Sunday, July 17, 2011
Lending drought threatens Britain's recovery
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

The economy is growing, though much more weakly than in a normal upturn, and that weakness is starting to be reflected in the job market.

Though employment rose by 50,000 in the March-May period, its growth looks to be levelling off. The Ernst & Young Item Club, using the Treasury’s model of the economy, will tomorrow revise down its predicting for growth this year to just 1.4%.

Things get better, with 2.2% growth next year and 2.5% in 2013, according to Item. But this is nothing to write home about. Even if the economy succeeds in cranking up to 2.5% growth in two years’ time, that will still be lacklustre by past standards.

By that stage of the recovery in the 1990s Britain had recorded three years of 3%-plus growth. This time it appears to be different.

There are several reasons. The government’s fiscal tightening will reduce growth, as will the squeeze on real incomes from high inflation (though last week’s drop from 4.5% to 4.2% was welcome).

I want to return, however, to a theme I launched last month, on June 12. The debate was raging over whether a Plan B was needed for fiscal policy, as it will again if second quarter growth figures are poor.

I argued that the problem was monetary, not fiscal. Britain does not have too little public spending, it does have far too little bank lending, particularly to small and medium-sized enterprises (SMEs). Such lending began to fall on an annual basis in early 2009 and it is still falling now, by around 6% annually.

Efforts to persuade the banks to lend more to smaller firms were failing, I argued, as they had failed in the latter days of the Labour government. If this continued the authorities would have to act, either by ordering lending by the part-nationalised banks, Lloyds and Royal Bank of Scotland (who between them have 45% of the SME market), or by means of direct lending by government.

There was a big response to that piece, including from senior members of the government. Downing Street is interested and engaged, as it should be. The Bank of England’s latest credit conditions survey suggests no improvement in credit availability to business during the current quarter.

The situation is most acute with SMEs but credit availability is also a problem in other parts of the economy. The housing market is moribund because mortgage availability is running at barely a third of pre-crisis levels and that is depressing building, construction and the many bits of the economy which rely on a reasonable level of housing turnover.

The problem is with the Treasury. When other government departments have raised the issue, the response they get from the Treasury is identical to the one they get from the banks, that the problem is not one of supply but demand.

The banks insist, in other words, that if only there was sufficent demand from SMEs for funding for viable projects, they would be happy to hand the money over. The Treasury tends to agree.

The problem, as the Bank’s diligent regional agents recently uncovered, is that many firms are reluctant to ask for loans or increased overdraft limits not just because they fear refusal but because they are worried that the response of their bank will be to toughen the terms of their existing borrowings. They may go in for a loan, in other words, but come out with a rate hike on their existing overdraft.

The only way to counter the Treasury view, of course, is evidence. Every minister and MP has examples of SMEs - some deserving, some less so - which have been turned down for loans. The unresolved question within government is whether this is systemic or happening only at the margins. The big figures for falling SME lending suggest the former.

The Treasury, the Business department and Downing Street are not the only players in this. The Independent Banking Commission will report at the end of September. While much of the interest and most of the responses from the banks has concentrated on the commission’s interim proposals for ring-fencing (though not separating) the banks’ investment banking activities, it also has another agenda.

That agenda is banking competition, of which there is plainly too little in Britain. Even after planned divestitures by Lloyds and RBS, the big five (including Barclays, HSBC and Santander) will have nearly 90% of the small business market.

They, together with the Nationwide building society, have 80% of mortgage lending and 87% of personal current accounts. Overall, according to the commission, Britain’s banking system will have become more concentrated as a result of the crisis than it was before.

Measures to encourage new entrants, who by their nature will be seeking to increase market share, will help. The Swedish bank Handelsbanken, together with others, is quietly making an impact on the SME market. The commission is investigating ways of reducing the barriers to entry into British banking but acknowledges this will not be easy.

Over time increased competition will boost credit supply, which is essential if recovery is to be maintained. We may not, however, have the luxury of waiting. Those in government who are concerned about this have to push the Treasury, which appears more concerned about the value of the nationalised bank stakes, into action.