In many ways, the fate of SMEs (small and medium size businesses) has come to define the current economic crisis. Across the political divide there is widespread enthusiasm for supporting this sector because it holds the key not just to improved growth figures but a more balanced, resilient and dynamic capitalist economy.

Rob Tinker is a researcher at the Fabian Society

In many ways, the fate of SMEs (small and medium size businesses) have come to define the current economic crisis. Across the political divide there is widespread enthusiasm for supporting this sector because it holds the key not just to improved growth figures but a more balanced, resilient and dynamic capitalist economy.

However at present measures to improve small businesses access to finance are not working, and so many are standing still. On the other hand, those that see the UK economy haunted by zombie companies – just barely surviving thanks to very loose monetary policy – are no more optimistic about growth.

So although now already buried underneath the ONS’ first quarter GDP figures for 2013, the government’s announcement this week that it will extend and upgrade its flagship ‘Funding for Lending’ (FLS) scheme should not be separated from yesterday’s news. The puzzle of ‘boosting’ credit to this section of the economy remains unsolved and is no small part of the reason that economic output remains flat.

In short, FLS allows the Bank of England to give out cheap money to financial institutions which, in theory, should enhance their lending capacity to SMEs. The only problem is that, until now, that is the opposite of what has happened. Banks took the cheap money and forgot the third word of the acronym, with the result that SME lending has contracted continually since 2011.

Singular focus on austerity

That banks are being instructed to hold more capital goes part of the way to explaining this. But given that on some measures SMEs account for 99 per cent UK businesses this provides little comfort. Responding to calls from, amongst others, the deputy prime minister to put FLS on a trial of ‘steroids’, yesterday’s announcement extends the life of the scheme and provides new incentives for a wider range of institutions to lend.

Although on one hand a genuine attempt at reviving economic health, it is also a political response to mounting concerns about UK’ singular focus on austerity.

But FLS-plus alone won’t solve the problem of SME access to finance. Market failure in the provision of finance to SMEs as well as structural ‘gaps’ in particular types and levels of credit should signal to the government that more intervention and innovation is required.

While the government appears to realise this in committing to a Business Bank, without adequate capitalisation above the £1bn already announced it is unlikely to be transformative.

Diverse funding sources

In response to this ‘new normal’, where discouraged ambition on the demand side compounds a more realistic pricing of risk in the in the supply of credit, a layer of innovative non-bank lenders have emerged to provide an alternative. Although unlikely to grow on the scale necessary the provision of debt and equity through peer-to-peer, crowd funding and factoring mechanisms at the least indicate a more diverse funding landscape in the future.

These recent innovations also point to fact that to meet the UK’s future business and infrastructure needs much more finance will come from non-bank sources such as pension funds. As a recent report by the Smith Institute notes, in 2011 local government pension schemes had an estimated market value of £143 billion at their disposal.

Wednesday’s adaptations to Funding for Lending are less important to yesterday’s GDP figures, although in the scheme of things one is not isolated from the other. Rather than a dose of steroids, Nick Clegg should take advice from his colleague Vince Cable, who in a recent article called for what could be a more effective medicine – an ‘eclectic approach‘.

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