First thoughts on UK credit easing: Divide in access to credit to remain

Published on by chris bowdler

A key feature of credit markets in the aftermath of the credit crunch has been extreme inequality in access to credit. Large corporations or relatively high net worth individuals perceived to have 'skin in the game' thanks to large amounts of loss absorbing capital have been able to fund themselves and often on favourable terms due to the effects of lax monetary policy, while those less able to put up collateral are denied credit or obtain it after paying a premium relative to other borrowers. Such differences in the cost of finance then amplify initial contrasts in financial performance as access to chaper funds ensures that the strong get stronger.

 

The National Loan Guarantee Scheme is most likely to reinforce this picture. Banks will pick the firms below the turnover threshold whom they are prepared to support and then price their loans at a discount (relative to the price absent any loan guarantee scheme) to reflect the subsidy on bank funding costs available when the government guarantees a portion of the banks' own funding in the markets. So the cost of debt will fall for a set of private sector firms, but there is no mechanism for ensuring an increase in net lending to the small business sector, and those firms unable to secure sufficient credit previously will find themselves in the same position going forward. Overall, whilst the credit easing scheme will lower the average cost of funds to the UK private sector, the inequality in private sector performance will continue and this is bad news given that small firms often offer the best prospects for rapid growth and job creation.

 

The National Loan Guarantee Scheme seeks to address the external finance premium that the money markets impose on the banks. A second and equally important external finance premium applies in the pricing of loans from the banks to the corporate sector. It is the second part of the chain that needs urgent attention. If the most crucial failure of the banking system at present, namely the very LOW QUANTITY of net lending is to be addressed, we need policies that induce banks to say yes to loan applications to which they would have previously said no. This means using government funds to partially guarantee not the loans from investors to banks, but from banks to firms, with the banks and firms in such relationships required to demonstrate the quality of the loan in order to qualify for the underwriying service.

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