State bank not yet obvious solution - Pt 3 - Costs and T&Cs for SMEs

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Maybe a state bank isn't needed just yet to plug a ‘growth capital' gap for SMEs but perhaps we do need a bank for improving the costs and T&Cs faced by SMEs, especially since the financial crisis.

How might a state bank improve the costs and T&Cs faced by SMEs?

A bank backed by the UK government would face a lower cost of borrowing for itself than commercial banks.

Because the government has the power to levy taxes, provided it doesn't let spending get way out of control and find itself in over its head in debt, it can usually borrow quite cheaply.

Exactly what too much spending and too much debt looks like will depend on the country in question, its fiscal policy, and general macroeconomic environment. Generally larger and more diverse economies can get away with higher deficits and debt levels than smaller and less diverse economies.

So, a state-backed bank would benefit from this cheaper cost of raising debt – maybe even the low cost associated with a AAA rating such as the UK government currently enjoys (for the moment).

The state bank could then pass on its own cheaper cost of funds to its SME customers. This would allow them to borrow for less than would otherwise be the case if they borrowed from commercial banks.

On top of this, the government (or the bank itself from retained earnings) might decide to go even further and provide explicit subsidies for the loans (or some of the loans) from its bank.

The combination of passing on a cheaper cost of borrowing and providing explicit subsidies is what the Germans' KfW does.

A state bank, depending on how it was constituted, could also go further and start altering some of the conditions attached to loans e.g. it could make it easier for SME borrowers to secure a loan without offering a personal guarantee.

But is creating a new state bank the best option for the UK to bring down costs and onerous T&Cs for SMEs?

The borrowing of the state bank would, I think, add to Public Sector Net Debt (PSND). Adding billions to PSND when the government has a target to have PSND falling by 2015/16 seems like something the government isn't going to be keen to do, at least in the short term. Hence they haven't let the proposed Green Investment Bank borrow until this target is met.

In fact, a higher PSND and/or violation of the commitment to have PSND falling in 2015/16 might have negative implications for the government's credit rating and therefore the cheaper cost of funds the state-bank would benefit from anyway.

Because the offsetting assets (the loans to companies) aren't readily convertible to cash, it would only be the liabilities not the assets that score on PSND (I think).

And if the government is standing behind the bank it will also create a potential liability for the event where the bank goes bust.

We all now know banks can and do fail – and there would be no backing out of bailing out this new state bank if we wanted it to be able to borrow cheaply.

Arguably a state bank that lends to companies that are unable (or unwilling) to borrow commercially is lending to a riskier set of companies.

The above only relates to the pass through of lower funding costs – let alone subsidies from the government (the German Government forked out €3 billion in subsidies to KfW in 2010). It could be worth it in terms of CBA - but it would seem to run counter to the government's fiscal stance and would therefore require massive offsetting spending cuts or tax rises if it were to happen now.

A state bank doesn't seem the obvious solution, at least in the short term, to try to tackle high costs and onerous T&Cs on lending for SMEs.

But that's not to say that nothing should be done…

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