In response to yesterday’s downward revision of growth expectations, Hiba Sameen argues that growth is most likely to come from precisely those start-ups and new SMEs that are currently struggling to access finance. Unless the Government can get the financial system working effectively, so as to allocate capital in a manner which facilitates innovation, it is unlikely that the ‘aspiration nation’ will come into being.
Once again the Budget has failed to deliver any prospect of a recovery or restoration of the path to growth. The Chancellor’s deficit reduction policy appears to be failing in its own terms – there has been no significant fall in the deficit since 2010/11. The Office of Budget Responsibility has also had to revise down growth expectations for the economy for the current year from 1.2% to 0.6%, although once again it has maintained its resolute optimism on longer term growth prospects, forecasting a return to trend growth within the next two years. So, deficit reduction is stalling and there is little prospect for a full recovery in the coming years. Restoring growth must be at the heart of all of the Chancellor’s plans – it is essential for jobs and wellbeing, as well as the fiscal consolidation plans.
One of the central barriers to restoring growth is that even five years after the financial crisis, our financial system remains dysfunctional and is manifestly failing to allocate capital to the right firms. The financial system promotes economic growth through the quality of capital allocation and not the overall rate of investment. It is inaccurate to view finance as a sort of plumbing system, whereby pouring credit in one end yields growth at the other. Rather, it functions as an economy’s central nervous system, choosing where to allocate resources; hence a functional financial system is essential for economic growth.
The financial crisis also appears to have permanently scarred Britain’s productivity through inefficient allocation of capital. Owing to historically low interest rates and banking bailouts in the aftermath of the crisis, struggling companies (aka ‘zombie firms’) can just about afford the interest payments on their loans, but not much more. There are zombie households, too – particularly those on interest-only mortgages who are unable to pay off the loan itself. Banks are holding a lot of unsustainable debt on their balance sheet and are thus unwilling or unable to lend to new innovative firms and start-ups with high-growth potential.
So, with growth increasingly unlikely and elusive, where should we now be looking? The answer is that growth and jobs are most likely to come from innovative new SMEs and start-ups that are currently struggling to access finance. Indeed, most firms report access to finance as one of the key obstacles to their growth (along with leadership and management skills). One potential hope is for alternative sources of lending to step in to plug the gap left by conventional bank lending. There is also the potential to develop new markets for lending – projects that were previously considered unviable could become viable with the introduction of new lending technologies and risk management techniques. With one government-commissioned report estimating the lending/funding gap for small businesses at between £26bn and £59bn over five years, there is a real opportunity for new forms of finance to grow rapidly to fill the gap. If realised, the returns for both businesses and the economy as a whole could be considerable.
Alternative finance represents a new, nimble ecosystem for small business finance, offering growing SMEs options as to how they fund their business. Last year saw nearly £250 million channelled through alternative finance platforms, and this stands to grow substantially in 2013 and beyond. Building on existing work in this area , the Big Innovation Centre recently released a provocation piece for another type of business debt finance – a ‘Flexible Project Investment’. An FPI is a series of project-based bonds, released to match the cash flow profile of a project.
There was little in the way of big announcements in today’s Budget, but there were indications that the government has been looking at some of the right areas to unlock growth. One notable announcement, missing in the Budget speech but included in the Budget document, outlined further details for the Business Bank announced by Vince Cable last year. A strategy document published today (21 Mar) will set out how the bank will develop between now and 2014 to provide long-term help for small businesses through £1 billion of funding. The bank will also provide immediate support through a £300 million investment scheme to help diversify and expand the supply of lending to businesses through non-bank lending schemes as mentioned above and will provide £75 million to expand the Business Angel Co-investment fund and extend the Enterprise Capital Funds.
Getting the financial system working efficiently again is essential for kick-starting the economy. Unless action is taken to fix the system and plug the gaps around business lending, there is a danger that the financial system will suffocate the aspiration nation before it has even taken its first breath.
Note: This article gives the views of the author, and not the position of the British Politics and Policy blog, nor of the London School of Economics. Please read our comments policy before posting.
Hiba Sameen is a researcher at the Big Innovation Centre, an initiative of The Work Foundation and Lancaster University.
“Getting the financial system working efficiently again is essential for kick-starting the economy. Unless action is taken to fix the system and plug the gaps around business lending, there is a danger that the financial system will suffocate the aspiration nation before it has even taken its first breath”.
Over 300 years of banking history is evidence enough (to any interested observer) that the banks are incapable of regulating themselves and that the state can never pay any regulator enough to police them. Nor is it willing to protect and/or reward any of the several ‘whistleblowers‘ who have brought banks and rich individuals alleged wrongdoing to their attention over the years (as have the police).
