EEF blog

Insights into UK manufacturing

Credit teasing

Andrew Johnson October 03, 2011 15:31

Osborne's announcement today that his officials are working on ways to introduce 'credit easing' has certainly created a lot of buzz.

He said in his speech that it was similar to the national loan guarantee scheme that the Conservatives had cooked up in opposition. But he also said it was another example of 'monetary activism' - a policy stance favoured by himself and Mr Cameron.

In other countries, notably the U.S., credit easing has meant the central bank changing the mix of assets it holds to include riskier, private sector assets as well as top-rated govt securities. The idea is that by buying private assets, like corporate bonds, directly, banks are freed up to lend more (and perhaps more riskily) directly to businesses.

If this credit easing were to happen at the same time as the central bank expanded its balance sheet (quantitative easing) the idea is the transmission could be more direct to the real economy, rather than relying on the portfolio effect of central bank demand for government securities encouraging financial institutions onto riskier assets.

By contrast the national loan guarantee scheme seemed to be an amped up version of Labour's Enterprise Finance Guarantee Scheme (which itself replaced the Small Firms Loan Guarantee Scheme). Here the government provides partial guarantees on loans made by commercial banks in return for fee. The coalition opted to extend the scheme in 2010 rather than bringing in the national loan guarantee scheme.

So which is it? Lot's of speculation already doing the rounds.

I think Osborne means the central bank getting involved in buying a wider range of assets. He was apparently glad-eyed about Adam Posen's  speech on alternative ways of doing QE a couple of weeks ago. The credit easing here could go in tandem with creating a securitising entity - like the 'Bennie' Posen proposed.

Plenty of questions about how credit easing might work:

  • How well placed is the govt to assess risk of private assets?
  • Does the risk of private assets turning bad create a fiscal liability that HMG must reflect?
  • How quickly can an entity securitising loans to SMEs be created?
  • Is the additional risk any kind of threat to the govts fiscal credibility?

Frenzied build-up to the Autumn statement begins now...

Beardy Americans and sado-masochism

Andrew Johnson September 23, 2011 10:38

Demand or supply?

Is credit growth negative because people don’t want to borrow or because banks don’t want to lend? The monetary hawks and sado-masochistic austerity lovers emphasis demand implosion.

Everyone’s paying off their debts. Nobody wants to borrow. Those with cash are worried about the future. Banks can’t lend to companies that don’t want their money.

On the other side of the coin are beardy Americans who in between saying the printing presses should crank up again and fiscal austerity belts should loosen, are clear that banks should be a little less tight and stop holding out on our growing SMEs.

While I’m sure there’s subtlety to both views that their respective acolytes will flourish at the hint of a challenge, my own view is a bit more mixed than these sometimes starkly expressed poles.
Both demand and supply are holding back credit growth.

 

Adam Posen kind of said this in his speech last week – but he thinks supply issues dominate – in particular those naughty banks and the lack of competition and capital in their sector.

I think it’s demand concerns that dominate. With near unprecedented turbulence in global markets that's not surprising and neither can you blame companies for being nervous about committing capital to investment. Too many manufacturers we talk to say that though things are going okay for them now, the constant rumble of doom in the media makes them shy away from investing.

But just because demand is the main factor doesn’t mean supply side issues aren’t important too. Why is it that small and medium companies are the most likely to show a divergence between their investment intentions and their actual investment behaviour?

These are the guys most reliant on the banking sector to provide their external finance.

Bank of England statistics (and EEF's own survey) show that for small firms at least credit continues to get dearer.

And as the bank-funded SME Finance Monitor has shown, 15% of SMEs don't even get as far as receiving dearer credit - fearful of being rejected by the bank - or worse, having their existing arrangements made more expensive.

For the banks, smaller firms are the most likely to be discriminated against, given the costs involved in scrutinising them, their lack of track record if they’re new, and the lack of pressure banks feel from competitors to compete for business.

How you see the issue of access to finance has important implications for possible policy responses. If credit growth is solely a demand problem, then it’s very easy – particularly if you favour fiscal austerity – to say that nothing can be done.

If you see tight supply as having a role, even if you think addressing it will all our problems, you may still see a possible improvement via policy (or market) action to improve the flow of finance.

People like Posen and in the House of Lords, Lord Skidelsky, see a role for state-sponsored institutions in the banking sector. Skildelsky is conducting a round table on this matter in November.

I myself might not stretch to this – for a start I don’t think a new state-sponsored bank could be made very quickly without perhaps using the government's existing stocks in RBS - which would be disastrous for the share value. But the same concern with the supply side of access to finance is why I’ve been banging on about the need to move further and faster on enhancing market competition in the UK banking sector.

 

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QE: can it really increase lending to small business?

