Correct me if I am wrong, but we have had a banking crisis caused by the banks lending too much to the wrong sort of people to buy assets which were too expensive like houses. Right?

This means that the banks are exposed to too many bad loans. Right?

This means their capital requirements, their cash on hand, is a little low. Right?

So …. wouldn’t that mean we want the banks to lend less and increase the amount of reserves they have available? How else could we hope to save the banking industry if not by controlling their over-lending?

@1: I’d invite you to read the rationale for increased lending set out in the Merlin Agreeement, to which I link. It’s only a couple of pages. Not my or LibCon’s agreement, but the banks’ and the government’s agreement.

We’re talking about lending for growth, not for “assets which were too expensive like houses’, which doesn’t form part of the Merlin agreement.

Peston is right in the sense that it’s not the banks fault that their HQ’s are staffed by people who should have been taken round the back of woodshed and put out of their misery by the market.

If you look outside these rather meaningless party-political arguments, there’s the biggest deleveraging ever known in anyone’s lifetime going on at the banks. Many of the world’s largest financial institutions are effectively being allowed to close, sometimes with a big noise (Ireland), other times quietly (Eurohypo, WestImmo, BoS). Banks are largely in the hands of politicians, none of which had a clue how to regulate banks during the boom, and no more idea now.

In this climate, and in any real-world environment, banks and government came up with a fairly meaningless target. Apparently without a sense of humour they called it “Project Merlin”. Like most government-set targets it was irrelevant at best and unhelpful at worst.

Against that backdrop the author of this piece grandly declares a “conspiracy” (though later – on the linked blog – admits that “It’s often difficult to decide what is cock-up and what is conspiracy”) and declares that “this deliberate tissue of lies” is part of the pursuit of “naked class power”. Er … hold on Dave Spart …

Looking at Paul’s analysis of the bank debt it’s clear that this is subject new to him. Refinancing existing debt isn’t about “business stability” nor about “enabling businesses to cope with continued bad trading times in the expectation that things will pick up”, it’s refinancing existing debt. If I borrow from a bank for a year and then a year later ask for that debt to be extended by a year I’m actually asking for a new loan. The bank will book that refi debt as new debt.

I could go on but when you’re accusing someone of a secret conspiracy based on lies then the onus is on the accuser to actually have some sense of what he’s talking about. Oh, my mistake, I thought this was a serious site.

Lending is still lending thoiugh – whatever you lend for a bank still has to hold capital against it.

So which do you want? Banks to rebuild their balance sheets and be safer or for them to lend more money?

You simply can’t have both as they are mutually exclusive….

I just posted a much longer piece but it got wiped. Basically, to a bank refi debt is new debt, moreover banks are collapsing around our ears (did you see Commerzbank’s results?) and you’re worried about making up some conspiracy based on a politically-motivated (ie meaningless) target? Wow, that’s some misplaced priority.

The idea was a bit loony to start with, for me. The banks have a duty to make a profit for their shareholders, so how can and why would they choose to make loans that don’t make them the most profit?

If you want a bank that makes loans that keep the economy afloat, that’s the government’s job – and I understand they have a couple of banks kicking around spare…

@7 – Because they want permission to keep operating? It’s not like businesses don’t need to comply with regulations or something, although from looking at the right wing press, they both have to with a ton of red tape and at the same time are mystical free spirits, I know…

Leon; it’s a good point, but I think regulations only *really* work well when you can measure them easily – are you dumping toxic chemicals in the river and so on. When it’s a bit more slippery and complicated – “are you making lending decisions beneficial to society as a whole” – then I think you’re probably entering into a losing game.

To put it another way, there’s an extent to which you can can influence behaviour the way you want to by changing the constraints (and/or the incentives). Beyond that, you’re probably better off changing the *goals* of the decision makers; ie, by bringing them under the control of the government.

@3: I’d half agree with this as a current state of affairs, but I’m not sure you can absolve the banks for not having the right staff when it as them that made a load of the capable staff redundant (not in HQ, but in branches). Further, there is an explicit commitment by the banks, in the Merlin Agreement,

to work with their ‘relationship managers’ to help them understand the bank’s lending commitments under the scheme. I’ve seen no evidence of this happening, through training etc., in my area.

