One nation banking

George Osborne arrived at the Treasury in May 2010 vowing to slash borrowing, get banks lending again and boost economic growth. Two-and-a-half years on, after the longest double recession since the second world war, it is clear he has neither the ideas nor the attitude to make this happen.

That’s why Britain is more in need than ever of genuine economic and financial reform. The government has never produced a serious plan for jobs and growth and has instead thrown a series of ad hoc measures at the nation’s hard-pressed businesses.

All too often we have seen the chancellor reluctantly forced to act after the emergence of bad news on the recovery, rather than setting out balanced plans based on economics instead of politics. The result is that measures to stimulate bank lending to small and medium-sized enterprises (SMEs) have had a back-of-the-envelope feel to them.

Project Merlin was supposed to boost business lending but the government’s agreement with the big five banks certainly lacked magic. Its targets applied to ‘gross’ rather than ‘net’ lending and it failed to take into account the cost or terms on which finance was offered. It was therefore no surprise when the largest participants – Lloyds, RBS, HSBC, Barclays and Santander – met their overall commitments last year but missed their targets for lending to small business.

And so it was that the chancellor’s second attempt at the issue – the £20 billion national loan guarantee scheme – proved also to be a let-down. George Osborne claimed the scheme, known as credit easing, would provide a “real boost to British business” but it only offered around £2.5bn in loans to firms before it was superseded after just eight months of operation.

These failures help explain why net lending to businesses fell every month during the coalition’s first two years in office. That’s why I hope the government will be luckier on its third attempt and that is ‘funding for lending’ scheme gets banks working for SMEs and the wider economy once again. This latest effort will see the Bank of England lend money at below-market rates to financial institutions over an 18 month drawdown period. But the jury’s still out on whether we will finally see a boost in new lending rather than simply ‘churn’.

It would be wrong, however, to simply sit back in Downing Street, wait and hope for the best, as Osborne and David Cameron seem so content to do, even though the economy has hardly grown over the last year. Instead we need more action to get us out of the rut. That is why funding for lending should be urgently reformed to help boost corporate lending.

The scheme’s current rules allow for the Bank of England to approve the participation of banks according to a ‘base stock’ of eligible loans, which are linked to the cost of borrowing. Under international regulations banks are required to hold more capital against corporate lending compared to that required for mortgages, which means they are receiving far greater returns from non-corporate lending arrangements.

The chancellor should review the funding for lending rules to either make the pricing mechanisms around corporate lending more effective, or alternatively look at the total mix of lending offered by those banks involved and ensure there is a greater weighting towards SME loans.

One of the few positive side-effects of the government’s series of half-hearted interventions is that more people now understand the importance of bank lending to SMEs. These firms are the lifeblood of the real economy and make up 99 per cent of all private sector businesses in the UK, according to the Federation of Small Businesses.

They also provide nearly 60 per cent of all private sector jobs – a figure that could increase if the sector is given the right support so firms can take on new workers. At a time when major corporates are sitting on surpluses and watching the euro crisis unfold just over the water, Britain’s SMEs are crying out for backing so they can invest in their staff, in new technologies and in exports to the emerging markets.

For this to happen, the government needs break its cycle of ill-thought out fiscal choices and budget u-turns and begin to think about the long-term. A sustainable recovery needs a fundamental shift in the way banks work – remembering their obligations to customers, as well as to shareholders.

For too long bank customers have faced a range of difficulties from disparities from region to region, and even neighbourhood to neighbourhood, in the availability of credit and other financial products. The time has come for more transparency and for the big banks to be more open about what they are lending, and where.

This approach has already worked in the US, where banks publish lending data and work with community banks, credit unions and charity banks to ensure all of the areas in which they operate have fairer access to financial services.

We should now consider this approach in Britain – not just for personal account holders but for businesses too. Identifying the parts of the country being neglected by banking policy could help local and national authorities shape support for small and medium-sized businesses more effectively.

The publication of anonymised data on what banks lend, to whom and where, as well as stronger incentives to operate right across the country, including with community banks, would help banks be more accountable to local customers. It could end discrimination against individuals and small companies in more deprived areas of Britain and put pressure on the financial services industry and government to plug the gaps in the market.