Felicity Burch September 19, 2011 13:29

The Bank of England today published a paper looking at the impact of QE. The paper finds that QE had an economically significant effect, and

“may have raised the level of real GDP by 1½ to 2% and increased inflation by ¾ to 1½ percentage points … equivalent to a 150 to 300 basis point cut in the Bank Rate”

There has already been some debate about these figures, and the authors point out that there are large uncertainties even with the range quoted, but nonetheless they provide a fair amount of ammunition for those who are arguing for more QE.

One of these people is Vince Cable. As he said in his conference speech today:

“A lot of responsibility rests on the Bank of England to relax monetary policy further linked to small business lending”

While there are certainly ways that loose monetary policy does help businesses, it is not entirely clear that policy needs to be any looser than it already is. As far as improving lending to business there are two key reasons why additionally QE may not help:

Firstly, the Bank’s report makes clear that, even with the first round of QE, “the MPC expected little [economic] impact” through the channel of increased bank lending, due to other strains in the financial system. The continued tighter conditions in the financial system are indicated by many factors outside headline rates on lending. Tighter terms and conditions such as stricter covenants in lending agreements and attempts to move companies to more security-heavy forms of lending are discouraging some companies from even approaching their bank to ask for loans.

Secondly, although QE – through reducing the interest rate on gilts – can increase the attractiveness of capital markets to investors, it is not altogether clear that this benefits smaller firms, many of whose owners will be reluctant to use capital market funding which requires them to give up equity.

It will therefore take more than QE to improve the flow of lending to small businesses (discounting, perhaps, some of Adam Posen’s more creative suggestions made last week).

Cable rightly said in today’s speech he wants to see an end to ‘feast and famine’ in bank lending to SMEs. A key step towards this would be an indication of how the government will act in response to the ICB’s recommendations on enhancing competition in the banking sector.

More competition in our banking sector would put downwards pressure on the costs of finance faced by SMEs – critical when we consider other forces simultaneously providing upward pressure.

This is just one example of the more vigorous reform agenda we would like to see the government pursue, as a necessary corollary to a credible fiscal consolidation plan. The government must show it is committed to a relentless programme of dismantling the most important barriers to growth.

Inflation is up, but at least one MPC member is more concerned about growth

Felicity Burch September 13, 2011 16:19

Inflation figures released today showed that CPI had crept up a little, to 4.5%, though this was broadly in line with expectations. But this is unlikely to move the monetary policy committee, whose members last month voted unanimously against a rate rise. But the committee’s arch-dove goes further.

Adam Posen thinks things are bad.

And he doesn’t just think they’re bad enough to merit more QE.

“Just because we have [QE] … does not mean we should stop there if the situation is sufficiently serious. Unfortunately, the underlying economic situation in the UK and throughout the G7 is that serious.”

Posen says it is “time for the Bank of England and HM Government to explore ways [to] make up some of the credit and investment gap” that is holding back growth.

What he suggests is:

That the government set up two new public institutions “one would be a public bank or authority for lending to small business” the other would be a Freddie Mac/Fannie Mae style entity to “bundle and securitize loans made to SMEs… to create a more liquid and deep market for illiquid securities which can then be sold off to banks”.

The Bank of England could, Posen suggests, support the creation of these institutions by providing the initial capital.

It’s certainly a bold suggestion or – as FT Alphaville put it – “an intriguing British take on the liquidity trap to say the least”.

QE or not QE, and is that the question?

Felicity Burch September 02, 2011 15:28

This coming Thursday the MPC will make its monetary policy announcement. Global economic indicators continue to suggest a weakening recovery, and following last month’s unanimous decision to keep rates on hold, no-one is expecting the committee to raise rates this month.

But there is some talk about increasing quantitative easing as a way to stimulate the recovery. Adam Posen has long been the lone voice on the MPC calling for increased QE, as he did once again in an article for Reuters on Wednesday.

His argument in favour of QE is as follows:

The evidence is clear that the Bank of England’s and the Federal Reserve’s asset purchases had a positive significant effect on consumption, on the relative prices of riskier assets, on credit availability, and on liquidity in the financial system. If the improvement was insufficient, because the response to a given injection was less than some hoped, increase the dose.

In other words, Posen believes QE works, and if it doesn’t work as well as it should, do more.

But is QE the right policy tool now? Today Allister Heath from CityAM argued that more QE would be wrong for the UK Economy saying that while there had been a slowdown recently “the British economy doesn’t need another boost to the money supply”. He has two key reasons for making this argument:

  1. There is potentially too much liquidity in the economy and more QE could exacerbate this, and may also lead to asset price bubbles
  2. What the UK really needs is lower inflation and greater certainty

While I agree that low inflation and certainty are very important for companies, Adam Posen’s article offers enough reasons to think that inflation could go down as well as up in the next year or so.

The first point is therefore more pertinent. There may indeed be too much liquidity in parts of the economy, in which case more QE could lead to the asset price bubbles and other problems that Heath’s article raises. But there are still areas of the economy where there is not enough liquidity and this is choking off growth – just ask companies who are unable to get loans at the moment.

And that raises the real question – does QE create liquidity for the people and business who need it? And if it doesn’t, then what will?

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