I find the frame of the debate – about scapegoating a group – irrelevant and unhelpful. It neither explains why banks did what they do nor sheds light onto their behaviour now. Banks are under particular pressure to bear down on costs, boosting margins, while increasing pricing on risky assets. This is meant to shift bank operations towards ‘better’ lending. What is MUCH more likely is it will just mean risk aversion and less lending.

Stagnation is not the fault of either the banks or the government.

Because it is neither’s legitimate role or responsibility to try to macro-manage the economy and it shows how far down the state corporatist path we have come that nobody seems to understand this.

At a micro level, banks should be competing with each other to make good quality investment decisions and loans to businesses and the fact that they are not is the legacy of the failed attempts at macro management over the years and the corporate cartel that ensued.

Stagnation is a consequence of the fact that the insolvent banks were not allowed to fail in 2008, everything else is just flimflam.

And Project Merlin is, to be generous, a Faustian contract.

Another Tom @4 and @6: I think yoiur first comment may be the longer one, just delayed appearing. It looks like the systems a bit slow this morning, probably caused by the trillions of hits on my devastating critique…….

Anyway, one of the politer ad hominens I’ve had over the years here: “Looking at Paul’s analysis of the bank debt it’s clear that this is subject new to him.” I’m grateful for the relative civility, though as I’m currently going through a refinancing process for my own social enterprise (with a non-Merlin provider) I’m not sure I’d agree it’s totally new.

However, if I’m new to refinancing, so must be the Bank of England, whose duty it is to monitor this stuff under the Merlin agreement, because what was ‘refinancing’ under the agreement becomes ‘rollover’ in the data provided by the banks and cleared for publication by the BoE. So too, must the Chief Economist at BCVA, who clearly sees a distinction between new lending and rollover lending and who will have noted – like me – that the ‘new lending’ as measured in the BoE’s other data (gathered under its stats code of practice) is roughly half of the overall lending claimed under the (non-code of practice) Merlin data collection process. Why/how would they actually be measured separately by the BoE if refi/rollover and new lending are indistinguishable on the Merlin banks’ books?

Moving on….you say: “Against that backdrop the author of this piece grandly declares a “conspiracy” (though later – on the linked blog – admits that “It’s often difficult to decide what is cock-up and what is conspiracy”).

Nice selective quoting, certainly, in which you cleverly omit the two key reasons I give for suggesting that, though it’s difficult to decide what is conspiracy and what’s cock-up, in this case it’s conspiracy. To refresh, these are: the odd, unchecked shift from ‘refinancing’ in the agreement to ‘rollover’ in the data collected; b) the fact that there should be no need to collect separate data in the first place because the quarterly Trends in Lending data already gives lending trend data in a statistically robust manner, so why would the banks go to the extra expense of providing additional data which hasn’t been sanctioned under the BoE’s code of practice?

@ Leon

Because they want permission to keep operating?

Well done, mate.

In that one sentence you encapsulate why we are all fucked……..

Tyler @5: Yes, I agree on the mutual exclusivity, but the Merlin agreement is about lending to rebalancing-the-economy type firms, and in terms of the overall addtional lending set out in the Merlin agreement we are only talking roughly £11 billion (from £179 billion gross new lending in 2010 to £190 billion in 2011), which from memory is rougly equivalent to the City’s annual bonus deal. So if properly agreed and measured, and with the relationship managers properly advised/trained on seeking out decent, secure investment opps with SMEs, I think the additional lending would make sense as part of the whole.

@14 – Ah yes, because in your world companies don’t benefit from externalities and thus don’t need to have any involvement in society. No bank, in your world, is going to bother lending to small business.

No, we’re fucked because we’ve let companies run riot. Oh, and that “austerity” thing which is pushing up borrowing and crippling the economy and hurting the poor.