Competition for the first time in three centuries would be a novelty for the banks and only a state supported (but not run) retail bank can provide that essential function
for the financial sector in a capitalist mixed market economy. The fact that there is no national retail bank system backed by the tax payer means that the nation is held to ransom by private banks, the financial class controlling the political landscape (it does not matter that the Bank of England was nationalized in 1946 it is hobbled by being tied to an overwhelmingly private finance sector which actually creates(through
fractional banking) most of the money in a system that investor ’confidence’ dominates).
Rothschild informed us as to the object of private finance “Give me control of a nation’s money supply [the ability to create debt]. I care not who makes the laws“. His contemporaries and his successors benefited from successive governments acquiescence in the primacy of privately owned financial organizations as the overwhelming form of financial institution available for the citizen to save in, invest in or borrow from. Citizens’ remunerations are paid directly into privately controlled coffers, with no secure alternative. They have a choice, to keep their savings
‘under the mattress’ or place it in one private financial institution or another (to try and maintain its value in an inflationary financial environment).
To maintain a capitalist mixed economy the national retail bank cannot compete on
rates. It would be the safest home for a citizen’s money, but not the most profitable home for a deposit nor the cheapest source of credit, the spread between savers rates and lending rates would be a fixed % greater than the average private bank rate spread (So the private bank can appeal to the more adventurous saver, investor and borrower who is after better, though more problematic, returns). The nationalized central bank, Bank of England in the UK, could alter the magnitude of the difference between the public and private saving and loan rates (but not be able to remove it – so a window of opportunity was always available for private banking) and the base
lending rate in order to encourage or discourage credit in the market as it presently does and so try to control the debt levels in the economy.
The national retail bank would automatically reinforce the central banks actions
because it would be an increasingly attractive safe home for savers and investors as base rates rose and eroded the proportionate difference between private and State bank savings rates. That would put pressure on private banks and restrict their issue of loans (cash could now move out of the private bank system as depositors, savers
and investors worried about the security of their money) and so diminish the need for the central bank to intervene further in the market. Also loans would become more readily available from the national bank because of the influx of funds. Alternatively savers and investors having confidence in PLC banks and looking for better returns would move their money out of the national retail bank.
All citizens could automatically be given an account for life (utilizing a national
insurance number) in a taxpayer guaranteed national retail bank. Through the national retail bank the citizen’s savings would assist private wealth creation of both individuals and businesses (by offering savings, investments and loans) and finance for public works. The tax payer would no longer subsidize corporate wealth creation by not guaranteeing deposits in private banks nor investing in them. The Bank of England’s power to influence bank behaviour would be enhanced. If they were ineptly managed, or engaged in unethical sales of financial products, individual banks could go bankrupt or have their banking permit revoked without threatening the national financial system’s viability.
All local authorities would be able to support (but not run) a credit union that would offer savings and current accounts (accessible by debit card) and small loans and into which all payments to its employees would be made (to transfer if they wish). National regional retail banks would be able to issue bonds, provide savings and current accounts (accessible by debit card), make loans and support local authority credit unions. The wages of all employees of the state would be paid into their national bank account (to transfer it if they wish). The taxpayer, via the nationalized central bank would be the lender of last resort for the public and private banking systems.
Governments have handed power to shape their nation’s future to a class whose aim was to maximize individual and business debt (more income for the bank) with as little
interference by the state as possible (a philosophy most governments subscribe
to). Supine governments were left with the responsibility of ineffectively controlling (through the central banks) the resulting booms and busts that were the inevitable result of finance houses generating more money (debt) than there were assets of matching value. Governments get blamed for allowing it to happen, which they deserve, but not for the right reason, they refuse to believe it is their responsibility to create and oversee the nation’s money system, not greedy bankers, for that stance they deserve all the vituperation they get.
It has always been an option to create a national retail bank as a place of safety
for citizens money and a vehicle for a streamlined system of universal benefit
and state pension disbursement beside a source of funds for enhanced pension
saving, education loans, public works and private businesses but the provision
of a safe home for citizens’ and businesses’ money has taken second place in
politicians minds to giving financiers the latitude of ‘light touch’ regulation to access investment and sell financial products at home and abroad, a privilege they used over several decades to fleece the public and institutions to the tune of billions (another oversight responsibility avoided by the FSA). A large number of the investments and products were totally unsuited to their financially illiterate customers, which included every strata of society and private and public institutions at home and abroad. Many of these deals are subject to worldwide multi-million dollar/pound claw-back litigation by individuals and organizations (public and private) who can afford the great expense of court proceedings that the average investor cannot.
Financial organizations are composed of inanimate systems whose integrity is completely dependent on the quality of the personnel who inhabit them (like any human construct) particularly those who occupy the key positions of authority. Their fitness should be judged by the results of their period of custody, not their reward
(in their present incarnation most are protected from liability for reparation). The Vickers Report does not address the need for a parallel banking system backed by the tax payer in order to provide the risk averse majority of the population with the choice of a secure home for their money. Vickers leaves the public at the mercy of bankers whose interest in any particular country’s future could be written on a postage stamp.