As the global economy faces up to the challenges of government debt management, sovereign risk and continuing eurozone problems, to name but a few, the threat of economic recession and even another financial crisis are recurring themes. August was certainly a challenging month for the world economy and September and October do not look any better. Concern about the world economy is likely to be centre stage for some considerable time.
This week is one of the most important in the global economic and financial calendar. The annual meetings of the IMF and World Bank take place when central bankers, finance ministers, bankers and economists gather in Washington. Already the apparent fragility of the post-financial crisis recovery is a major theme. Previous economic forecasts for growth and recovery in some major economies are being downgraded and the UK is one of these economies. Already the UK has announced new infrastructure spending and a further lowering of the Bank of England discount rate is being mooted in some circles.
The global situation and prospects are complex problems. Different countries and regions have both similar and different challenges. Most countries, for example, are affected by any setbacks in the US economy, still a major global economic driver. Eastern economies, on the other hand, are apparently more diversified than western ones and in a better position to grow more strongly. More generally, though, what the world really needs is a demand boost. There are many options (and collections of options) to target this and bank lending is one of them.
The recent overhaul of international banking regulations (the so-called Basel 3) addressed head on the impact of bank risk (especially capital adequacy) regulations that impact on bank lending. If bank regulators increase the amount of capital (risk coverage) that banks have to hold in their own balance sheets, then bank lending may be curtailed as a result. Such regulations (which are related directly to the amount of risk assumed by banks) have historically tended to increase the amount of bank capital required when banks become more risky. Since this is invariably during the downward phase of the economic cycle (when bank borrowers are most likely to default and so bank risks are running at a higher level), bank lending may be reduced at the very time that governments want banks to lend more in order to boost the economy (that is, to help boost demand).
The new Basel 3 regulations for banks have been designed to help mitigate this problem. But these regulations are pretty complex and they will take many years to be implemented. In the meantime, the impact of these new rules is still uncertain. At the same time, banks are being required today to hold more capital, considerably more capital, than before. At the same time, other major banking reforms (like the Vickers Commission in the UK) are being promulgated. The exact details of these reforms are still to be clarified, much less their longer term (intended and otherwise) consequences.
Against this background, the question remains – ‘Are UK banks providing enough help to the smaller business sector?’ Since this sector is an important pool of entrepreneurial activity and growth, this is an important question in its own right. Starving this sector of needed funds may not be a good contribution to a government’s overall attempts to ‘demand boost’ the economy, especially in the current and developing economic climate.
Of course, the other side of the coin is that bankers have been criticised (indeed vilified) in the build up to the last crisis for taking excessive risks. Criticising them now for being unduly cautious seems a strange twist of morality! No one would dispute that banks should be prudent and that banking risks and returns should be balanced judiciously. But banks also have a wider economic role and responsibility. They are able to ‘borrow short and lend longer’ (and thereby earn profit) because their depositors (us) fund them and ultimately (in extremis) the State (that is taxpayers, us!) backs them by protecting a country’s aggregate bank deposit base.
So what is the evidence on UK bank lending to smaller businesses ? At best it is mixed and conflicting. At worst there are some real concerns and growing evidence (albeit often anecdotal) that some banks at least are not doing enough. A recent report by the Bank of England, for example, found that many small firms were hoarding cash because they were too scared to ask for a bank loan. This hoarded cash could have been used to grow their own businesses more strongly. These ‘cash hoarding entrepreneurs’ worry that a new loan request could lead to a full scale review of their finances that might lead to a reduction in existing overdraft lines.
This research appears to support the many warnings from Vince Cable (UK Business Secretary) and the Federation of Small Businesses. A summer (2011) poll for Labour also showed that half of the small businesses surveyed in the past 12 months had used savings, credit cards or personal loans to finance their firms, rather than applying directly to a bank. Over a third of 48 per cent of the firms in this same survey that had applied for a bank loan in the past year had been unsuccessful in their first request. European research (for example, the first report of the European Credit Risk Survey) also reports a growing concern across Europe that the impact of stricter banking regulations and respective bank attitudes may conspire to reduce the availability of credit.
In the UK, the banks retort that they accept around 80 per cent of loan applications from small and medium sized firms. The British Bankers Association also argues that the volume of UK bank lending in relation to loan demand appears high. Mr Cable (and others), on the other hand, would argue that a sizeable percentage of needy business borrowers are simply put off from applying for bank loans in the first place.
The jury may still be out, but the banks clearly have at least a case to address in their lending to small businesses. As banks strengthen their own capital and risk management systems, small businesses should be the first beneficiaries. The small business sector is the ‘entrepreneurial engine’ of the economy. No good lending proposition from a small business should be rejected and banks must be incentivised to encourage and welcome a growing volume of such propositions.
Professor Bullion