@9 – And setting lending targets is a reasonable middle ground. Now, fine the banks by the same percentage of their profit as they’re missing the lending targets by…

Another Tom @6 and @11: You say

“you’re worried about making up some conspiracy based on a politically-motivated (ie meaningless) target? Wow, that’s some misplaced priority.”

and

“I find the frame of the debate – about scapegoating a group – irrelevant and unhelpful. It neither explains why banks did what they do nor sheds light onto their behaviour now.

In broader terms I agree, and I’m sure you’ll join with me in supporting the bound-to-come LibCon blogpost about not scapegoating the poor/ill/unemployed/ etc/ etc.

Even so, I think it’s reasonable for a political blog to point out that the terms of a much-vaunted government initiative, under which the PM was able to state last week at PMQs that bank lending to small business is going up, when under more sensible measures it’s actually going down, are wrong and misleading. It’s also reasonable to point out that a senior BBC journalist has not checked source data.

It’s through exposing, in LibCon/my blog’s own small way, such hypocrisies and falsehoods in government/dominant media, that we may get to the broader, more honest focus on what needs to be done, which you rightly desire.

Thanks for the response. I don’t think applying for a loan makes you a finance expert but that’s by the by.

Note the following two points in the BoE’s release:

1. “These data are not collected under the Bank of England’s Statistical Code of Practice and the definitions of data used vary across banks.”
2. “Data include facilities that are undrawn or drawn.”

I have no idea why you are trying to draw a distinction between “rollover” and “refinancing”. You could also find the words “extension” and “amendment”. In modern-day banking parlance they could all mean the same thing.

“Why/how would they actually be measured separately by the BoE if refi/rollover and new lending are indistinguishable on the Merlin banks’ books?”

Maybe because all the institutions you mention are involved in a political argument about who should be scapegoated? (And the BoE has jealous guard of its own statistics.)

“Nice selective quoting”

You have no evidence of a conspiracy however many times you assert that it may be so.

Frankly, if I was on the left and critical of finance I could think of a 100 better things to do than coming up with secret plots. If you accept that Project Merlin is a political target then it all becomes rather clear and all this conspiratorial nonsense is a big waste of energy.

@17 after having worked in finance for well over a decade I find if you start out with the assumption that the media and politicians know nothing about debt and credit then you save yourself an awful lot of time. The assumption is rarely proved wrong.

Leon @16,

Ah yes, because in your world companies don’t benefit from externalities and thus don’t need to have any involvement in society. No bank, in your world, is going to bother lending to small business.

I wonder what the logic of that assertion is? Whilst the cartel of banks, backed by government, we have at the moment have no particular incentive to take risks, it is worth noting that small-business lending is hardly a high-risk activity anyway (the interest rates are calculated to cover the risk and a bit more…), So even in the current risk-adverse environment there is still lending to small businesses – even if a lot is keeping existing credit facilities going (i.e. keeping existing businesses and jobs going…).

If we liberalised the market – guaranteed only deposits, and ensured that these were taken out of the assets of bankrupt banks first, and therefore allowed businesses to fail – we would open it to more competititon, and this would allow more risk-taking, and therefore more creative lending. By reducing the need for competition and minimalising the risks of following a safe strategy (ironically it seems that guaranteeing the losses of banks is rewarding risks by allowing them to not have to take any more and still live comfortably – I struggle to see who can support this as an outcome).

More government control either has to be direct state control (and state-directed systems have been tried repeatedly, and not worked as well as we might wish – plus they are open to serious corruption) or in the form of the cartel-system of a few banks (and a larger number of small organisations that cannot break into the large company’s market share) that we currently enjoy, and which whilst they are presumably meeting their lending targets, are also clearly doing so in a safe way, renewing safe credit rather than having to take risks.

Incidentally, Paul was almost right with his criticism – but he saw it as a balance-book trick, rather than realising it is a real-world issue of lack of incentive to support new initiatives. I think Another Tom is probably right on the lack of need for seeing conspiracy, because cartels do not need to conspire to live happily without risk taking.

