Why Osborne is right

Tuesday, 4th October 2011, 6:02pm

The phrase “credit easing” is a new one for British politics, and many a head was scratched yesterday when the Chancellor announced his plans. We at Coffee House were skeptical, but we asked Sam Gyimah – who proposed the scheme in the summer – to explain how it works. We’re delighted that he accepted.

Credit easing was the big announcement in the Chancellor’s speech yesterday. The absence of policy detail led many commentators to project their worst fears. By the Chancellor’s own admission, the idea is yet to be fleshed out by the Treasury – but this is not a Gordon Brown-style debt concealment con. It’s an innovative and much-needed response to one of the biggest problems facing British small businesses.

In July, I launched a consultation with NESTA and talked to lots of companies. It was clear we need to come up with something more than bank-lending to stimulate the supply of credit to drive growth. In this context, yesterday’s announcement is a significant shift in the debate. The Chancellor’s idea to look at small business bonds, potentially using the Government's balance sheet if necessary, is a promising one.

First, the current institutional framework for lending to small companies — or SMEs to use the acronym — is simply not functioning properly. As the Bank of England reported last week, businesses are still struggling to get credit, despite some £20.5 billion being made available as part of the project Merlin agreement. This isn’t about picking losers or giving sub-prime loans. If creditworthy businesses cannot get credit, or fail to apply for credit for fear of rejection, then they are unlikely to set up a new plant, open a new office or take on additional staff. Without businesses engaging in this sort of activity, we will have no growth and no jobs.

Fraser Nelson said yesterday that if the bank isn’t lending to a business, then there must be a reason. It’s is not that simple. Most banks are rebuilding their balance sheets to comply with stricter capital requirements. As they go through this restructuring, they’re understandably less keen to lend — especially to a market segment that is not highly profitable (estimates of the return on equity for SME range from 6 per cent – 8 per cent). Most businesses find their bank managers more interested in selling them expensive products such as insurance or foreign exchange services, when all they need is a loan.

If companies can wait for the 15 weeks it can take to get some loans approved, what they find is that fees can be excessive, facilities can be revised or withdrawn unexpectedly, and any deal with their bank is on a take it or leave it basis.

A free marketer might say: if the banks fail, then new entrants will come and undercut them. Well, that’s the theory. In practice, 90 per cent of the UK banking market is concentrated in the hands of five banks and has been for the best part of a decade. You can say that we need greater competition in British retail banking, but the reality is that we don’t have it. Our small businesses are stuck, and need help.

Bashing the banks and urging to lend more, as we have done since 2008, has failed to solve the problem. With so little competition, and the need for banks to repair their balance sheets, they’re just not able. What is needed is a shake-up of the lending landscape to increase competition, drive down costs and get credit flowing to the right businesses: those with the size, cashflow profile and growth prospects to support the debt, which are the real mittelstand of the UK economy.

Boldness is required and the funding landscape needs to be reformed. Again, a free marketeer may say wince at the idea of state intervention. But consider the history. In the 1940s, the Government created 3i. In the 1990s, it created the Alternative Investment Market (AIM). Today, the chancellor is right to be challenging the Treasury to come up with a 21st century solution, by helping incubate a market in bonds for small companies.

The private sector will doubtless play its part in this process. New solutions are emerging, such as Funding Circle or Market Invoice, where rich folk — or “high net worth individuals” are they’re called in the trade — are able to lend to small businesses on a peer-to-peer platform. But a bond market, in whatever form it eventually takes, has the potential to change the lending landscape dramatically. Today, big businesses do not have to borrow from a bank. They can go directly to a financial marketplace and get cheaper finance directly from investors. Hotel Chocolat and King of Shaves offer two well-known examples from the private sector, but even a housing association has been able to raise £140 million from retail investors through the London Stock Exchange bond platform, and councils are also looking to tap this form of non-bank funding. It is right for the government to investigate how this of source of finance could be made available to all the right businesses, rather than stand on the sidelines.

There are, of course, numerous challenges in the way. The barriers for lots of businesses accessing bond markets are the costs of regulation, compliance and listing. The govt can simplify the process of listing a bond for smaller businesses. It will have to ensure only creditworthy businesses pass. Debt finance is not appropriate for every company at every stage of development, so how the loans are issued will be important. Any structure would have to ensure that there is proper separation between the institutions screening and those buying and guaranteeing the bonds. Challenging as these issues are, there is a good precedent in the Small Business Administration, which guarantees small business lending operations in the US. The SBA is notable for having backed Apple and Sun Microsystems in the past.

One of the fringes at Tory Conference tonight is called “Be bold for growth.” This is precisely what the Chancellor is doing. He has thrown down the gauntlet to find new models to address the challenges facing the lending landscape today. I can understand why some might feel nervous about a new mechanism involving debt. But this is a carefully-assembled and badly-needed solution to one of the biggest problems confronting British small companies today.

Sam Gyimah is Conservative MP for East Surrey

More articles from: Sam Gyimah MP | this section

Print this article | Email to a friend | Permalink | Comments (3)

Post this entry to: del.icio.us | Digg | Newsvine | NowPublic | Reddit

Previous Back to Blog Next

Post comment

deucelow

October 6th, 2011 6:54am Report this comment

I think we can all see where this is going! A quasi government scheme to lend money to business is surely just a scandal in incubation. Who makes the decision what a creditworthy business plan is? Who will wear the headlines {and losses} when businesses fail? Who will wear the headlines {and brickbats} when overlooked business for the scheme take off?
Add to the fact that - by your parties own ideology - Government is not terribly good at picking winners or losers in private enterprise anyway...a historical fact borne out by results.
This is idiotic stuff at best.