Page last updated at 14:43 GMT, Wednesday, 14 January 2009

Q&A: Why aren't the banks lending?

Bank notes
Some fear the government is throwing good money after bad.

The government has unveiled a plan to guarantee up to 20bn of bank loans to small businesses.

In return for a fee, the state will, in effect, insure banks against firms defaulting on loan repayments.

It is the latest initiative to get banks lending again and help small business survive the economic downturn.

Haven't steps already been taken to try to encourage lending?

The government and the Bank of England have both already introduced a number of measures to get lending back to more normal levels.

  • The Treasury spent 37bn taking stakes in RBS, Lloyds TSB and HBOS and both Northern Rock and Bradford & Bingley have been nationalised
  • It also offered 450bn worth of short-term loans and loan guarantees to encourage banks to lend to each other
  • The Bank of England has also taken measures to provide more liquidity to banks by allowing them to swap risky assets for more secure government debt.
  • Interest rates have been cut to the lowest level in more than 300 years.

So why isn't this working?

Banks are still writing off bad debts and other assets that have fallen sharply in value during the credit crunch.

Working Capital Scheme: Will secure up to 20bn of short-term bank lending to firms with a turnover of up to 500m
Enterprise Finance Guarantee Scheme: Will secure up to 1.3bn of additional bank loans to small firms with turnover of up to 25m
Capital for Enterprise Fund: 50m from the government, plus 25m from the banks, to invest in small firms that need cash

If some of the new capital injected by the government just matches write-downs it cannot be used to lend.

And as the economic downturn causes more companies to go under and jobs to be lost, fears of more defaults make banks reluctant lend.

Regulators are also requiring banks to keep more capital to cushion themselves against further losses, further reducing the amount of money available.

What's more, foreign financial institutions that had been active in the UK are now focusing on their home markets.

Are lenders cutting back on credit?

Lenders have reduced the amount of credit available both to companies and to households and this is expected to shrink further.

This is in part because mortgage providers are tightening their lending conditions and demanding bigger deposits.

But the total amount of outstanding debt - both individual and corporate - is still increasing, albeit at a much slower pace than during the boom years.

Figures from the British Bankers Association showed that lending to small business by High Street banks increased by 153m in November.

But the average monthly increase in 2007 was 268m.

Is the government throwing good money after bad?

Business groups have welcomed the new measures for small businesses, while the Conservatives say they came up with the plans first.

The Association of Chartered Certified Accountants reckons that if implemented properly, the loan guarantees could help smaller firms access credit on reasonable terms and strengthen banks' balance sheets.

But it warns that the government must be prepared to guarantee genuinely risky loans for the scheme to have real benefit.

Liberal Democrat shadow chancellor Vince Cable says that the government should ensure that the banks owned or part-owned by taxpayers maintain lending.

"We have to make sure the taxpayer gets value for money for the vast sums that have been put into the banking system," he says.

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