The National Loan Scheme Conundrum

Originally published in Entrepreneur Country, 02 December 2011.

I watched George Osborne’s Autumn Statement on Tuesday with a great deal of interest. I was eagerly anticipating the statement confirming exactly how £20billion in funding will be delivered to SMEs, a story that had been circulating in the press for the previous few days.

I won’t bore you with my comments and thoughts on the overall statement, George’s performance or Ed Balls counter – If you are interested, please do take a look at my Twitter feed (@naszub) for the instantaneous reactions. (I will however reiterate one point that is still perplexing me – Ed used the phrase “illiterate fantasy” can somebody please explain that to me????)I will instead focus on the crux of my loss of sleep for the past few nights in the hope somebody can prove me wrong and put my mind to rest.The National Loan Guarantee (NLG) scheme was announced as a measure to provide SMEs with access to cheaper finance – a potential saving of 1% on the cost of borrowing George said. “Great!” I thought. The saving would come about as a result of the UK govt. providing guarantees for borrowing. “Woohoo!” Went my brain.Then, after a latte and a jog, being the curious fellow I am, I started to delve a little deeper into the proposal, started doing some research on how the scheme would be delivered. This is when neurons started popping in my head.

See, here is what I understand; and it worries me. I would dearly love for someone to correct what I must obviously have wrong: the NLG benefits the banks and not SMEs.

From what I understand, the NLG scheme will allow BANKS to borrow in the money markets, most likely by issuing bonds, to the tune of £20billion, backed by a government guarantee. I.e. if the BANK goes bankrupt, the government will pay out to the owners of the bank debt. As a result of this guarantee, the banks can borrow at lower rates, essentially borrowing against the Government’s AAA credit rating. It is then assumed that the banks will pass on the cost saving to SMEs seeking loans. SME loans are not actually guaranteed themselves.

The problem – I can’t find any evidence to suggest that the banks MUST use the £20billion they raise to lend to SMEs. This is extremely concerning, and as I said, nagging me to the detriment of my sleep.

If my suspicions are correct and the banks are not obliged to lend the money to SMEs, they will not; for the same reasons they are not lending today. Credit risk and the high (highest) capital charge for lending to SMEs will not change. The opportunity cost of lending to SMEs will continue to drive the use of funds in other areas of the bank – lending to larger corps (a shift in capital that is clearly apparent in Project Merlin stats) or, more likely, into their capital markets divisions.

In essence, without a contract forcing them to lend the money to SMEs, the funding raised under the NLG will be used to bolster liquidity in day to day operations within capital markets, thus further increasing the profitability of this part of the bank, by increasing the scale of the activity that can be carried out. In a similar vein to Quantitative Easing (who holds large quantities of government debt? The banks. Who processes the transactions for other institutions selling bonds back to the government. and charge a fee? The banks. What happens when the government announces a QE programme which runs for several months? The price of the bonds goes up – more profit to…..yes you guessed it, the BANKS), the wool is somewhat being pulled over our eyes; the banks are guaranteed to benefit, SMEs will likely be no better off.

It could be that more detail on the mechanics of the NLG scheme will emerge that subside my concern. It could be, as I have stated I hope, that I have got this completely wrong. For once, I really want to be.

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