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Since the banks were ‘bailed out’ with taxpayers money, a regular refrain from across the political divide has been that the banks are doing decisive harm to the country by refusing to lend to small businesses.
If this refrain were accurate, banks would be denying capital to the businesses that create the jobs to engender a sustainable recovery, instead choosing to deploy the capital in complicated financial instruments that create little value, or pumping up housing markets, or in paying enormous bonuses to bank employees.
This latter is an argument that Vince Cable in particular was vocal in espousing, and as soon as the real state of the bonus culture, now much more shares based than cash based, becomes apparent, he will doubtless claim the credit for that.
But when I met with Dr. Cable recently at a dinner, he was anxious to emphasise that the real reason that lending to small businesses has not taken off in the way that the sturdy economic recovery we have witnessed in the UK implies that it should, is because of the Basel III banking regulations.
Cable went so far as to say that, ‘we tried to fight on this, but they are international rules.’
The rule in question is that banks must retain five times more capital when they issue a loan to a business than they do when they issue a mortgage on a house. As the profits from any business derive from the return that can be achieved on capital, banks are put in a position where the incentive the regulator is insisting on, is for the banks to lend to the housing market, and not to businesses.
In addition, those same regulations already require banks to hold more capital than at any time in history; not a bad thing in itself, but it means that banks cannot deploy capital as freely now as they could in the past. So the regulator is restricting the amount of capital available in the market, and then incentivising the capital which is available to be deployed in the housing market. Such a policy threatens to ferment another credit bubble in the housing market.
The final point to make is that when the Basel III regulations require banks to hold capital, the capital must be held in cash, or other ‘liquid assets’, as defined by the regulators, and mortgage backed securities are counted as liquid. Those are bundles of mortgages traded on financial markets. Business loans are not counted as liquid by the regulator, further incentivising the banks to do exactly what policy makers post-credit crunch should be discouraging: the reliance of banking systems on the housing market.
Luckily, as often happens, when the regulation fails, the market steps in. Dr. Cable mentioned the increase in ‘crowdfunding’ and ‘business angel’ type finance for business and the bond market which offers a better deal for many businesses now than any bank ever could, but we need to do more to create the sort of economy that can sustain the Liberal Democrat party slogan, ‘opportunity for all.’
* David Thorpe was the Liberal Democrat Prospective Parliamentary Candidate for East Ham in the 2015 General Election
