Coalition’s crazy credit contradiction
YOU can’t have lending without borrowing. They are the two sides of the same coin. Yet try telling that to those who, in the same sentence, want more lending yet also want the UK to deleverage. As contradictions go, it takes some beating.
But this entire debate is disturbingly muddled. Two different concepts are mixed up: net lending – the increase in debt after accounting for repayments – and gross lending – which tallies up new loans and doesn’t account for the repayment of previous loans. Unless you ban people from paying back debts, nobody can control net lending – banks and politicians can only impact gross lending, and even then really only have influence on the potential supply of new loans (unless you force people to accept loans, or increase their untapped facilities, such as overdrafts, without telling them, and classify it as an increase in credit).
The Merlin deal, which supposedly fixed targets for lending, the results of which were published yesterday, was always a joke – on that the Labour party is right, albeit for the wrong reasons. The agreement was defined in such a way that it was never meaningful. It was a preposterous attempt by the Treasury to centrally plan credit without actually doing anything about it. At least it was never going to trigger another epidemic of sub-prime lending, which is what it sometimes seems this government would like (even though the crisis was caused by too much cheap money lent to the wrong people). The Treasury’s forthcoming attempt at boosting small business loans – via credit easing – could mean loans that now get turned down because they are deemed too risky will happen, backed by controversial new guarantees from taxpayers.
So given that retail banks make money from lending, why aren’t we in a new credit bubble? Why aren’t the banks doing what so many people want, and lending like crazy? The answer is two-fold: the demand for credit is down – cautious individuals and firms are deleveraging. The supply of credit is also being restrained. UK banks have rightly realised that they must be safer. Foreign lenders have partly withdrawn from the UK; finance is deglobalising. And official banking policy – as devised by Basel, the EU, the FSA and so on – is to make banks hold more, higher quality capital and maintain increased liquidity.
Because banks need to make a certain return on their capital to be viable, and can’t lend as much as they did before for every given unit of capital, this is reducing the supply and increasing the cost of credit. Long-run, this makes banks safer; short-run, it constrains the economy and the money supply. On top of that, lending to small businesses is deemed by regulators higher risk than other kinds of lending – so banks are forced to hold more capital against loans to small firms, making lending to them even less profitable. Marginal loans will no longer be viable and won’t happen. Yet a government that claims to want to boost small firms has signed up to this.
The capital adequacy rules are designed to encourage some lending and discourage other kinds. They are working too well. If politicians are really worried about the availability of credit for small firms, they should suspend the rules – not embark on QE or credit easing, which merely address the consequences, rather root causes, of the problem, and guarantee nasty side-effects. The current situation is one giant, preposterous contradiction.
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