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UK KfW must lend wisely, not too well

The ghostly form of the UK’s small business development bank is becoming visible. One can guess how it might work. But government rhetoric that it will unlock a dammed flood of credit to thirsty Bill Gates types is misleading. Modest and careful assistance can help SMEs. Thinking of this as a macro stimulus splurge will end in tears.

The UK’s development bank will be a bank. At least, it will be called a bank. That much is clear now about the plan, after Vince Cable, business secretary, got to bask in the glory of the idea on Monday.

In a timetable that was no doubt carefully negotiated between the UK’s coalition government partners, the Liberal Democrat Cable was allowed to tell the public that the bank would have £1bn of capital from the government, plus private capital, reckoned by commentators to be another £1bn, so that it could support £10bn of lending to small and medium-sized businesses.

What he only hinted at was how it would operate. George Osborne, Conservative chancellor of the exchequer, will have the prize of announcing that in his Autumn Statement on December 5.

There are clues in Cable’s language, however. The bank will be at “arm’s length” from the government and “commercially focused”. It will “facilitate the provision of loans, including long-term capital, to UK firms through banks and other financial institutions”, by “harnessing the power of capital markets”. Finally, we are told “it will not displace or subsidise banks” but “encourage the development of private sector solutions and enable the market to work properly”.

It seems clear that the new bank will not itself lend to businesses, nor originate loans directly. Nor will its effort be focused, like the Funding for Lending Scheme, on subsidising banks’ funding. Its capital requirement suggests that it will be taking risk. And it will use the wholesale markets.

It sounds like the UK KfW will be taking some of the junior risk, perhaps including the equity layer, in pools of SME loans originated by banks and other financial firms. The senior portions of the loans will be financed in the capital markets, either through the balance sheet of the intermediary firm, or directly, as in a securitisation, or perhaps even through debt issuance by the development bank.

Gingering up

Exactly how this will change financing conditions for SMEs is hard to predict. Its mere creation could inspire confidence among entrepreneurs and encourage them to go ahead with investments they had been backpedalling.

If it supports lending in a way that stimulates loans to borrowers that were previously deprived — especially new start-ups, and businesses with only a short track record — that could make a difference.

One of the lowest rungs of businesses is those financed with a mortgage on the entrepreneur’s home. A definite change since the financial crisis has been the sharp rise in the average deposits required for mortgages. A 95% loan-to-value mortgage used to be fairly easy to come by; now it is much rarer.

But no one should expect the UK’s Business Bank to produce a new crop of Microsofts and Googles — or even Dysons — nor a sudden surge in sustainable economic growth.

The seven biggest UK banks already provide £39bn of debt to small firms with annual bank account turnover up to £1m, according to the March British Bankers’ Association figures.

They lend £64bn to firms with turnover from £1m to £25m. In each category there are several billions of loan facilities that are available but undrawn; and each group’s balances in deposit accounts exceeds its borrowings.

The great majority of UK SMEs, in other words, are already financed — and it is fair to assume that among them are the better ones.

Although SMEs employ 45% of British workers, they are not, as a study by the British Private Equity & Venture Capital Association points out, very capital-intensive. That means more finance would not necessarily enable them to grow rapidly. Furthermore, only about 6% of SMEs are high growth firms — the same proportion as among large companies.

Look before you lend

It sounds harsh to say it, but it is not necessarily right for everyone with an idea for a business to receive a loan to finance it. Some ideas are good and managers competent; others are not — or may need to improve their idea before launching it.

Entrepreneurship, whether or not it involves innovation, and whether or not it is ever likely to lead to a large business, should be encouraged and nurtured. But getting that right is not about pressing the risk pedal to the floor.

As EuroWeek has argued before, the best thing the UK KfW could bring is an infusion of German long term thinking to industrial policy and finance.

That may be too much to hope for, but what the Business Bank must aim to be is a wise head — making sure good businesses are helped, without the straitjacket of shareholder pressure — but not just turning on the money taps and hoping for the best.

In the consumer banking sector, that was the policy until 2007, and look where it got us. Plenty of growth, then a crash. That UK banks were more stringent in their underwriting of SME loans than they were of mortgages and credit cards is not a curse, but a blessing.

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