Actually i may owe Robert Peston half an apology. I don’t know why he blogged in exoneration of the banks yesterday, when in July he clearly had some homework: http://www.bbc.co.uk/news/business-14280628:

“More seriously perhaps, Royal Bank of Scotland – by far the biggest lender to small businesses – does not include undrawn overdraft facilities in its Merlin data. By contrast, the other banks include undrawn overdraft facilities in their Merlin numbers to a greater or lesser extent.

What that means is that most of the banks have the ability to hit their small business lending targets by increasing the borrowing limits of their existing reliable customers, whether or not those customers have demanded or want an increased overdraft.”

His focus on how the banks are fiddling the numbers is different from mine/BCVA’s, but he did at least recognise that something dodgy is going on (and he also refers to the code of practice issue).

All of which puzzles me even more as to why he’s defended the banks like this this time around.

Paul,

I can see your argument that the banks are possibly fudging the figures to make it look as if they are doing more new lending than they actually are, and you may well be right. But to be honest I don’t really think that’s the issue.

Firstly, do we really want banks to take on more risk? I would remind you that it was excessive risk in retail and corporate lending that brought down three of the four banks that failed in the 2008 financial crisis and contributed to the failure of RBS.

The sheer illogicality of Project Merlin is breathtaking, actually – on the one hand we want banks to be more prudent in their risk-taking and increase their capital buffers to protect us from losses, but on the other hand we want them to lend more to SMEs at higher risk in the interests of “rebalancing the economy”. How on earth is anyone supposed to square that circle?

Secondly, there’s the little matter of how much debt we really want in our economy. According to BIS figures household debt is about 100% of GDP and corporate debt about 125%. That’s in addition to our public debt of around 80% of GDP. Those three combined are sufficient to explain economic stagnation. Do we want MORE debt in our economy – or should we really be allowing this credit bubble to deflate, even if it means accepting stagnation for a while?

I’m not opposed to the idea of banks lending to SMEs that are viable businesses and a good investment risk. Indeed, I borrowed a bit more myself this year (much to my surprise my bank regarded me as a good risk!) I have a real problem with the idea that banks should be lending to enterprises of marginal viability just to get the economy growing or because the government says they should.

@22 – “Those three combined are sufficient to explain economic stagnation. ”

Sure, nothing to do with rock-bottom consumer confidence. No.

And it’s not just marginal businesses who can’t get funding. It’s many. Even for what was, a short time ago, routine short-term funding.

The downstream systemic consequences of banks being reluctant to lend to SMEs for business projects, because of the higher risks involved, are that such decisions will turn out to be a self-fulfilling prophecy.

The government is relying on net exports, business investment and Britain’s heavily indebted consumers to make up for the cuts in public spending to maintain aggregate demand. With the hiatus in the Eurozone, it is optimistic to expect much of a contribution from additional net exports – and by the news this morning, the Pound was appreciating against the Euro.

@10

I’d half agree with this as a current state of affairs, but I’m not sure you can absolve the banks for not having the right staff when it as them that made a load of the capable staff redundant (not in HQ, but in branches). Further, there is an explicit commitment by the banks, in the Merlin Agreement,

I think if you consider that we’re now 16 years (if you accept that the dot com bubble began in 1995) into a situation where financial profits have been largely driven by bubbles, it’s not particularly unreasonable for banks to get rid of those localised mechanisms when there’s no incentive not to.

Why lend to K.P Plumbing when you can loan to Brazil at 5% or Australia at 4%?

@12

Stagnation is a consequence of the fact that the insolvent banks were not allowed to fail in 2008, everything else is just flimflam.

Which is a consequence of the dot com bubble not being allowed to take its re-allocative course because of Greenspan and his interest rate bullshit, which has now left us nowhere to go.

Every time states double down on failure, it just gets worse and worse.

23 Leon Wolfson

1) Highly-indebted consumers don’t want to spend money, of course. And nor do consumers who are worried about losing their jobs. So yes, consumer confidence absolutely has a bearing on this.

2) What is your evidence that viable businesses can’t get short-term funding? I run a small business and had no trouble at all borrowing more from a High Street bank this year.

24 Bob B

“The government is relying on net exports, business investment and Britain’s heavily indebted consumers to make up for the cuts in public spending to maintain aggregate demand.”

