Why Banks Prefer Liquidating SMEs Rather Than Supporting Them
Executive Summary
For SME founders, bank behaviour often feels contradictory: public messaging promises support, yet operational reality favours rapid liquidation. This disconnect is not driven by malice but by regulatory mathematics. Our analysis of the 2024–2026 regulatory landscape confirms that the shift to IFRS 9/CECL "Expected Credit Loss" models has created a "Provisioning Cliff." Once a loan migrates from Stage 2 (Watchlist) to Stage 3 (Default), banks must book lifetime losses immediately, devastating their P&L.
Combined with the high operational cost of human workout teams and the density of Risk-Weighted Assets (RWA) for distressed loans, the rational economic choice for a bank is frequently to crystallise a loss today rather than pursue an uncertain recovery tomorrow.
Core Strategic Insight
The "Support Unit" Paradox: While banks label their distressed teams as "Business Support" or "Special Assets," their primary KPI is often not the survival of the borrower, but the velocity of capital recycling. The regulatory cost of holding a distressed asset on the balance sheet now exceeds the potential upside of a successful turnaround for loans under £5m.
Diagnostic Analysis: The Mechanics of Liquidation
The perception that banks act against their own interests by liquidating potentially viable companies is incorrect. Under current frameworks, liquidation is often the profit-maximising decision. This behaviour is driven by three specific mechanisms: the IFRS 9 "Cliff," RWA Density, and the Fixed Cost of Workout.
1. The IFRS 9 "Provisioning Cliff"
The most significant structural shift in the last decade has been the move from "Incurred Loss" (booking a loss only when the company dies) to "Expected Credit Loss". This creates a three-stage trap where "Stage 2" (Underperforming) requires booking lifetime expected losses immediately. The bank has effectively already taken the P&L hit; liquidation simply crystallises the tax write-off.
2. RWA and Capital Density
Distressed loans consume immense regulatory capital. A defaulted loan can attract risk weights of 150%+. For a bank treasurer, liquidating—even at a loss—frees up that capital to be redeployed into new, profitable lending. The opportunity cost of holding distress is higher than the loss from selling it.
3. Fixed Costs
Genuine turnaround requires "high touch" management. The legal and admin costs for a £2m loan are similar to a £50m loan. Banks effectively run a triage system: loans too small to absorb workout costs are processed for exit.
Exhibits
Click quadrants to reveal bank strategy.
10-Step Implementation Roadmap
How to navigate the "Support Unit". Click steps to expand.
Closing Signal
The era of "relationship banking" for distressed SMEs is effectively over. It has been replaced by a regulatory environment that penalises patience. The goal is not to convince the bank of your vision, but to prove mathematically that your exit plan offers a higher Net Present Value (NPV) than their liquidation process.