A big letdown for small businesses

Salvation for small businesses starved of bank lending was due to arrive in the Chancellor's Budget on 21 March. But as we get ever closer to the big day, there are growing fears that salvation will turn out to be yet another damp squib. One of the central planks of the Budget was supposed to be a "credit easing" scheme to ensure hundreds of thousands of small businesses across the country will be able to borrow at reasonable rates. The genesis of the idea was a speech by Adam Posen, a member of the Bank of England's Monetary Policy Committee, last September in the Cotswolds town of Wotton-under-Edge, in which he advocated a host of ways to increase the flow of credit to the sector. Mr Posen recommended the establishment of a new UK bank, mandated to make loans to small businesses, as well as a new financial institution that would buy up bundles of these loans. He suggested that the Treasury and the Bank of England should combine their resources to make the system work. The message seemed to get through. The following month, George Osborne announced at the Conservative Party conference that he would bring forward an ambitious "credit easing" scheme to help small firms. And the Chancellor's aides briefed that this would involve the securitisation of business loans to small companies, just as Mr Posen had urged. All this was interpreted as a tacit admission from the Chancellor that the Government's Project Merlin agreement with the banks – which set the institutions individual targets to make credit available to small businesses – was not working. Merlin had specified gross, rather than net, lending targets. So when some firms paid off their overdrafts, banks found they could shrink their overall lending to small businesses, while still meeting their targets. Credit easing was to be bigger and more effective than Merlin. The Autumn Statement in November set out more details. But these turned out to be a highly watered-down version of what Mr Posen had pressed for. There was to be a National Loan Guarantee Scheme, which would guarantee £20bn of private banks' wholesale funding provided they channelled the money to businesses in the form of low interest loans. There was also a promise of a £1bn public-private co-investment fund, in which the Government would invest in small business loans alongside private investors. But the loan-bundling scheme was downgraded to a distant aspiration. And there was no mention at all of a new small business lending bank. Even this modest package has hit problems. The private banks that were supposed to participate in the National Loan Guarantee Scheme have been complaining, saying that they can already get relatively cheap funding from the wholesale lending markets without the Government's help. They have also baulked at making credit available to small firms at the low interest rates the Treasury is demanding. They claim that the conditions being offered by the Government at the moment are too unattractive. But a retreat from the Government would be dangerous. Reducing the fee charged by the state for the insurance offered to the banks would make the deal look like yet another giant subsidy to the reviled sector. And allowing the banks to charge a higher interest to small firms for the new lending would undermine the very purpose of the scheme. Already some are predicting a re-run of the Merlin debacle, in which a hollowed-out scheme is labelled a great step forward. Lord Oakeshott, who resigned as a Liberal Democrat Treasury spokesman over what he saw as a cave-in by the Treasury to the banks when Merlin was being negotiated, says that credit easing is a dead end. What is needed to help small firms, he says, is not guarantees for the banks, but tougher and properly enforced lending targets. "Why try to invent a new car called credit easing when we really need more petrol in the banks' tanks and drivers steering in the right direction?" he has asked. But the Treasury will not resurrect Merlin, which came to an end in February. Credit easing is now the only show in town as far as small businesses are concerned. The Treasury says it is confident that it will be in a position to deliver something effective by the time of the Budget. But after the failure of Merlin, the pressure for the Treasury to come up with the goods for small firms is intense. One more letdown and most will likely conclude that salvation is never going to arrive – at least not from this Government. What does "credit easing" actually mean? 1) National Loan Guarantee Scheme The Treasury guarantees a portion of a private bank's wholesale funding, up to a total of £20bn for the whole scheme. In return, the bank agrees to use the funding to provide cheap credit to small firms. If those loans go bad, the banks themselves take the losses. But the government guarantee gives them a handy slice of cheap funding. If the bank were to go bust before paying back this slice of funding, the Government would have to pay off the bank's creditors. The banks pay the Treasury a fee for providing this funding insurance. The £20bn becomes a contingent liability on the Government's balance sheet for the duration of the insurance contract. 2) Business Finance Partnership This is a public co-investment fund. The Government puts £1bn of public money on the table, which it pledges to commit to special managed investment funds that will make loans to small and medium-sized firms. But it will only make the funding available provided that private sector investors match the state's cash. The government's cash stake is a carrot to entice private investors into the funds. 3) Securitisation Banks make loans to a large number of small businesses. They then package these loans up into tradable securities that are then sold to other investors. The idea is that these securities will only be a moderate credit risk because, even if one small business goes bust and cannot repay its loan, most of the other firms whose loans make up the security will survive and meet their liabilities. The scheme should also encourage banks to make even more credit available to small firms since they would not have to hold the loans to maturity on their balance sheets, but could sell them on.