Interest Rates, Spreads & the True Cost of Credit

Credit pricing is central to SME borrowing decisions, influencing both the volume and timing of loan uptake. Understanding how interest rates, spreads, and funding conditions interact is crucial for SMEs planning financing and for lenders managing risk and profitability.

1. Recent Trends in SME Loan Rates

SMEs have experienced fluctuations in borrowing costs over the past year:

• November 2024: Effective interest rates on new SME loans stood at 7.17%, reflecting prior macroeconomic tightening.
• January 2025: Rates eased slightly to approximately 7.00%, the lowest since May 2023.
• July 2025: Effective rates on new loans fell further to 6.41%, indicating a gradual softening of credit costs.

These shifts suggest lenders are responding to capital and funding conditions, but even 6–7% rates remain materially higher than pre-pandemic norms, highlighting ongoing cost pressures for SMEs.

2. The Role of Margins and Credit Spreads

Beyond base interest rates, the margin or credit spread reflects lender judgment and risk assessment:

• Risk premia: Borrower-specific credit risk, sector exposure, and historical performance affect spreads.
• Term structure: Longer-duration facilities often carry higher spreads to account for funding uncertainty.
• Sectoral differentiation: High-risk or cyclical sectors may face elevated margins, while low-risk sectors enjoy narrower spreads.

For SMEs with already tight margins, these spreads can make borrowing prohibitively expensive, leading some firms to defer borrowing or rely on internal capital.

3. Impact on SME Borrowing Behaviour

High effective rates and spreads influence how and when SMEs borrow:

• Deferred borrowing: Firms may delay investment or expansion to avoid high financing costs.
• Internal capital utilisation: SMEs may draw on cash reserves instead of taking loans, limiting external credit uptake.
• Selective borrowing: Businesses may pursue only essential or high-return projects to justify the cost of finance.

As rates moderate, we expect credit volumes to rebound, but only if conversion friction (application complexity, collateral requirements) and perceived credit risk remain manageable.

4. Strategic Takeaways for SMEs

• Evaluate timing: Borrowing when effective rates are lower can reduce overall financing costs.
• Shop for competitive margins: Explore alternative lenders, specialist finance providers, and hybrid solutions to minimise credit spreads.
• Assess internal vs external capital: Compare the opportunity cost of internal funds with prevailing loan rates to make informed decisions.
• Plan for term structure impacts: Consider shorter-term, revolving, or flexible facilities to manage exposure to interest rate changes.

5. Strategic Takeaways for Lenders

• Calibrate spreads carefully: Balance risk-adjusted returns with market competitiveness to avoid deterring credit-worthy SMEs.
• Segment by sector and term: Differentiated pricing improves portfolio quality while supporting growth in lower-risk areas.
• Monitor funding conditions: Shifts in deposit rates, wholesale funding, or regulatory capital affect the ability to offer competitive rates.
• Reduce conversion friction: Streamlined processes, digital onboarding, and flexible underwriting encourage borrowing even when rates are elevated.

6. Conclusion: The True Cost of SME Credit

Interest rates and credit spreads are central determinants of SME borrowing behaviour, shaping both demand and timing. While recent months have seen a gradual easing, effective rates remain above historical norms, making pricing, risk assessment, and operational efficiency critical for lenders.

For SMEs, careful evaluation of rates, spreads, and financing alternatives can optimise cost of capital, support strategic investments, and maintain liquidity. For lenders, understanding how rates interact with borrower risk and sector dynamics is key to driving sustainable SME lending growth in a competitive and evolving market.