Page last updated at 22:25 GMT, Monday, 29 March 2010 23:25 UK

UK bank lending the key to economic recovery

By Richard Anderson
Business reporter, BBC News

Police in front of RBS
There has been a great deal of public anger directed towards the UK's banks

The UK government has provided nearly £1 trillion of support to the banking sector since the onset of the financial crisis.

That is more than half the entire annual economic output of the UK.

And the reason? Banks, the government insists, provide access to money, without which individuals and businesses cannot spend and invest, and without which the UK economy cannot grow.

This same reason was given by the Bank of England as one of the key aims of pumping a further £200bn into the economy through its quantitative easing (QE) programme.

Lending looks set to remain pretty weak for several years as banks build up their capital ratios
Vicky Redwood, UK economist, Capital Economics

Although the Bank has since played down the importance of stimulating lending, QE was designed specifically to increase bank lending, lower the cost of borrowing and boost asset prices when it was introduced in March last year.

The message, then, was loud and clear - without bank lending increasing significantly, there was no hope for a full economic recovery.

Falling lending

So, have banks started lending more given the unprecedented amounts of cash pumped into the sector? The simple answer is no. In fact, they are lending even less.

The Bank of England's own figures show that mortgage lending has fallen significantly since QE was introduced.

In the 12 months between March last year and February, the last month for which figures are available, financial institutions lent on average £14bn a month. During the previous year, they lent on average £18.6bn a month.

Lending to consumers through personal loans, credit cards and overdrafts has also fallen slightly, from on average £15.6bn a month during the 12 months before QE, to on average £14.2bn a month since.

Chancellor of the Exchequer Alistair Darling
The government has failed to get banks to lend more

Lending figures for businesses are more tricky. The Bank does not provide data on gross lending, only on what it calls net flows, which include money being paid back to commercial banks.

These show clearly that businesses are now paying far more back to banks than banks are lending out.

In the 12 months before QE, banks were lending out on average £2.4bn a month; in the 12 months since, businesses are paying back on average £4.5bn a month.

Businesses are undoubtedly paying more back to banks, but banks admit they are lending less.

Blame game

So why are banks lending less?

They have been widely criticised by politicians, business groups, the public and the media for not doing more to help provide funding during the recession, particularly in light of the vast amounts of cash pumped into the system.

Economies can grow for a period without lending growth, but it is very difficult to believe they can go on growing without it
Andrew Smith, chief economist, KPMG

The fact the government has spent almost £120bn on nationalising Northern Rock and taking substantial stakes in both Royal Bank of Scotland (RBS) and Lloyds Banking Group has provided yet more ammunition for their critics.

But despite political pressure to lend more, RBS said last month it had not met government lending targets for businesses, while Lloyds said hitting its targets would be "challenging".

The Federation of Small Businesses is clear where the blame lies.

"We have done a lot of surveys showing that businesses want to borrow money, but are not being accepted by banks - even viable businesses with viable business plans," says a spokesperson for the group.

"Now they are not even going to banks as they have already been refused, so they are finding other ways of raising cash, such as selling assets or using personal funds."

And the banks certainly have a strong incentive to withhold loans, as they need to recapitalise after heavy losses during the credit crunch.

"Banks don't have the risk appetite [any more]. Their capital bases are still not that high, and there still may be more losses to come," says Vicky Redwood, UK economist at Capital Economics.

In other words, banks need to keep hold of the extra money for themselves.

'Cautious outlook'

But just blaming the banks is too simplistic. There is another important reason why lending has not picked up - businesses and individuals do not actually want to borrow.

"Recent studies from the Bank and the government are clear - they show a significant fall in the number of applications by businesses for new loans and overdrafts," says Angela Knight, chief executive of the British Bankers Association.

"In a downturn, we would expect to see this, as businesses reduce their overheads by paying off their debt."

And this is not just a convenient excuse. The Confederation of Business Industry (CBI) confirms that many companies simply are not looking to borrow money.

The Bank of England
The Bank of England has pumped 200bn into the economy

"Businesses are more cautious in their longer-term outlook - they are more risk averse," says Russell Greggs, chairman of the CBI's Small and Medium Enterprise Council.

He adds, however, that bank lending criteria have become too strict. "They need to come back a bit," he says.

And while the government has singularly failed to get banks lending again, it could, with stronger political will, force their hand, at least with those banks in which it holds significant stakes.

There is nothing it can do, however, to force businesses and individuals to borrow more.

As Andrew Smith, chief economist at KPMG, says: "It is concerning that the supply side has dried up, but demand has dried up as well and this is rather more difficult to deal with."

'Weak recovery'

Whatever the reason, whoever is to blame, the fact remains that banks are simply not lending enough to stimulate economic growth.

And this is of critical importance to the UK economy's recovery prospects. By pumping so much money into the banking sector, the government acknowledged as much more than a year ago.

"Economies can grow for a period without lending growth, but it is very difficult to believe they can go on growing without it," says Mr Smith.

In fact, there are only three ways in which the UK economy can recover, says Vicky Redwood.

One is through a public sector spending drive.

But the Labour and Conservative parties have both pledged to slash public spending to reduce the country's massive budget deficit should they win the general election, so this is not an option.

The second is through a consumer spending drive. But with one of the highest levels of household debt in the world, the UK consumer is in no position to go on any kind of spending spree.

The third option is through private sector spending, which simply will not happen without increased access to funding through bank loans.

"Lending looks set to remain pretty weak for several years as banks build up their capital ratios. For this reason, it's hard to see beyond a pretty sluggish recovery," argues Vicky Redwood.

Depressing words, but for the UK economy to get back on its feet the banks must lend more, something they have singularly failed to do despite both the vast amounts of taxpayer money pumped into the banking system by the government and the £200bn created by the Bank of England.

Quite how to get banks lending again is one of the biggest conundrums facing the chancellor this summer, whomever that may be.

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