The Economic Voice

In a speech to the Institute of Directors’ Annual Convention at Indig02 on Wednesday 25 April, Deputy Prime Minister Nick Clegg is expected to say:

But I’d like to spend the rest of my speech on access to finance, specifically. We have a very serious problem here: Because, if the banks aren’t lending enough; you can’t grow; our recovery is slowed.

Some people are saying that reforms intended to fix the banking sector are actually making the problem worse, that efforts to replace recklessness with responsibility have swung the pendulum too far the other way. So I want to deal with that claim first, before coming on to government action to support lending.

The central criticism is this: Because the banks have been instructed to build up their capital stocks under new international regulations, BASEL III, and following the Vickers report. They’re rushing to fill their black holes. And, in the process, becoming too risk adverse in their lending; too demanding in their terms.

So let me be clear on the government’s position: I don’t apologise for taking a tough approach. The events of 2008 represented a catastrophic failure of regulation the likes of which must never be allowed to happen again. These more stringent capital requirements are essential for building a banking sector that is strong and reliable – which business needs too. Indeed, in Europe the UK is resisting attempts to dilute the measures, which would leave our economy exposed.

But these new requirements are not a reason to sacrifice business lending – because they don’t need to meet them overnight. The banks are not in some impossible catch 22. And it is not beyond them to get the balance right: Taking advantage of the flexibility built into the regulation: The very sensible timetable, which gives them until 2019 to meet their capital targets, allowing them to make progress in a phased and steady way.

Some in the banks might argue that the real issue is a lack of demand – that’s why lending’s down. And I don’t deny that demand may be an issue. But I hear time and time again from businesses like yours that you are desperate for the loans. There is no excuse for turning down solid loan applications from viable firms. And we need to ask: how much capital are banks devoting to business lending compared to their trading operations? How much are they distributing to shareholders or top executives, compared to business?

My message to the banks is this: Yes, of course, get your balance sheets in order. Meet the new capital requirements. But don’t lurch to the other extreme at the expense of British business. Don’t unnecessarily hoard capital when businesses need loans. Don’t sit on your hands while firms are crying out for cash. And understand that getting credit to businesses is in your interests too. Healthy banks have diverse portfolios – lending to business for the longer-term as well as participating in the short-term money markets. And a healthy banking system needs a growing economy as much as everyone else.

For the government’s part, we are doing everything we can to increase the flow of credit and finance to SMEs.

Ministers cannot march into the banks and start taking their individual lending decisions for them. But we can and we are using our position to exert pressure: That’s how we negotiated £76bn for SMEs through Project Merlin; and how we got them to set up the £2.5b Business Growth Fund to invest in high growth UK firms.

Despite the enormous strain on the public finances. We’re also devoting huge resources to supporting lending. Last month we launched the £20bn National Loan Guarantee Scheme.
We’re also directly providing funding through a number of programmes. Including, for example, the £2.4bn Regional Growth Fund, which supports firms in communities too reliant on the public sector and of course the government’s fiscal policies have created the monetary space for the Bank of England’s quantitative easing programme, giving the banks more capacity to lend.

And, beyond applying pressure and providing direct support, there’s another, crucial, lending lever. One we’ve perhaps talked less about: Promoting competition, driving lending by creating a financing landscape that is much more competitive and diverse.

Our financial sector has become dominated by a handful of global giants, so preoccupied with their investment arms, so bewitched by the high returns offered by the international money markets, they don’t always remember how to do good old fashioned business banking. I’ve lost count of the times I’ve heard about local branch networks being left to wither on the vine.

We need a much more diverse lending landscape. So that your firms have more choice and the banks have to compete. Look across the Atlantic and you’ll find three times as many independent banks as here in the UK. Germany has hundreds of local savings banks that match local depositors’ moneys to the needs of local business. We need to break open the market here in the UK, with more competition within the sector as well as more alternative sources of finance, outside of it.

In the sector, we are already seeing positive signs, more challengers to the larger incumbents. Handelsbanken, the Swedish bank, are setting up more branches here, empowering their local managers to take local decisions. Aldermore has confirmed they want to participate in the Government’s National Loan Guarantee scheme. In the consumer sphere, Virgin Money and Metro Bank are steadily growing their branch networks. We want to see more of that. And one of the new financial regulators – the Financial Conduct Authority will have an explicit duty to promote competition in financial services and markets.

And, outside of the traditional sector, because this is so important, Government is directly intervening to create more alternatives to the big banks.

Stepping in, for example, to boost finance to specific, high value industries. That’s the purpose of the Green Investment Bank – the world’s first national financial institution devoted to green investment which will be used to unlock low carbon growth.

And we’re doing something no government has ever done before: investing directly to unlock non-bank sources of finance.

Tim Breedon, the Legal & General CEO, looked into this very issue for Vince Cable and he found that many of the alternative financing mechanisms that exist out there, if properly harnessed, can help close the financing gap. Not to replace traditional banks – which of course have a crucial role to play - but to compliment them, to open up choice.

Like peer-to-peer lending: Platforms that introduce investors or lenders to firms needing cash. Many of you will know how they work: as, kind of, dating agencies that match people with money to entrepreneurs. The Americans have just passed a new law to make peer-to-peer platforms easier to set up.

Supply chain finance is another. Say you supply parts to a big manufacturing plant. Perhaps, under the contract, they have three months to pay you. But maybe you can’t wait that long.
Under these schemes a third party lender will step in and cover your bill. They know the big plant will pay up, so they give you the money, confident they’ll get it back and – crucially – at an interest rate close to the one the plant enjoys. The lender makes money, the plant benefits from suppliers paid up in time and you use the bigger firms’ financial clout to get paid.

Then there’s mezzanine financing. Loans with an in-built holiday – so you don’t begin repayments straight away. A lifeline for people with great ideas but who will take a bit of time to start seeing a return.

Many of you will have come across these models. But you’ve told us that they can be difficult to access, or they have trouble getting going. There’s real potential there, but someone needs to step in and give them a boost. Since the late 1990s we’ve seen government do that with venture capitalism to help tackle the equity gap. Now we need to be similarly ambitious on non-bank financing to help tackle the finance gap.

So the Coalition is going to invest directly in non-bank finance as part of our £1.2bn Business Finance Partnership. £700m will be invested through up to seven fund managers who will lend directly to British firms. There will be additional investment from the private sector with our share eventually returned to government. That still leaves half a billion, £100m of which will be invested in banking alternatives for SMEs. And, if we see quick take off, I will certainly want us to invest the remainder as quickly as we can.

Investments will be made over the coming months, to precisely the kinds of schemes I’ve described and I’m issuing a call to all of you today: Tell us your ideal way to bypass the banks to unlock new channels of capital. How can we help rewire money to the small business world? Because, yes, we’re rebuilding the banking sector to make it safe. Yes, we’re intervening to make the banks lend. Yes we’re supporting credit and investment ourselves. But the missing parts of this puzzle are competition and diversity. So tell us what would work for you.