David Merlin-Jones presents the case for a British investment bank, funded through the money 'printed' for quantitative easing; it will do far more good than simply buying gilts
David Merlin-Jones is director of the “Wealth of Nations” project at Civitas. His report on the enterprise bank concept, “Extending lending: The case for a state-backed investment bank” is released today
It is a rather depressing time to be a small or medium-sized British business in need of cash. Commercial banks’ willingness to lend has shrunk dramatically and while this is a natural product of the recession and government pressure to recapitalise, they have also failed to deliver the increased lending to small and medium enterprises (SMEs) promised under Project Merlin.
The figures speak for themselves: 35 per cent of small and medium-sized businesses sought finance in 2007 and this rose to 42 per cent in 2010. In 2007, successful loan finance approaches to banks were around 90 per cent. This fell to 65 per cent in 2010.
The problem is that the value of bank loans often sought by SMEs, typically between £250,000 and £2 million, is not serviced by other lenders. It is too much for friends and family to raise and too little to attract institutional lenders’ interest.
Without access to finance, SMEs, the backbone of the British economy, will struggle to grow, increase exports and employ more people. Given they constitute 60 per cent of private sector employment and 50 per cent of private sector turnover, this is a huge drag on the economy.
The issue is compounded by the fact that some of our economic rivals have the means to overcome the lending problem in their countries via state banks.
America, the supposed beating heart of capitalism, has made great use of its Small Business Administration (SBA) which provides guarantees on commercial banks’ loans to otherwise unattractive businesses. Between them, the SBA’s two major loan programmes protected 550,000 jobs in 2010 alone.
In Germany, state-owned KfW provides loans to businesses through other commercial banks and in 2010 it loaned the record sum of €28.5 billion, creating 66,000 jobs and protecting another 1.3 million.
Without the state-backed lending, neither country would have been able to recover so quickly from the recession.
Given the continued seriousness of the problem in the UK, our solution must be dramatic, decisive and permanent: the creation of a British state-backed industry bank, perhaps called the Enterprise Bank.
Its aim would be simple: lend to any company, regardless of sector, which has been rejected by the commercial banks. The sole proviso would be that these companies must be creditworthy and demonstrate the capacity for long-term success. The sizes of loans offered should reflect those most frequently sought from banks, in the rough £250,000 to £2 million range.
The Enterprise Bank’s (EB) state-backed nature is crucial to its operation, as it would utilise the UK government’s AAA credit rating to leverage cheaper credit in capital markets. The savings could then be passed on to the borrower.
The aim is for the EB to work alongside commercial lenders, augmenting rather than replacing the current system. It should use a hybrid model of the American SBA and German KfW, so borrowers would first apply to the EB through their commercial bank. Cooperation could be incentivised by paying a fee to these banks for acting as intermediaries.
However, if commercial banks are uninterested, borrowers could apply directly to the EB. This way, crowding out is avoided while the borrowing company’s position is never jeopardised.
The idea of a national investment bank is not new. Indeed, Britain had one for decades in the post-war period, called the Industrial and Commercial Finance Corporation (ICFC). The concept has been experiencing a resurgence of late, although various other proposed models have focussed on the need to fund infrastructure rather than businesses or weighted them as equal priorities.
The Enterprise Bank model differs from these by lending purely to private businesses. Investing in infrastructure is of course important, but this can be done through other entities. Given the EB will have limited resources, these are best spent on overcoming the deficiencies of the current financial system and aiding the companies integral to economic growth.
While the EB should be free from politicians dictating where investments should be made, as others have rightly argued, this does not mean it should be run dispassionately by bankers. Instead, the lending decisions of the EB should be made by industrial experts with specialised knowledge.
The industrial ethos of the bank should be reflected in its organisation. It merits a decentralised structure, with branches located in manufacturing heartlands, to avoid the insular mentality the commercial banks suffer from.
The government has yet to realise how simple setting up the EB could be.
The state already holds an 84 per cent stake in RBS, so this (currently loss-making) part of the financial services problem could be transformed into the solution. In terms of funding, the government has shown itself unwilling to commit large sums of money to revitalising the economy: the Green Investment Bank’s £3 billion and the Business Growth Fund’s £1.5 billion are hardly game-changers.
To truly overcome the lending crisis, the EB should receive funding from the quantitative easing (QE) programme with the money diverted away from purchasing gilts. After the initial cash injection, the EB should be expected to run without further state money by reinvesting profits on its loans.
Arguably, this will be far more effective for kick-starting the economy than traditional QE and will mean the Bank can function without ever needing taxpayer money.
It is clear that Britain cannot rely on the commercial banks as a means of escaping the recession and if our economic rivals are willing to use state banks to help their businesses we are damaging our own prospects by not following suit. It is high time for the UK to adopt more pragmatic practises in the financial sector, and realise that the free market does not hold the answers to everything.
The Enterprise Bank concept puts public good before profits and, through this, ensures our economic renaissance.
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• Miliband: British Investment Bank could provide government banking for entrepreneurs when market fails – Will Straw, February 3rd 2012
• Mandelson weighs in behind National Investment Bank – Alex Hern, January 27th 2012
• The economy is crying out for more investment; we need a British Investment Bank – Will Straw, January 14th 2012
• A new strategy to help save UK manufacturing – Tony Burke, December 5th 2011
• Will Osborne alter course? And how should Labour respond? – Matthew Pitt, September 15th 2011