Are we funding another round of losses?



Surely history teaches us that given freedom, banks will either do something stupid (125%, self-certified and buy-to-let mortgages), evil (manipulating LIBOR) or both (Payment Protection Insurance.)

So we have to view with concern the decision by the Financial Services Authority to allow banks to treat lending to businesses under the Funding for Lending Scheme as virtually risk free, so that they do not have to set aside capital to cover possible defaults.

You can see why the FSA, presumably with the blessing of the Treasury, has done it. All the Government’s various attempts so far to get the banks to lend to small and medium-sized firms have failed. The voluntary Project Merlin targets were missed, the National Guarantee Scheme did not produce any appreciable upturn and so far Funding for Lending – under which the Bank of England will make available up to £80 billion in ultra low cost money to the banks – has reduced their cost of capital, but done little or nothing for cash-starved small firms. Loans to businesses shrank by £2.2 billion in August.

The banks cite lack of demand for their disappointing lending figures and it is true that the sort of companies the banks want to have as their customers – sound, long-established businesses with good cash flow – are holding back investment until they see an upturn in the economy.

But below them is a mass of smaller, newer businesses which are being squeezed by late payment by their customers and stagnant demand. They are keen – or even desperate – to borrow, but lack the security or track record to satisfy the banks. Doubtless there are a lot of firms which are doomed no matter what; their business models are not robust enough to survive until the economy starts to pick up.

But there are also a lot of viable businesses which need to be nurtured through the recession if we are to have an industrial base capable of generating growth. Able to borrow at record low rates from the Bank of England, the 13 banks which have signed up to the scheme can pass on the cash to SMEs at highly profitable margins. With the Government effectively taking the risk, the temptation for them must be not to bother sorting the sheep from the goats, but to begin lending as much and as quickly as they can.

If they do that, it will be the taxpayer who – again – picks up the tab.