Why banks don't lend to businesses

Amongst all the smoke about the current budget, the problem of bank lending to small and medium sized businesses does not get much detailed debate. The trenches between the government and the Labour opposition are drawn roughly along the lines of trying to incentivise the banks to lend, or order the state owned banks to lend. The latter position is taken of course by many Labour politicians and union leaders who like to bash bankers for the damage done to the economy during the balance sheet crisis of 2008/9.

The Business Secretary Vince Cable has stubbornly tried to get away from these caricatures of the problem and recently outlined once again why banks are not lending. Apart from the de-leveraging that banks are currently doing to prevent any future bailout (and are required by European and British law), the main reason for their failure to lend is actually their weak presence in the local economy. British banks may have become major global players and draw much of the profits from foreign investments, but, despite their protestations and adverts to the contrary they have failed to foster strong community relationships with small and medium sized businesses in the local economy. It is here that local knowledge is generated which would allow banks to accurately assess risks of investments, and make informed choices about the financial support they grant to local businesses.

Not quite so local

This lack of local knowledge is not something that happened over night. In fact, Britain has long cultivated a different banking culture to that of Germany where banks are highly diversified and engaged in the local economy through investments. British banks have mainly drawn their income from investments in the commodity and financial markets whereas the investment functions often fell to entrepreneurial and venture capital. To turn this around and to create a more diversified banking sector is a major undertaking, and it would start with promoting more competition in the banking sector in Britain.