It should be possible to improve the connection between small businesses and community banks, but it is not something that can happen overnight. I was encouraged to see the Community Development Finance Association has formed a partnership with the British Bankers’ Association to develop a pilot referral scheme, in which companies whose application for a loan was turned down will be put in touch with the most appropriate community lender. The scheme will concentrate on SME lending for loans of up to £50,000 initially, but figures of that kind can still make the difference between survival or closure for small or early stage businesses.

The state also has a responsibility to deliver value for money from its stake in the banks. For all its current problems, the financial sector has stabilised, due in part to the bold action taken by Gordon Brown and other world leaders at the height of the crisis.

So now, with business confidence in the doldrums and Britain facing the prospect of years of low growth, it is worth reviewing how well the government uses its bank shareholdings for the benefit of all in society.

The apparent unwillingness of the major banks to engage in normal lending practices is a matter of daily concern for small businesses. Yet the banks seem impervious to the entreaties of ministers to change behaviour.

The major banks are, of course, engaged in recapitalisation efforts and it is widely suspected that this trumps new lending when it comes to their core priorities. Nevertheless, it is legitimate to ask: should the government be a more active shareholder and encourage the banks it owns to change their practices?

While ministers have been relying on the dictum that any ‘intervention’ may jeopardise a return to the market of these state-owned banks, there are increasing voices calling for proximate stewardship by the shareholder.

It is reasonable to dialogue between the shareholder and executives on overarching business strategy – as any good investor would do with its portfolio companies. Given the significant role that banks play in society at large, I believe that it is perfectly acceptable for ministers to engage in such dialogue.

There is still more to be done, however, because our drive for growth must be relentless and co-ordinated– a fact the government has failed to grasp with its piecemeal approach.

The current redrawing of the banking landscape provides a chance to create a British investment bank. The concept has worked in the US, for example, where a similar institution lent money to a young Steve Jobs in the 1970s when ordinary bank managers struggled to understand his ideas, which ultimately led to the creation of Apple.

Today Britain is the only one of the G8 countries not to have a dedicated institution dealing with SME financing issues and initiatives, which is why Labour commissioned Nick Tott, a former partner in a City law firm, to examine the arguments for a new bank. He presented a strong case yet so far the government has resisted. Instead Vince Cable has thrown his weight behind a new business bank – and I fear if reports are right it will really be a repackaging of existing schemes, will take 18 months to get started and will not actually provide any loans itself.

A national investment bank that is genuinely new would be able to channel finance to Britain’s army of SMEs to help them to make the sustainable investments that are vital to their future and to that of the entire country.

Increasing choice in this way would benefit both business and personal customers. That has begun to happen already, with the Co-operative Group’s acquisition of 632 ‘Project Verde’ branches from Lloyds, propelling the mutual to be Britain’s sixth-largest bank. Sealing the deal has been a remarkable success for the Co-op, but the Treasury can take little credit because Lloyds was forced to sell under EU state aid rules.

Even more choice on the high street is needed however. Ed Miliband has spoken of his desire to see seven big banks, rather than the current five, and for that to happen it is vital that Royal Bank of Scotland presses on with its attempts to sell 316 branches, after the recent collapse of a deal with Santander.

This is not just about change for the sake of change. Increased competition would prompt banks to provide cheaper and simpler products and would disrupt the old model, where lenders relied on the lack of information and the lack of alternatives to eke out steady profits from personal and business customers year after year.

There are choices for government policy here and there are numerous ways to tackle the shortcomings in the banking system and create the conditions for a sustainable recovery. Many of these present opportunities to get a better deal for the taxpayers who stumped up to support the financial sector during the crisis.

Success requires a government which takes an active approach to the banking industry, can demonstrate a clear understanding of the challenges facing personal customers and small businesses and has a credible plan for nationwide economic growth.

This current coalition falls short in all these areas which is why Labour will continue to push for a cheaper, fairer banking system that uses local links to make informed decisions on SME lending and to stimulate the economic recovery which this country so desperately needs.