Banks in the U.K. face a sharp increase in costs to recover state-backed loans, while widespread defaults could also lead to tax hikes, said analysts.

So far banks have distributed almost £45 billion in Bounce Back Loans, or BBLs, to smaller firms in the pandemic. The loans of up to £50,000 are 100% guaranteed by the state, but banks are responsible for repayment collection. These loans were due for repayment at 2.5% interest in May, just over a year since the scheme was set up, but now Chancellor Rishi Sunak has extended the deadline for the first repayment on the loans by a further six months.

As companies default, banks "will have to turn around and ask the government to reimburse them for a bad loan," said Fahed Kunwar, analyst at Redburn, in an interview.

"It is likely to sour the relationship between the government and the banks ... let's not forget, the banks have been bailed out by the back door — the capital ratio of the banks is up around 100 basis points in one of the worst recessions in history. When those losses start coming on to the government balance sheet, the concern would be that there would be an increase in corporation tax," he said.

UK Finance, which represents the banking industry, is working on a scheme to create a special vehicle involving banks and specialist debt collections firms to recover debts on unpaid BBLs. However, not all of the bigger banks are keen to sign up to the scheme and The Times reported that the scheme is likely to be abandoned.

The Business Banking Resolution Service, a group set up with the support of banks to resolve disputes, has estimated that 43% of borrowers do not intend to pay back the loans. Dan Frumkin, CEO of Metro Bank PLC, told S&P Global Market Intelligence last year that he expected "a significant amount" of loans to go bad.

'Unmanageable debt'

The Federation of Small Businesses said in December 2020 that the proportion of small firms carrying some form of debt had risen to 69% from 56%, with the share describing their debt as "unmanageable" up to 40% from 13% during the pandemic.

"The administrative expense burden on the banks will increase markedly because the banks will come under pressure if they are perceived to be forcing defaults on these BBLs in an aggressive manner," said Kunwar.

He compared the potential pitfalls for banks seeking to recover bad debts to the problems at Royal Bank of Scotland, now NatWest Group PLC, after the 2008 financial crisis, when its Global Restructuring Group was accused of pushing the companies it was set up to help into restructuring and then profiting by buying assets at heavily reduced prices. A Financial Conduct Authority report a decade later concluded there were "widespread and systematic" problems at the group but found no evidence that the bank artificially distressed healthy companies.

"The administrative burden on the banks — because they need to ensure they understand the nature of the defaults exposed and when to trigger a default and when not to — is going to mean banks' expenses go up," said Kunwar.

U.K. banks are already subject to a surcharge of 8% on profits on top of corporation tax of 19%, while there is also a bank levy, a tax on banks' U.K. liabilities of 0.1%.

Investec analyst Ian Gordon said banks' costs could rise as they recover BBLs, noting that banks are considering working together to recover BBLs gone bad. He, too, is also concerned that banks could face higher tax levels.

"If and when it blows up and the government is faced with significant losses there could be a quid pro quo then might they see banks as a target to recoup it from? Yes. I assume, too, we will see some upward creep in corporation tax. I certainly see it as a risk," said Gordon in an interview.

Standard approach

Both the government and the banking industry have agreed that a standardized approach to debt recovery makes sense.

However, some of the larger banks are reluctant to join the UK Finance project with one leading bank, for instance, which declined to be named while talks continued, telling S&P Global Market Intelligence that it was merely one of a number of options being considered.

Metro Bank, which at the third quarter of 2020 had provided £1.3 billion in BBLs, told S&P Global Market Intelligence it intended to stick with the UK Finance scheme.

UK Finance said its scheme was still in the process of being formed.

"The detailed design of a collective approach to debt recovery is still in development. This would provide a consistent approach to the handling of outstanding BBLs, however individual lenders may want to take their own view to recoveries," said a spokesman.

The bigger banks have supplied the majority of BBLs, as befits their greater share of small business lending. Lloyds Banking Group PLC, for example, had loaned £8.4 billion in BBLs at the end of the third quarter of 2020, but that has now increased to more than £9 billion to more than 300,000 firms.

NatWest, meanwhile, reported it had loaned £7.9 billion in BBLs at the end of the third quarter but as of the beginning of February had approved 291,000 applications totaling £8.92 billion. Barclays PLC, which had approved £9.2 billion BBLs at the third quarter, has now approved £10.36 billion to more than 330,000 customers. HSBC Holdings PLC provided £6.3 billion at the third quarter of 2020.