The Bank of Gideon

Apparently we will have to wait until the pre-budget report in late November for full details of UK Chancellor George ("Gideon") Osborne's new "credit easing" plan, which is aimed at kick-starting lending to small and medium-sized enterprises (SMEs). Still, the whole concept is sufficiently surprising -- dare one say, out of left field? -- that there's plenty to be said about it even now.

"Credit easing" will apparently involve the Treasury becoming directly involved in the financing of SMEs by acquiring their debts or bonds. The fact that the government is even thinking along these lines seems like an admission that two key initiatives -- quantitative easing (QE) and the "Project Merlin" agreement with the banks -- have failed to produce an acceptable rise in bank lending to SMEs. This should not really be a surprise to anyone. As has been regularly pointed out, both in this blog and in more reputable circles, the government wants the banks to do two essentially contradictory things: boost their capital ratios, and make more loans.

QE has always been a pushing-on-a-string endeavour. Banks are happy to see all that cheap cash washing around in the economy, but it does nothing to increase their willingness to lend. As for Project Merlin, most of the available data suggest that the banks have in fact come quite close to meeting the lending targets agreed with the government. The banks' contention that any slowness in lending growth reflects a lack of demand for credit seems quite plausible, though there is some evidence that SMEs have been less well served than larger corporations.

As long as the pressure to rebuild capital remains in place, there's little reason to think that credit easing (CE) will do much to change the behaviour of the banks. If CE involves the Treasury buying packages of loans from the banks, which is one of the possible approaches, it's more than likely that the banks will simply use the proceeds to add to their capital reserves, rather than going out and sourcing new loans. In that case, the result would simply be to shift some of the risk of lending to SMEs from the banks to the Treasury, or rather, to the taxpayer.

That risk will be further heightened if the banks are "selective" about what they pass on to the Treasury. Banks can only make money if they lend money, so they have no incentive to divest themselves of good. well-secured, performing loans. It's been suggested that the Treasury will protect itself from getting stuffed with the banks' less desirable loans by using credit rating agencies to assess the quality of what's on offer, which for some indefinable reason seems like a less than reassuring prospect.

OK, then what if CE involves direct lending by the Treasury (or a newly-established SME lending body), rather than just a giant secondary market or factoring scheme for the banks' existing loans? This would raise a whole different set of issues. What expertise does the Treasury have in this area, that would allow it to reassure taxpayers that it can assess credit risk better than the banks? There are plenty of currently or soon to be unemployed bankers out there that could be hired, but it would be truly astounding if that was what a Conservative government had in mind. And in any case, setting up such a body, funded at the lower rates available to the Treasury, might induce the banks to wash their hands of SME lending altogether, which would be in nobody's long-term interest.

No doubt the lobbying will be intense in the coming weeks, and it's clear that to this point, the SMEs are out-shouting the banks. It will be interesting to see what winds up in the pre-budget statement, due on 29 November. In the meantime, do I detect the ghost of Harold Wilson chortling somewhere in the background?