Treasury subsidises small-business loans


The government is to back loans for small and medium-sized businesses

Too-clever banking may have played a role in getting us into the economic and financial mess we're in.

But the Treasury hopes that a bit of financial engineering of its own will help to get us out.

The Chancellor, George Osborne, is aiming to use limited quantities of taxpayers' money to unlock private-sector cash and to stimulate activity by private-sector businesses, at a time when those businesses are scaling back investment and expansion ambitions.

The most eye-catching initiative, which goes by the name of credit easing, could reduce the interests costs on £20bn of loans for small- and medium-size businesses by around 1% over the next couple of years.

Then there's a separate proposal to subsidise to the tune of £1bn the creation of new private-sector funds that would lend to all but the very biggest businesses - in competition with the banks that currently dominate business lending.

Finally, the Treasury will be giving technical assistance to pension funds, to unlock around £20bn of British pension savers' cash for investment in roads, rail, and other infrastructure projects - to get British pension funds providing capital to improve infrastructure in the way that Canadian and Australian pension funds already do.

All three initiatives will probably be seen as useful help for the private sector, at a time when conditions are extremely tough.

But none, to use David Cameron's metaphor about what the ailing eurozone needs, will be seen as a "big bazooka" for the flatlining British economy.

Of the three, credit easing may have the biggest short-term effect.

This is what it involves.

First, the Treasury is taking back from the Bank of England £40bn of the £50bn of guarantees it has provided to cover losses on possible purchases of corporate bonds under the Asset Purchase Facility.

That was a scheme set up early in 2009, at the height of the recession, to allow the Bank of England to purchase the debt of companies, in the hope that this would make it easier and cheaper for businesses to borrow at a time when financial markets were not functioning properly.

The Bank never used anywhere like the full £50bn. And the Governor of the Bank, Sir Mervyn King, has advised Mr Osborne that it can continue to function adequately with a continuing guarantee of just £10bn.

So there is - in effect - £40bn of capacity to support finance for the private sector going begging (so to speak).

And that's what Mr Osborne has decided to deploy, in an attempt to channel finance to smaller businesses - which (as you can't have missed) have been complaining that the banks have not been providing enough credit and charge too much for what credit they do provide.

Now the important thing to stress is that the Treasury is not providing direct loans to small businesses. Taxpayers' cash is not being handed over.

What is happening, under what will be named the National Loan Guarantee Scheme (a moniker dreamed up for the last Tory manifesto), is that some of what banks borrow from investors - up to £20bn of the debt that banks sell in the first couple of years of the scheme - will have a guarantee from the Treasury.

To put it another way, the lenders to the banks will know that in the unlikely event that the banks can't pay them back, taxpayers would pay them back.

So the inherent riskiness of these loans will be lessened - and that means that the banks will be able to borrow at lower interest rates.

Here are the important bits of all this:

  1. the Treasury will insist that all the money the banks borrow in this way must be lent to smaller businesses (defined as any business with turnover or sales of less than £50m); and
  2. the reduction in the interest rate paid by the banks, the effective subsidy to the banks provided by taxpayers, must be passed on to small businesses, in the form of a cut - of around 1% - in the interest on loans provided to them.

So, if all goes to plan, smaller businesses should be able to borrow in total around £20bn at an interest rate around 1% cheaper than would otherwise be the case.

Which should be helpful to them. But won't transform their prospects.

It is important, for example, to be aware that guaranteeing banks' debts in this way may not lead to any increased supply of credit to small businesses.

The Treasury would like to see an increase in the availability of credit. And will distribute the guarantees to banks in a way that, it hopes, makes it most likely that there will be more credit available.

But the Treasury concedes that a rise in net lending can't be taken for granted.

Here's the reason why there may not be many more loans to smaller companies: the eurozone crisis is making it much harder for banks to borrow, so the new guarantee from taxpayers may simply fill a hole in the banks' financing needs rather than allowing them to borrow additional money.

None of which is to say that credit easing is a waste of time.

In today's challenging economic circumstances, providing confidence that there will be £20bn of finance available at slightly cheaper rates is probably not to be sniffed at.

Anyway, I've probably bored you into a near-comatose state with all this. But there are a couple of other points to make.

What the Treasury is proposing is similar to a smaller scheme already run by the European Union's publicly-owned bank, the European Investment Bank.

