COVID-19 - Government Lending Schemes: FCA publishes Dear CEO letter on SME Lending

It has been widely reported that significant amounts of taxpayers’ money has been lost through the Bounce Back Loan Scheme (“BBLS”) to fraud and business default. At one stage the National Audit Office estimated £15bn to £26bn, although more recently, reports suggest that this figure is a significant over-estimate. Nevertheless, it is likely that there has been some application fraud and it is clear that the FCA is concerned about it.    

In this article, we examine the FCA’s latest Dear CEO letter and what this tells us about its current expectations and concerns in relation to the government lending schemes. Whilst the letter’s title indicates a focus on fraud, the FCA also used the letter to remind firms of its expectations in terms of the treatment of SME customers.

Headlines

• The FCA wants firms to ensure they investigate and report fraud to all relevant stakeholders
• Firms need to be properly resourced to make sure this is done thoroughly and in a timely manner
• The FCA’s focus is on the fair treatment of, and appropriate outcomes for, SME customers in collections and recoveries activities
• The Senior Managers and Certification Regime is the key tool the FCA will use to ensure this is achieved.

On 28 July 2021 the FCA published a Dear CEO Letter setting out the FCA’s expectations on reporting fraudulent activity (“the July 2021 Letter”).[1] This is the latest in a line of correspondence from the FCA in relation to SME Lending over the course of the pandemic, the first of which was published in April 2020 (“the April 2020 Letter”).[2]

The July 2021 Letter requires firms:

• to inform the FCA of allegations that an FCA firm, as a BBLS borrower, has been involved in fraudulent activity[3];
• be alert to identifying fraud more generally in undertaking collection and recovery activities;
• to keep resourcing levels under review to identify and report financial crime in a timely manner; and
• to “assess, monitor and manage” controls to identify fraud cases effectively in line with existing requirements, such as in SYSC.

The July 2021 Letter also reminds firms of the requirements:

• under the BBLS to inform the British Business Bank (“BBB”) of identified or alleged fraud under the BBLS scheme rules;
• under the Proceeds of Crime Act to report suspicions of money laundering;
• to report fraud to Action Fraud (or Police Scotland as appropriate); and
• to report fraud to other regulators or professional bodies, as appropriate for relevant borrowers.

Background

Lending under the Covid-19 government schemes came to an end on 31 March 2021. The Recovery Loan Scheme (“RLS”) is now in place as a successor to the Coronavirus Business Interruption Loan Scheme (“CBILS”) and the BBLS. No longer open to new lending, the focus for the CBILS and the BBLS is now on forbearance, collections, recoveries and potentially restructuring.

Facilities worth:

• £47.36 billion were provided under the BBLS;
• £26.39 billion were provided under the CBILS;
• £5.56 billion were provided under the Coronavirus Large Business Interruption Loan Scheme (“CLBILS”); and
• £1.1 billion were provided under the Future Fund.[4]

The schemes are guaranteed by the Government (80% for CBILS and 100% for BBLS). However, liability for repayment remains 100% with the borrower and, therefore, lenders will need to pursue borrowers before the guarantees can be called upon. The initial payment falling due is the first true test of the risk that a lender faces in any lending. What is unusual about the government schemes is that, in the majority of cases, the first payment does not fall due for 12 months.

There is a significant level of anticipated default across the schemes. In July 2020 the Office for Budget Responsibility forecast that up to 40% of BBLS, and up to 10% of CBILS and CLBILS borrowers[5] will default.

The level of default will arise partly from pure credit risk with issues around affordability, mistakes in the timing of payments and misunderstandings about the responsibility/legal liability on the borrower to repay the loans. Fraud is also expected to play a significant role, particularly for the BBLS.

Fraud risk

Whilst the full picture of fraud in the schemes will take time to emerge, the Cabinet Office’s Government Counter Fraud Function believe that fraud is likely to be “significantly above” the general estimates of public sector fraud levels of 0.5% to 5%.

The BBB instructed PricewaterhouseCoopers LLP to conduct a risk review before the BBLS scheme was launched. This noted a “very high” fraud risk with the possibility of duplicative applications, self-certification fraud, lack of a legitimate business, impersonation and organised crime. This led to the BBB issuing a Reservation Notice (which was published at the end of September 2020) and requesting a Ministerial Direction to proceed with the scheme due to the credit and fraud risks identified[6]. As a result of the credit and fraud risks specific to the BBLS, the National Audit Office estimated that between 35% and 60% of BBLS loans may not be repaid[7]. It is therefore not surprising that the FCA is focusing on the issue.

As the FCA noted in the July 2021 Letter “the unique nature of the BBLS has led to it being the target of fraudulent activity”. The BBLS had lower eligibility criteria than CLBILS and CBILS which increased the credit and fraud related risks. Lenders were required to conduct anti-fraud, AML and KYC checks, but not the usual credit and affordability checks which would be carried out on standard lending. The reporting system to detect duplicated loan applications was not operational for the first month, and it could not monitor risks or prevent fraud in real time.

As set out in the July 2021 Letter, once firms identify fraud in relation to BBLS, they need to investigate it and consider their reporting requirements, and to make sure this is done in a timely manner.

