Friday, 11 May 2012

Banks aren’t lending to SMEs – boo hoo.

British politicians have over the last year or so been worrying about the reluctance of banks to lend to small and medium size enterprises (SMEs). I criticised politicians for this concern about a year ago here. It’s time to make some additional points on this topic.

In addition to politicians, Positive Money makes much of the fact that banks lend primarily to those purchasing property while failing to fund SMEs and socially desirable stuff like infrastructure. (Incidentally, I support Positive Money, but disagree with them on a few points.)

Investments made primarily or partially because of their social desirability are dead loss from the strictly commercial point of view (at least that’s certainly the case with the National Health Service and state education). Given that banks undertake to repay depositors about £100 for every £100 deposited, it is a BLATANT SELF-CONTRADICTION to expect banks to invest in loss makers. (To be more accurate, banks undertake to repay the original £100 possibly plus interest and possibly less expenses.)

As regards SMEs, much the same point applies: it is a SELF-CONTRADICTION to ask an institution to guarantee to return £100 per £100 deposited AND take significant risks.
In contrast, for those who want to take a risk, there are plenty of options: i) the stock exchange, ii) start your own business, iii) help a friend or relative with their business, iv) bet on a horse.

Banks INEVITABLY go for safe investments, like property. And even property has not proved safe enough over the last five years.

Frances Coppola makes a good job of attacking the “banks must lend more to SMEs” argument.

As pointed out above, it is fundamentally silly to expect an institution which guarantees to return money to depositors to take risks. But of course the way we’ve solved this problem so far is to have government guarantee banks. And for the naïve, that seems to solve the problem: banks can take risks while depositors’ money is safe. Problem is that that just means taxpayers are subsidising commerce. And it’s not the taxpayer’s job to do this.

A vastly more intelligent and logical solution to the above safety / risk conundrum is to make depositors come clean: that is, force them to decide between safety and risk taking. Put another way, depositors need to be prevented from having their cake and eating it (enjoying the rewards of risk without actually taking any risk).

And that can be done via the “two account” system advocated by Positive Money and others in their joint submission to the Vickers commission. (See “Step 1”, p.7, here.)

The two account system enables a depositor to EXPLICITLY allow the depositor’s bank to take a risk with their money. The benefit for the depositor is a better rate of interest. The drawback is that this is COMMERCE, and there is no obligation on taxpayers to rescue those who take commercial risks if everything goes belly up. That is, under the two account system, depositors who explicitly let their bank take a risk with their money do not get their money back, or don’t get all of it back, if everything goes belly up.

That two account system might result in far more money being allocated to SMEs than politicians wittering on about the subject.

Is more alcohol the solution to alcoholism?

Another fundamental absurdity in politicians’ concern about bank lending to SMEs is that we’ve just had a credit crunch caused by excessive and irresponsible borrowing (in case you hadn’t noticed). And the solution adopted by the authorities? Well it’s to cut interest rates so as to encourage more lending and borrowing. You just couldn’t make it up.

In particular, having lent irresponsibly, banks have learned their lesson. They’re more cautious about lending. Politicians, it seems, have not learned any lessons. Politicians think the solution for excessive lending and borrowing is yet more lending (to SMEs in particular).

Presumably politicians think the cure for alcoholism is to supply alcoholics with yet more alcohol. And the cure for someone with a broken leg? Presumably it’s to break the other leg.

Lenders need specialist knowledge.

Lending to an SME ideally involves a detailed knowledge of the particular business the SME is in. And the average British bank manager just does not have that knowledge. Thus loans to, or investments to SMEs will inevitably tend to come from specialist lenders: not bog standard high street banks.

For example, Siemens has set up a bank. Siemens clearly has a detailed knowledge of the business it is in.

As this Financial Times article put it, “Siemens often acts an anchor lender, prompting other banks to participate as they presume that the engineering group is better placed to judge the technological risks of a project.”

Less lending constrains economic growth?

A popular argument put by economic illiterates (aka politicians) is that less lending means less economic growth. This is also an argument put by banks when lobbying for less bank regulation. And politicians fall for the argument every time.

Well is blindingly obvious that less lending means less growth ALL ELSE EQUAL. But of course there is no need for all else to be equal. That is, given less lending, demand and growth can perfectly well be boosted by boosting plain simple old consumer spending and/or increased public spending.

That boosts firms’ order books, and for what it is worth, there is nothing that potential lenders like more than a firm with a full order book.



  1. That two step system already exists.

    We have crowdcube for equity and zopa for loans.

    Sometimes I wonder whether if we just nationalised the payment systems we could get rid of traditional banks altogether and nobody would miss them.

  2. Hi Neil,

    Crowdcube and Zopa do not a two account system make – to quote Shakespeare. Reason is that they are a minute proportion of the total “borrow / lend” market, plus doing business with C and Z is voluntary. In contrast, the two account system would be compulsory and cover the ENTIRE borrow and lend market – or at least would involve all deposit takers.

    Reason for that is the under the current system, banks plus their customers can effectively rob taxpayers, as Mervy King pointed out. That is depositors can gain the advantages of lending to commercial entities via banks (i.e. get more interest than they otherwise would) while carrying none of the risks – the taxpayer carries the risk.

    The two account system disposes of much of that cross subsidisation.

    Re nationalisation, I don’t think nationalisation as such solves many problems (not that I’m strongly against it). I.e. the important point is to have a set of regulations that brings us the best possible banking system. Who actually owns banks is a minor point. Though obviously left wing “clause 4” enthusiasts will see things differently.

  3. Community local banks, as advocated by Richard Werner along the German system, could be part of the answer.


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