Via British banks, it has provided lower-cost loans of £2.3bn in aggregate to more than 7,500 small UK businesses over the past three years.

Now for the Treasury, what matters about the EIB's trailblazing is that the EIB has a mechanism for auditing and checking that the finance and subsidy it provides to British banks is actually passed on to businesses: the Treasury will use the EIB's verification procedures.

Also, the Treasury will share out the guarantees to banks based on a formula that takes into account whether individual banks have been increasing or shrinking the amount of credit provided to smaller businesses: so any bank that's providing relatively more small-business loans will be rewarded with disproportionately more of the taxpayer guarantees.

An official also told me that the Treasury would try to increase competition in the market for business loans, by favouring smaller so-called "challenger banks" when allocating the loan subsidies.

Which in theory means that Santander will get more of the subsidies relative to its current share of the small-business market, whereas the overwhelming market leader, Royal Bank of Scotland, will get fewer of the subsidies.

As for the timing of all this, credit easing should be up and running by January - whereas as the other two initiatives will take longer to have an effect.

One of them, called the Business Finance Partnership, will make available £1bn of real cash, for which investment firms can bid.

The idea is that private-equity firms, such as 3i, or fund managers such as M&G, will match whatever dosh the Treasury provides in this way, and the combined sum will form the equity capital of brand new funds that will then lend to businesses with turnover of up to £500m.

The idea is that since the £1bn is equity capital for the funds, or the portion of the funds available to absorb losses on credit provided to businesses, it can be "leveraged up" or multiplied by borrowing from investors.

So, for argument's sake, if it was distributed between five funds, along with equity capital provided by the five funds' respective backers, and the total equity capital was then leveraged with debt by five times, this would could make available £10bn of loans to businesses.

Note that this is very different from the guarantees provided in the credit-easing scheme. The £1bn is real money at serious risk of incurring losses.

Even so, the Treasury says the £1bn could be just a start. Broadly it sees the £1bn as a trial sum, being deployed to "prove the concept". If it were to work, more money would be made available.

And again there is a model for this scheme, in this case a fund created by M&G a couple of years ago, called the M&G UK Companies Financing Fund, which to date has lent £630m to seven companies, including Stobart Group, Barratt Developments and Taylor Wimpey.

As you can see from the M&G fund, the recipients of the help are pretty big companies, which for various reasons did not want to borrow from banks and were unable to raise the money they needed on capital markets by selling bonds to investors.

To put the £20bn of credit-easing and £1bn for the Business Finance Partnership into some kind of context, every year our big banks provide just over £100bn of actual loans to businesses, on the Bank of England's figures.

I am immediately going to confuse you by citing two other figures: under this year's "Merlin" deal with the Treasury, the big banks are committed to make £190bn of credit available to all businesses and £76bn of credit available to small- and medium-size enterprises or SMEs.

However, the Merlin figures include unused credit facilities, so they are supposed to show what companies could borrow, not what they've actually borrowed.

Also the definition of an SME for Merlin is a business with a turnover of £25m or less. Which means the annual credit needs of companies with turnover of up to £50m is probably over £100bn.

The conclusion to be drawn, whether you define the market in the way that the Bank of England does, or the way that the Merlin deal does, is that £20bn of subsidised finance is significant but not transformative.

Robert Peston, economics editor Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 1.

    A bit like the sub-prime proposals re housing, then.

  • rate this

    Comment number 2.

    The last Government rewarded the banks by kindly refunding them their stake money when they gambled and lost ( that was nice ).

    So what does this government do now ? Tells the banks to lend more, but not to worry, if someone does not pay you back, it’s not a problem as we’ll kindly cover any loses for you ( isn’t that nice again ? ).

    The banks are laughing all the way to the bank !

  • rate this

    Comment number 3.

    Any loans that are granted will be offered at the banks "normal" usury rate + 1%. And the banks say thank you Mr Treasury for boosting our profits, again! A bit cynical but remarkably true given how apparent handouts are swallowed up by the greedy banks.

  • rate this

    Comment number 4.

    Better to invest in public housing and infrastructure. At least we will have something to show for the investment. If I ran a small business I would be looking to survive this period not expand.

  • rate this

    Comment number 5.

