THERE are two possible ways forward for the banking industry. The first is to do nothing and try and brave out the storm, chucking the occasional insult at detractors. The second is to show some humility, reach out, make sensible reforms – and invest some of its own cash – to improve matters and fight its opponents with genuine facts, arguments and economic analysis. After prevaricating for ages, the industry has now adopted the second strategy, responding at last to those who argue that it is unfairly limiting credit and charging too much.
There are lots of good suggestions – and a few dud ones – in last night’s Business Lending Taskforce report, organized by the British Bankers’ Association and co-signed by the CEOs of Barclays, HSBC, Lloyds, RBS, Santander and Standard Chartered. A new £1.5bn growth fund will provide capital for viable businesses, a great move; if managed properly, this could pave the way for a new, 21st century tide of venture capitalism. It is right that this fund won’t be co-financed by the taxpayer. It will specialise in long term equity growth capital for firms requiring between £2m and £10m. Other good ideas include helping mid-sized firms gain access to syndicated debt and trade finance, largely by improving information. Other moves that may help include pre re-financing dialogues 12 months’ ahead of any term loan coming to an end, and better appeals processes for declined loan applications. We shall obviously have to wait to see how effective these measures turn out to be – and whether the £1.5bn is enough.
The report is pretty balanced when it comes to lending and borrowing figures. The arguments confirm my suspicion that the biggest problem is the decline in the demand for credit, combined with the demise of foreign bank supply – but it also points out that some firms may have given up and are therefore not approaching their banks. Overall business credit facilities (including overdrafts) are only 75 per cent utilised. Undrawn, committed facilities from banks exceed £85bn, with a further £70bn of committed, undrawn facilities available from other lenders.
Loan applications by small firms across the main high street banks are 20 per cent lower than at the start of 2008, either because demand is lower or because small firms are so sure they will be turned down that they are not applying. Overdraft applications for firms with a turnover of less than £1m are 50 per cent down. Yet most applications are given the green light: approval rates for the £1m-£25m turnover band have held up, at 97 per cent for overdrafts and 90 per cent for loans. For small firms as a whole, 80 per cent of overdrafts are approved, up from 67 per cent in late 2009; loan approval rates are 70 per cent, up from to 63 per cent.
Perhaps the most worrying part of the report is that which deals with funding costs – and how this will push up rates charged to borrowers. Wholesale funding accounts for 19 per cent of the total – and costs have permanently risen (rightly so, given how underpriced everything was pre-2007). Five-year credit default swap spreads are currently 1.4 per cent, compared to a pre-crisis figure of 0.1 per cent. Vast amounts of debt maturing over the next few years will have to be refinanced at these higher costs; the industry faces serious financing challenges. Higher capital requirements will also increase the cost of lending, as expensive equity replaces cheaper debt. Every one per cent increase in the capital requirement will boost the price of credit by 0.13 per cent. Lending to small firms is more risky than average, and banks are required to hold more capital against an equivalently sized loan as a result. This magnifying effect means that interest rates on loans to small business will increase by even more than other loans. Basel III could also lift trade finance prices by 20 per cent to 40 per cent. The FSA’s new liquidity rules will also add a further 0.1 per cent to margins. Finally, banks will need to re-price credit to take account of a more realistic default risk. Write-offs for business lending were just 0.3 per cent in 2007 and were wrongly (and naively) expected to remain low, but subsequently peaked at 1.3 per cent during 2010. Again, this will push up the cost of credit for all firms.
All in all, a sensible and frank report from the banks. It is a shame we had to wait so long before the industry finally got its act together.