State bank not yet obvious solution - Part 1 - problems to address

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There's been a lot of talk about the need to create a state banking institution.

Industrial banks, national investment banks, SME banks, regional banks – and the government's mis-labelled ‘green investment bank' are all the subject of regular debate.

Why is this happening?

The common element in all these diverse ideas is that people feel our current financial system is not allowing finance to get to where it needs to be either to support the level of growth or the type of growth our economy needs. But we need more detail on the specific finance problems our economy faces to see how good a solution a state bank is for all or indeed any of them.

Some people point to the inadequate supply of capital to support growing SMEs. Various reports from the 1930s (McMillan) or 50s (Wilson I think) right up to the 00s (Rowlands) point out that for a certain group of established SMEs, the market does not provide sufficient capital to support growth that may otherwise occur.

This is a particular subset of all SMEs. The Rowlands Review from 2009 suggests its companies of £5-100 million turnover looking for £2-10 million in patient, preferably debt capital to fund investments to grow i.e. not very small start ups and not larger mid-sized businesses where other options may be more appropriate.

Then there are the terms, conditions, and costs of lending. This affects a wider group of SMEs. Here we're talking about fees, covenants in lending agreements, for personal guarantee requirements and so forth.

These problems are a bit stickier than the growth capital supply gap, as in some cases there is a lot of noise about what happens to SMEs even though banks are not necessarily being unreasonable. Some inappropriate lending pre-financial crisis has to be wound back.

A large degree of noise around these issues from poor customer service also unhelpfully muddies the water.

That's not to say there isn't an issue here to address but it's not a straightforward case of it all being the financial sector's fault.

Next there are problems associated with supposed misallocation of resources by markets. This is the idea that only 15% of the UK financial sector's investments over the ten years before the financial crisis went into non-financial companies (excluding property companies). The spectacular crash of 2007-09 next to the finance-starvation of the productive sector ‘proves' the financial sector must have been backing the wrong horses.

These problems could be as general as needing to see more finance flow into the ‘real economy' to as specific as certain sectors e.g. manufacturing need special attention.

This is quite a different set of problems from the other two in that it is a fundamental questioning of how financial markets are working and the incentives inherent in them as opposed to more specific inadequacies in a system that is otherwise sound.

The last set of commonly mentioned problems relate to an underinvestment in technology and infrastructure, especially environmentally focused technology and infrastructure. This is the rationale behind a ‘green investment bank'.

I think these issues are actually less about the functioning of the financial sector than they are about externalities that are not being priced in the market.

So my first point in testing whether a state bank is an obvious thing to bring in is to say that with such a variety of problems to address, does it seem likely that a state investment bank will fix them all? Such an institution would have to be quite versatile and adaptable...not a noted feature of state entities.

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