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Will the National Loan Guarantee Scheme provide a stimulus for the economy to grow?

Posted By Hiba Sameen

20 March 2012

In the run-up to the Budget, the Chancellor has announced the launch of the National Loan Guarantee Scheme as part of his credit easing plans to help the economy grow. The scheme guarantees, in the first instance, £5bn of funds (which will increase to up to £20bn depending on the success of the scheme) for companies with a turnover of up to £50m at interest rates discounted by 100 basis points. The Federation of Small Businesses has recently reported that 60% of small businesses felt that credit was unaffordable – thus, this scheme should go some way to help reduce that burden. 

I have written previously about how a workable loan guarantee scheme would need to be structured for the banks to participate. As the different funding structures result in different costs of capital and funding for banks, the Treasury has had to negotiate with each bank on separate terms to ensure that each is properly incentivised to pass the funds on to the right businesses in order to stimulate the economy. It appears to have overcome these issues with the scheme structure as all the big banks, apart from HSBC have signed up for the scheme. As I noted in my previous post, the scheme was not commercially viable for HSBC as they are largely funded by cheap deposits as opposed to wholesale markets. The largest users of the scheme are likely to be the two government owned banks RBS and Lloyds.
 
However, the key question is whether this scheme will provide any stimulus for enterprises, and the economy, to grow. Is it simply the case that firms are being starved of the funds they need to grow, create jobs and drive the economic recovery? Or is there a lack of effective demand for credit due to low business confidence and economic uncertainty? The figures in the last inflation report show that net lending fell by £10.7bn in 2011 but it’s not clear whether this shrinkage is due to supply-side or demand issues. The jury is still out on whether the fall in the lending is due financial market dysfunction or is there a fundamental lack of demand to grow as firms and households continue on the long and arduous path to reduce their debt overhang.

Recently, MPC member Ben Broadbent has argued that household debt is not the problem, and that the problem is in fact leverage in the financial sector, which has primarily made losses on overseas debt. Still, the rise in the number of distressed mortgages and foreclosures indicates that for many households and businesses there are still unsustainable levels of debt in the corporate and household sectors that need to be reduced before the economy can recover.

I am of the opinion that the lack of growth in SMEs is the result of the interaction between various supply and demand factors in the lending market and it is very likely that the supply of credit in the market made available through this scheme will not be met by a demand from firms to grow. Even so, a fiscal stimulus from the Treasury in the form of credit easing funds may in of itself provide confidence to markets and firms to grow and expand.

 

Comments in Chronological Order (Total 1 Comments)

Teneric

20 Mar 2012 11:18PM

I wonder if companies are really being starved of cash. A recent report in the US says that larger companies certainly have piles of cash because they are not investing. For the SME market we have still seen that companies that provide a real and realistic business plan always get the loan they requested. Perhaps some SMEs aren't approaching their banks correctly ?

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