Most economists would agree that the frustratingly slow economic turnaround in Europe is attributable largely to the inability of businesses – especially small ones – to secure bank loans for expansion. Banks argue that after burning their fingers in the current recession, they are not prepared to loan money to high-risk enterprises and prefer to recycle cash around the financial system.
We need to start looking at the totality of our national debt, including that of state-owned commercial organisations
One solution being considered by the British Government is a state-owned business investment bank “to bypass the broken British banking system that remains one of the major obstacles to economic recovery”. What is happening in Britain is not unique and many other EU countries are experiencing the negative effects of a dysfunctional banking system. But is the setting up of a business investment bank likely to provide the liquidity that businesses need?
The bailouts of RBS and Lloyds Banking Group have meant that these banks are now largely owned by the State. This does not mean that the Chancellor or the Business Secretary dictate the day-to-day lending policies of these banks. All that the Government can do is to appeal to the leaders of these banks to pass on some of the funds they received from taxpayers to businesses. It seems that in this advice is being largely ignored.
There could be various reasons for this impasse. Retail banks often take a short-term view on lending to businesses, even if in theory they could provide lending for even up to 15 years to finance capital expenditure. An investment bank could take a longer term view. It could also raise long-term finance directly in the markets, avoiding the messy government guarantees schemes that could exonerate banks from suffering any losses in case their lending judgement proves to be defective. Rewarding banks for making wrong lending decisions is nothing more than promoting moral hazard.
But another more important reason is that many European banks have quite a few skeletons in their cupboards – skeletons collected in the happy-go-lucky days when they lent freely to everyone from first-time buyers with no wage slips to property developers who operated Ponzi schemes to boost their turnover and profits.
Regulators everywhere need to reflect on the concern shown by the Bank of England’s financial policy committee that is fretting on what has popularly become known as ‘extend and pretend’ – the banks’ practice of showing lenience to borrowers who can’t make repayments, rather than write down the value of their loans and face the knock-on effects across their balance sheets.
A recent article in The Economist confirmed that UK banks are indeed extending and pretending: “More British firms are making losses, but they are not being shut down. In part this reflects banks’ willingness to cheapen or extend old customers’ credit – keeping dying firms alive to avoid taking a loss themselves. At the same time, credit for new firms with better prospects remains tight.”
The IMF, the European Commission, the rating agencies, as well as the Central Bank have shown concern about the level of provisioning for doubtful debts that Maltese banks maintain. These independent analysts of our banking system are particularly uneasy about the amount of collateral that our banks hold in the form of property. Can anyone reassure us that our banks have not fallen in the trap of what the Bank of England has termed as ‘extend and pretend’?
The setting up of a local business investment bank could also help the Government to finance its infrastructure projects in a sensible way. While our political leaders seem to be more aware of the risks of our ballooning national debt, there has been little effort to start tackling our debt mountain in a systematic and credible way. We need to start looking at the totality of our national debt, including that of state-owned commercial organisations.
Rating agencies keep reminding us that our debt-to-GDP ratio is significantly higher than those of similarly rated countries. This is a not-so-hidden warning that unless we reduce our debt, we risk a further downgrade. The setting up of special purpose vehicles to manage the financing of specific projects could be one solution, but it certainly leaves the issue of ineffective debt management at a comprehensive level unresolved.
The setting up of a business investment and development bank could be a way to provide private businesses with much needed liquidity and put some order in the way we manage our public debt.
johncassarwhite@yahoo.com