RBS IS again under fire – this time over a series of reports into its behaviour towards small business lending. But while accusations by entrepreneur Lawrence Tomlinson took all the headlines yesterday (notably his allegation that RBS put viable firms into default to make a profit), a second report by former Bank of England deputy governor Sir Andrew Large makes for interesting reading. And it has implications for the banking system beyond RBS.
To a great extent, Large recognises that the contraction in RBS’s ability to lend was a function of the need to make it a safer bank after 2008. He noted that lending standards had been adjusted to be in line with the “prudential standards set by regulators”.
While Large attributes some of the squeeze on lending to “risk aversion” from relationship managers and credit officers, the bulk of the shift came from an adjustment to more prudent lending standards. And much of this has been forced on the banks by the regulators. Yes, lending standards pre-2008 were too lax, and the banks needed to increase both those standards and the capital set against those loans. But this is not a cost free exercise. In doing so – by definition – the credit available from banks would fall.
This is why, time and again, I have argued that policymakers cannot urge banks to lend more and at the same time expect them to become safer. They are not being honest, and that applies as much to politicians as it does to the Bank of England.
SME lending is just about the most capital intensive lending a bank can undertake, because it is also just about the riskiest lending it can do. As regulators have demanded ever higher capital ratios, the capital required for SME lending has grown accordingly, leading banks to adjust their lending behaviour. In particular, higher capital ratios will mean banks requiring higher margins to offset the extra cost of the capital and, often, more security. The reason for the latter is that secured SME lending attracts a lower capital charge than unsecured lending.
This, in my view, lies behind the gap between banks saying credit is available and SMEs saying it isn’t. Banks are prepared to lend, but only against much tougher lending criteria. Not surprisingly, many SME owners conclude that they would rather not borrow than put their house up as security to a bank that has recently tightened its lending criteria.
Vince Cable highlighted last week that the Funding for Lending Scheme (FLS) has boosted mortgage lending and not SME lending. Again, this is due to capital requirements, as mortgage lending needs much less capital (a 60 per cent loan-to-value (LTV) mortgage requires around 20 to 25 per cent of the capital of an unsecured SME loan). The government’s Help to Buy scheme tilts the field further in favour of mortgages, as it lowers markedly the capital required to fund high LTV mortgages.
If Cable and Mark Carney want small business lending to grow, they must revisit the capital required by banks for such lending. Ideally, this would be linked to lending under FLS. Otherwise small firms will need to wait until banks have excess capital again, which the regulators seem set on ensuring will not happen any time soon.
James Barty is senior consultant for financial policy at Policy Exchange @PXFinance