Policy makers must refresh SME approach; Clear vision needed, including proper plan to police non-banks

November 25, 2013 7:10 pm

Policy makers must refresh SME approach

By Patrick Jenkins

Clear vision needed, including proper plan to police non-banks

The ability of smaller businesses to secure bank loans – or, rather, their inability to do so – is back at the centre of the political agenda. As policy makers across the western world try desperately to fan the flickering flames of business recovery, attention has turned to the SMEs that underpin most economies, and why they are not investing more by borrowing more.The UK authorities have taken a dual approach of punishment and reward. The stick, wielded again on Monday against Royal Bank of Scotland in two critical reports, has been to bash banks for failing to lend. The carrot has been the Bank of England’s Funding for Lending Scheme, which grants banks finance on attractive terms, particularly for SME loans.

Those tactics have been echoed, to some degree, in other markets around the world. But, lately, central bankers in the US and continental Europe have seemed drawn to a different agenda – one that combines the carrot-and-stick approach in one. Both the US Federal Reserve and the European Central Bank have made noises about negative interest rates.

Last week, the Fed signalled that it may cut the 0.25 per cent rate it pays on money deposited with it by commercial banks. Earlier in the month, ECB president Mario Draghi raised the prospect too, speaking of being “technically ready” for negative rates. Commercial bankers in turn have begun warning that any cut could prompt them to introduce negative deposit rates for their own customers.

That, of course, is the whole idea: if banks themselves receive a zero or negative return on a central bank deposit, they might be more inclined to invest the money elsewhere – for example, in a loan to a credit-starved SME. Similarly, if a cash-rich SME customer was going to be charged by its bank for depositing money, it might be more inclined to invest the money in a growth plan instead.

The theory is neat. But the practice is unlikely to be. Many bankers are already repeating their age-old line that a lack of SME appetite to borrow, rather than a lack of credit supply, is to blame for the logjam in SME expansion.

The data prove little either way, though there is stark evidence of a contraction. In the UK, for example, SME lending volumes have slumped by nearly a quarter to £170bn since their 2009 peak, according to one of those RBS reports, authored by former BoE deputy governor Sir Andrew Large. Comprehensive data for global SME lending are hard to come by, but it is fair to assume that other western markets have been through something similar.

An ECB survey this month reported a net 5 per cent increase in SMEs’ need for bank loans over the six months to October, but a net 11 per cent decrease in the availability of credit.

There are multiple reasons. A fair chunk of the lending broadly covered by the SME label was to the kind of commercial property business to which banks lent far too much to in the run-up to the 2008 crisis. So shrinkage here is welcome and necessary. SME lending is riskier than other forms of lending, so more cautious post-crisis banks are more likely to direct their money to safer big companies or well-heeled homebuyers.

Compounding that mood is the reality of global capital regulations, which make it far more costly to lend to smaller businesses. Bankers say a typical SME loan might absorb $5 of capital for every $100 of loan, compared with about $1.50 for an average mortgage.

It is time policy makers came up with a convincing plan to deal with the problem.

Global regulators should look again at the system of risk weightings ascribed to SME lending. This is a topic that Germany’s savings bank sector, buttressed by a Bundesbank research paper with a similar recommendation, has been lobbying on for some time, convinced that SME default data are not as bad as everyone thinks. Central bank bosses from Germany, Italy and France are now said to be testing the validity of the idea.

If risk weightings are left unchanged, policy makers should try a different tack, focusing instead on boosting the role of non-banks. Far more could be done to promote the role of capital markets – with extra tax relief, for example, to encourage larger SMEs to issue bonds. Similarly, there could be new incentives for “shadow banks” to finance SMEs. Either way, there needs to be a clear vision, including a proper regulatory plan to police non-banks.

All in all, the combined efforts of politicians’ bank-bashing and central banks’ monetary policy making have produced limited results to date. If SMEs are really going to spark an economic recovery any time soon, fresher thinking is needed to sustain them.