Lending by banks and building societies in the three months to February tumbled by around £9bn. In February alone lending fell by £4bn to its lowest level for almost two years, according to The Daily Telegraph.
It is sobering news when everyone wants the banks to make more money available to business so that we can grow out of the recession.
Why is this happening? There are a number of things at play. First, banks want unreasonable levels of security and that is making investment propositions unfeasible. Also, it is getting more expensive despite base rates being at record lows. But of course banks don’t fund themselves at base rate, they have to go on the markets themselves to borrow and what they can borrow at is dependent upon the quality of the assets they hold.
Another factor is the new solvency requirement that is making banks hoard more cash. They do this in two ways: they don’t lend, thereby not creating any risk; and they reduce customer borrowing by reducing overdraft levels for customers. This is where real damage happens because as cash comes in, the banks snaffle it and at a stroke working capital available to firms has gone.
Enterprises that don’t have much in the way of fixed assets find it tougher to borrow money. A construction company when compared to a manufacturer of a similar turnover has negligible assets. It has people and it has contracts and advance payments. The manufacturer may have a wide customer base, a factory and plant and equipment, a product and designs as well as inventory. There is reasonable security to borrow upon. Also there is often predictability in the business.
It’s pretty clear that Project Merlin, the government’s deal with the banks to improve cash flow for SMEs, is making little impact.
The biggest danger to firms is usually as recessions are ending and business starts to improve. That’s when the shortage of cash hits hardest. Without the support of lenders, it becomes impossible to continue.
Overall confidence is not helped by the problems in the Eurozone and the imposition of strict austerity measures as the medicine. With some commentators threatening the collapse of the euro and others the reverse, it’s hard to understand what will happen, hence lenders’ defensive attitude.
The medicine we are being asked to take seems to be killing the patient, so you have to question the medicine.