    No doubt this will be wrapped in the usual red tape making it impossible for small businesses to really benefit without spending hours applying.
    Also will they want to borrow, if there is nobody buying their products or services will they actually want to take on the risk of further debt?
    Cutting taxes and red tape would help to stimulate the economy far more effectively and quickly.

  • rate this

    Comment number 6.

    Smoke and Mirrors that will benefit nobody but bankers and private equity companies, but not surprised about that from this government - i'll scratch your back if you scratch mine

  • rate this

    Comment number 7.

    Mr Osbourne has said we need these kind of measures 'to avoid us going back into recession' - for him (as a respresentative of the government) to admit this, it means that things from their perspective, are about to get substantially worse. Link this ti his hurried sale of Norther Rock and a bleak picture is painted.

  • rate this

    Comment number 8.

    So Gideon gives another 40bn to the banks, who will no doubt use it to bolster their balance sheets. I thought Project Merlin was about getting the banks to loan, considering we either own them or financially support them with billions of tax pounds. What about the Government loaning cash directly to small business?

  • rate this

    Comment number 9.

    Moral hazard? What moral hazard?

    Incidentally, part of this money that's being handed to bankers is coming out of the judges' pension fund, so I have high expectations that the service level agreement that the banks will need to sign will be enforced rather rigorously.

  • rate this

    Comment number 10.

    That's what you get when you bail out bankrupt banks and let them concentrate on bonuses and gambling instead of banking. The government has to try to bypass the zombie banks and do their job for them.

    How much easier it would have been to just nationalise bankrupt banks and reorganise them to do banking instead of fraud schemes and gambling.

  • rate this

    Comment number 11.

    It's been interesting watching this - about 2.00am it was £10bn, first thing it was £20bn, and low, it's now £40bn.

    The bit I don't understand is how come it's needed. The banks were bailed out on the understanding that they would resume lending at pre-2008 levels. If they haven't met their obligation, surely some action should be being taken - about time some heads rolled?

  • rate this

    Comment number 12.

    Money is fungible: money from this "guaranteed source" will replace, rather than add to, the more expensive money they were using from other sources.

    As for the 1% reduction in interest, it's laughable. So a secured loan to an SME will cost 13% instead of 14%?

    Channeling money through banks for anything is just giving it to them.

    This is just another taxpayer subsidy for the banks!

  • rate this

    Comment number 13.

    So, under which cup is the ball ?

  • rate this

    Comment number 14.

    Nationalise the banks! They belong to the tax-payer anyway.

    The banks were led by their (round objects) by their employees who wanted big bonuses for behaving recklessly and greedily and they deserve to lose their independence. The bonus seekers will not be missed when they decamp - just look at the state they got us into!

  • rate this

    Comment number 15.

    More from the tupperware party. Without growth nothing can endure let alone recover. The lies and obfuscation cannot conceal the fact that the bankers, and the rich failed catastrophically but appear not to have to suffer materially. At what point does it become obvious that the future tax income cannot be sacrificed ad infinitum to maintain the deception that everything can be got over.

  • rate this

    Comment number 16.

    You can lend business as much money as you like but it won't stimulate growth or create meaningful jobs. If you want growth you HAVE to get people buying things. It's buying stuff that creates demand - for that, job security is paramout. You're unlikely to go out on a spending spree if you think you'll lose your job next week. Can't Osborne see that?

  • rate this

    Comment number 17.

    Just another way to prop up the banks astonishingly bad balance sheets the banks have.They must have a fantastic hold over our political class to allow this to happen.
    And still we have no legislation to cover us from harm, its all old boys handshakes and pats on backs.
    The occupy movements are right our politicians are going to continue to support the banks until we force them to do otherwise.

  • rate this

    Comment number 18.

    Much as this sounds like a good thing it is most likely to go to existing reasonable sized SMEs rather than fund small business innovation. I will test this soon. The banks simply need more competition - the government should fund a new range of small business financing outlets to cut out the cream skimmers. This would also bring real information from the coal-face.

  • rate this

    Comment number 19.

    Might work if the money was coming through a nationalised bank

  • rate this

    Comment number 20.

    When Mr Osborne met the banks to discuss this did he still have his trousers when he left? It seems like they picked his pockets and got another nice subsidy for nothing. I don't think this guarantee will result in any new lending and a reduction of 1% on the exorbitant interest rates charged to small business is not enough in return for a government guarantee.The 20bn is just window dressing.


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