The arrogance behind Project Merlin.

U.K. banks are allegedly not lending enough to Small and Medium size Enterprises (SMEs). Project Merlin is an agreement between the UK government and banks under which banks promise to lend a minimum sum to SMEs per year (amongst other things).

The first nonsense here is that if one believes in free markets, as the UK government claims to, why is govt interfering with bank’s decisions on who are creditworthy customers? After all, this sort of decision is supposed to be one of the basic skills of banks.

The second nonsense is the assumption that bank loans are the best or only way of funding SMEs. If an economy is being held back because of lack of lending for what are genuinely profitable projects, interest rates would be forced up. But there is no evidence of this happening.

Conclusion so far: if an economy is operating below capacity, the best solution is the obvious one, namely to raise demand. That, amongst other things, will make lending more profitable. As to whether it is large banks, small banks or other entities that do the lending, well that absolutely nothing to do with government.

As to evidence that that borrowing from non-bank sources is a substantial source of funding for SMEs, a recent survey by the Forum of Private Business found that financial support from friends and family to jump from 10% of their total funding in 2010 to 45% in 2011*.

But SMEs realise (as does everyone) that with govt nowadays grabbing about half GDP, there is plenty of profit to be had from sucking up to politicians as opposed to doing anything useful. That’s why most SMEs probably back Merlin (at the same time and holding their noses, no doubt).

Given the nonsensical logic behind Merlin, why did this “project” arise in the first place?

One factor is that is that banks are trying to repair their balance sheets, and a part of this exercise consists of being more cautious about lending than prior to the crunch: probably a good idea in view of the grossly irresponsible lending that took place prior to the crunch and caused the crunch.

Second, it does the egos of the London based elite (bankers and politicians) no end of good to see regional businesses come to them cap in hand for money rather than see such businesses find other sources of finance. The same arrogance is evident in the US: politicians there prefer to hand out taxpayers’ money to Wall Street than to Main Street. Wall Street in turn funds the election expenses of politicians. The elite looks after the elite.

* Source: Sunday Times Business Section article entitled “Don’t trip up over loans close to home”, 6th March 2011.

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