suggestions. These included a transition period to give banks and their clients time to adjust, as well as “grandfathering” of existing contracts in order to minimise the legal and operational disruption to banks and their clients.

Above all, businesses told us that they want the status quo preserved. The majority hope Brexit negotiations will result in similar levels of access to and costs of wholesale banking services as they have today. They feel strongly that the political negotiations should keep in mind the impact of Brexit on real economy end users. The continued stability of pan-European capital markets and future economic growth depend on it.

This article was originally published by The Telegraph on 4 April 2017