Which explains why the Government is so worried about the Eurozone crisis. Their economic strategy was utterly dependent on increasing exports, which would have been primarily to Europe as the UK’s major export market. As that’s obviously not going to happen, public spending cuts will drive the economy into recession. In the absence of exports increase, you can’t cut public spending while the private sector is net saving without causing the economy to shrink. Mind you, some people think this is a good thing (not me, though!)

@26 – Debt? Uncertainty and hence low spending because of a *depressing outlook*, among those WITH money to spend.

And er….first page google result?

http://www.bbc.co.uk/news/business-15156609
http://www.businesszone.co.uk/topic/finances/small-businesses-struggle-secure-lending-loans/37133
http://www.bytestart.co.uk/content/finance/funding/BofE-small-business-credit-conditions.shtml
http://www.moneywise.co.uk/markets/corporate-news/are-big-banks-failing-small-businesses
http://www.telegraph.co.uk/finance/yourbusiness/8836528/Entrepreneurs-fear-approaching-their-bank.html

…I could go on, but really?

Paul,

Why do you think banks are not lending?

If there are loans to be made that banks can reasonably expect to be repaid, why aren’t they making them? That is, after all, how they make money.

One explanation for lower net lending is of course demand-side – in the current climate firms are cautious and do not want to borrow, and many of them are accumulating rainy-day cash balances rather than seeking to borrow. I don’t know how you have ruled out this explanation.

But if you favour a supply-side explanation, I’d be curious to know why you think banks are declining profitable lending opportunities.

One explanation is that the requirement that banks improve their capital buffers is causing them to shrink their balance sheets. If that is your favoured explanation, how would you solve this problem?

Leon,

Interesting collection of links. All except the first talk about the high cost of borrowing, and the last is an example of what we call “discouraged demand”. The Moneywise one makes a good point about the centralisation of lending decisions making bank lending to small businesses bureaucratic and inflexible, a point with which I would agree. Realistically, though, lending to startups and businesses in depressed sectors such as retail is going to be expensive. I’ve argued for a while that the requirement for banks to increase their capital means that they will increase the spread between lending rates and rates paid to savers. I think we are seeing this happening, and part of the problem with small business lending therefore is businesses being unwilling or unable to pay the increased cost. I think it is also fair to argue that banks are reducing their balance sheets, and the highest-risk lending is bound to be the first to go. Established businesses with good cashflow are probably experiencing much less difficulty with financing than startups and businesses with uncertain cashflow (hence the difficulty with overdrafts, which are typically used to manage cash flow problems).

@30 – Oh it feeds off itself, absolutely, in that it discourages many people from trying in the first place. But they really are hurting even established customers with credit facilities, causing both current and potential jobs to be lost.

These are *not* big bets. It would be perhaps be reasonable for the government to provide a low level of guarantees towards default levels in return for penalties for not meeting the targets.

Also, some sectors run on periodic overdrafts practically indefinitely, and in the past banks have been sensible about this… (The refrain in one of them “I told the bank what I was doing, they were fine, then they changed their mind AFTER I’d used the facility” also strikes me as something which shouldn’t be allowed to stand)

@31 Leon Wolfson

Government guarantees for small business lending were mooted by Osborne at the Tory party conference, as I recall – though he hasn’t done anything about it yet. In principle I think this is a good idea, although there would have to be caps on the guaranteed amount as it’s potentially a high risk for government money.

As overdrafts are uncommitted lines of credit they can be withdrawn without notice. I agree it’s unfriendly and unhelpful actually to do so though.

If we’re talking small business lending – I’ve just been told by a friend that his company’s overdraft is over £25K, and therefore the bank require it to be secured against his house!

So the bank’s risk is tiny.

Apparently smaller overdrafts are not secured.

Wonder if the borrowing for a social enterprise above – required security against bricks and mortar?

Frances/Luis in particular: Sorry I didn’t get back to this last night, didn’t get back in till late. Will try to respond later to legit. questions about why/what instead, though of course the OP was really a crituque of Merlin in its own terms.