GAD Evaluates Commercial Interest Rates for Innovation Loans

We have analysed options to produce commercially equivalent interest rates to be used by Innovate UK Loans Ltd ("Innovate UK"), a subsidiary of UK Research and Innovation, in assessing the 'market equivalent' value of their innovation loans to micro, small and medium-sized enterprises (SMEs).

Innovate UK has a loan portfolio of £140 million innovation loans to SMEs for projects leading to innovative new products, processes or services.

Innovate UK's purpose is to stimulate later stage innovation to drive productivity and growth in the UK economy. They offer loans at interest rates which are lower than those which companies could achieve commercially elsewhere.

Calculating rates

The Government Actuary's Department (GAD) has offered analysis and advice on setting commercially equivalent interest rates, to enable their accounts to reflect the level of subsidy inherent within the loans that Innovate UK provides to SMEs.

There is no defined method for calculating the commercial equivalent interest rates. We set evaluation criteria, researched a range of viable approaches and recommended one to Innovate UK that best met their requirements.

Identify options

We identified these options for calculating an appropriate commercial interest rate by:

  • using previous experience of providing advice to other government-backed schemes and lenders
  • discussions with relevant public sector entities on their approaches and publicly available information on approaches taken across industry
  • considering the legislative environment around providing subsidies (including UK Subsidy Control Act 2022 and the EU State Aid regime)
  • using an approach that was suitable to meet our client's reporting requirements demonstrating compliance with international financial reporting standards and to meet the needs of our client's decision makers' and auditor's governance needs

As part of our evaluation criteria, for assessing methodologies for setting commercially equivalent interest rates, we examined the:

  • availability and cost of data
  • applicability to Innovate UK's loan book
  • consistency with Innovate UK's current modelling approach
  • reflectiveness of market conditions
  • consistency with the principles of the UK Subsidy Control Act

Eva Grace, one of the report's authors said: "This was all about providing Innovate UK with an appropriate methodology to calculate commercially equivalent interest rates, an area where there is no standard approach or a wealth of relevant data. Our analysis took into account Innovate UK's needs, as well as market practice and available and appropriate data."

Stephen Stewart, Financial Reporting Manager at Innovate UK, said: "We have formed a very professional and productive working relationship with GAD for this work, and indeed a couple of other related assignments, following our procurement processes.

"GAD understood our brief really quickly and was able to carry out their assignment, to time and within budget, whilst keeping us well informed of developments.

"Feedback from senior, industry experienced management of the quality has been very positive. The end product report was well considered and clear with practical recommendations for implementation. I would not hesitate to consider GAD for suitable professional advisory work in the future. I have also valued additional insights on future industry developments in our field of work in GAD run forums."

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