Credit risk sits at the heart of every lending decision. As economic conditions shift — from interest rate volatility to supply-chain disruptions — lenders must constantly reassess the resilience of their portfolios. With business margins still under pressure and economic uncertainty lingering, questions around default rates, write-offs, and non-performing exposures (NPEs) are becoming increasingly important.
In its latest outlook, EY’s Item Club forecasts write-off rates of roughly 0.17% in 2025–2026, implying a relatively benign credit environment. But how realistic is this expectation? And how are lenders preparing for unexpected shocks beneath the surface?
This blog explores default dynamics, stress-testing approaches, early warning indicators, and the broader question of whether current credit risk assumptions are robust enough for the coming business cycle.
At the aggregate level, UK SME credit performance has been more resilient than many predicted. Despite the pressures of inflation, wage growth, and higher interest costs, widespread defaults have been contained.
But aggregate stability can sometimes mask pockets of vulnerability.
Some sectors continue to carry elevated default risk:
In these segments, non-performing exposures are rising faster than national averages — raising questions about the plausibility of a near-record-low write-off rate in 2025–2026.
EY’s projected 0.17% write-off rate would represent a low point in the credit cycle. For context, write-offs averaged closer to 0.25–0.35% during stable pre-pandemic years, and much higher in stress episodes.
A write-off rate near 0.17% could be achievable if:
Several factors could push write-offs above forecasts:
While 0.17% is not impossible, it may underestimate the tail risks embedded in a still-fragile SME economy.
Stress testing is now a defining component of modern credit risk management. Lenders evaluate how portfolios behave under adverse scenarios that simulate macroeconomic shocks.
Sophisticated lenders run both bottom-up stress tests (loan-level) and top-down exercises (portfolio-level macro scenarios).
Beyond modelling, lenders build structural resilience through:
More focus on historical profitability, cash conversion, and realistic forecasts.
Restricting exposure to volatile industries.
Maintaining forward-looking expected credit loss (ECL) coverage.
Combining asset classes (asset finance, invoice finance, term loans) to stabilise risk.
Including information covenants, liquidity requirements, or DSCR thresholds.
More frequent data reviews, particularly for SMEs with variable cash-flow cycles.
Emerging risks rarely appear suddenly; they are often preceded by behavioural or operational signals. Lenders increasingly rely on early warning systems to catch deterioration before default occurs.
Defaults often spread across business networks:
Lenders increasingly map these interdependencies to spot contagion risk early.
While the baseline outlook for SME credit quality remains stable, the environment is still uncertain. For SMEs, this means:
Lenders will overweight cash-flow resilience in credit decisions.
Clean, timely accounts and clear explanations of margin movements are critical.
Reducing dependence on single points of failure.
Especially for businesses with loans maturing in 2025–2026.
Open dialogue can prevent temporary stress from becoming a default event.
On the surface, SME credit quality heading into 2025 looks notably stable — even optimistic — with forecasts such as EY’s 0.17% write-off rate suggesting calm conditions ahead.
But beneath the aggregate numbers lie real pockets of sectoral stress, margin pressures, and potential contagion channels. Lenders are right to remain cautious, running stress tests and monitoring early warning indicators closely.
The key message is balance: credit performance may remain strong, but the risks are far from gone. The businesses — and lenders — that stay vigilant, diversify risk, and adapt quickly will be best positioned to navigate whatever the next phase of the economic cycle brings.
As a founder of multiple businesses, Jamie believes that mindset, discipline and ambition are key drivers for success, both for his businesses and for his clients.
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