The question for firms will be what constitutes “fraud” that should be reported. There will be outright criminal frauds, such as impersonation or deliberate misuse of the schemes through duplicative applications. Other circumstances may not be so clear cut and could lead to differing interpretations. For example, for the BBLS, with self-certified eligibility, will a potential misrepresentation in the application form constitute fraud that should be reported?

As the first payments fall due, the credit and fraud risks will begin to emerge and the projections of likely default and fraud can start to be assessed against real data.

FCA expectations for the treatment of SME customers

As noted above, the FCA set its expectations for lending to small businesses at an early stage in the pandemic with the April 2020 Letter. This acknowledged that the activity of lending to an SME mostly sits outside the FCA’s scope, but reminded firms that the Senior Managers and Certification Regime (“SMCR”) defines the responsibilities and accountability of senior managers which applies to all activities they conduct whether regulated or not.

The FCA therefore indicated how it would use the SMCR and individual accountability as the tool to drive fair customer outcomes. The April 2020 Letter also noted that the FCA has recognised the Standards of Lending Practice for Business Customers[9] (“the Standards”) as an industry code, and this would be considered when the FCA assesses how customers have been treated. The Standards were updated in August 2020 in certain respects to take into account CBILS and BBLS and the way in which they have been designed and implemented[10] but have not been updated since.

The FCA issued a statement on its approach to regulation of firms in relation to CBILS and BBLS on 27 April 2020[11] (“the FCA Statement”). This has been updated as the schemes have evolved, with the most recent update on 26 May 2021 explaining that CBILS and BBLS were closed to new applications as at 31 March 2021. On the same day the FCA issued a statement in relation to the RLS confirming that “most of the lending” available as part of the RLS would not be a regulated activity and most applications would be outside of the regulatory perimeter.

In the July 2021 Letter, the FCA took the opportunity to remind firms of its focus on ensuring that SMEs receive appropriate outcomes as we enter the recovery phase of Covid 19; and the FCA’s rules to support the fair treatment of customers through the regulated collections and recoveries process (Principle 6, requiring firms to pay due regard to the interests of customers and to treat them fairly and the Consumer Credit Sourcebook Chapter 7 (CONC 7)).

Where CONC 7 applies the FCA notes it wants “to see a focus on ensuring [SME customers] are treated with forbearance and due consideration” when in default or arrears difficulties. The FCA refers to its guidance ‘Bounce Back Loan Scheme: guidance for firms on the use of Pay As You Grow options’[12] which the FCA notes will assist firms in treating customers fairly.

The latest FCA letter reiterates the importance of SMCR when considering SME collections and recoveries activities.

The guidance to lenders therefore remains to treat customers in line with existing policies and procedures once the first repayment falls due together with the FCA’s expectations which have been underlined since the April 2020 Letter. Senior managers will need to be in a position to evidence how this has been achieved.

Next steps

The July 2021 Letter provides a reminder for firms to report fraud to relevant stakeholders, with a particular interest from the FCA in fraud involving FCA regulated firms. It also continues the theme from the FCA of reminding firms of its focus on seeing appropriate and fair outcomes for SME customers, and the regulatory framework that exists for that purpose.

There is plenty for lenders to think about as the customer journeys progress, with continued economic uncertainty. What many anticipate will be a cliff edge once government support measures fall away and the potential for a surge in defaults will no doubt create a myriad of issues.

One thing that is for certain is the management of this debt and the issues arising will be with lenders for a long time to come.

 

This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full terms and conditions on our website.

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[1]  https://www.fca.org.uk/publication/correspondence/dear-ceo-letter-sme-lending.pdf

[2]  https://www.fca.org.uk/publication/correspondence/dear-ceo-lending-small-businesses-coronavirus.pdf

[3]  under the FCA’s Principles of Business, PRIN 11 - Relations with regulators, requires a firm to deal with its regulators in an open and cooperative way, and must disclose to the FCA anything relating to the firm of which that regulator would reasonably expect notice.

[4]  Source: HM Treasury: https://www.gov.uk/government/news/final-covid-loans-data-reveals-80-billion-of-government-support-through-the-pandemic

[5]  Source: Office for Budget Responsibility, Fiscal sustainability report, July 2020, p65-68

[6]  https://www.british-business-bank.co.uk/wp-content/uploads/2020/09/200502-BBB-BBLS-reservation-notice-FINAL-tagged.pdf

[7]  https://www.nao.org.uk/wp-content/uploads/2020/10/Investigation-into-the-Bounce-Back-Loan-Scheme.pdf

[8]  https://www.lendingstandardsboard.org.uk/wp-content/uploads/2020/05/LSB-Update-Standards-of-Lending-Practice-business-CBILS-and-BBLS-4-MayFINAL-v2.pdf

[9]  The latest update was 5 August 2020.

[10]  https://www.fca.org.uk/news/statements/coronavirus-business-interruption-loan-scheme-bounce-back-loan-scheme 

[11]  https://www.fca.org.uk/publications/finalised-guidance/bounce-back-loan-scheme-guidance-firms-using-pay-you-grow-options