Leading article: Our dysfunctional banks must be compelled to lend

If small businesses go to the wall for lack of credit, we will all suffer

October 24, 2008

The conditions were made very clear. In return for last week's £37bn state recapitalisation of Britain's high street banks, the rescued financial institutions were expected to maintain their lending to the wider economy. But we are now seeing that laying out such conditions was the easy bit – the hard part is enforcing them.

Many small and medium-size businesses are complaining that the lending terms offered to them by the banks have worsened, despite last week's bailout. The banks say they are doing everything they can to help clients. But that is not the message coming up from the high street. Small companies report being charged higher interest rates and hit by extra fees. The Government is aware of the problem. The Business Secretary, Peter Mandelson, yesterday unveiled plans to bring bank bosses and small business representatives together within the next fortnight to "thrash out" a way forward.

To make sense of this we need to look at the bigger picture. Having been guilty of lending with irresponsible abandon during the boom, banks are now brutally cutting back their provision of credit. Thousands of blameless small businesses are suffering as a result. Why small businesses? Because, unlike large corporations, the banks are not afraid to squeeze them. Many firms rely heavily on overdraft services too, which gives the banks extra leverage. In short, they are an easy target. Of course, it is not hard to see why the banks are behaving this way. Their priority, as they see it, is to repair their ravaged balance sheets. They do not want to increase their exposure to potentially defaulting borrowers. From their own narrow perspective, each bank is making a rational decision. There is no incentive for them to lend more loosely, especially if competitors are not doing so.

Yet to understand is not to condone. The irony is that banks are not only cutting the throats of their small customers but their own too. Cutting lending to the economy at this time will make the recession more severe. And the harder times become, the more bad loans will ultimately end up on their books. It is important to remember too that Britain's small businesses employ some 14 millon people, about half of the national workforce. Crucify this sector, and you severely damage the entire economy. The lesson is clear. The banking sector is discredited and dysfunctional. Worse, it is behaving like this, just as Britain is entering a downturn. The Government's clear responsibility is to force the banks to act in the national interest. That means commanding them to lend to small businesses on fair terms. Banks also need to be instructed to go easy on repossessions to ensure house prices do not wildly overshoot on the downside.

An important distinction needs to be made. No one is suggesting banks should return to the irresponsible lending levels of the boom years, or to extend credit to companies and customers that are obviously a poor risk. It means ensuring that perfectly good companies do not go to the wall for lack of funding and that people can keep their homes, rather than face repossession.

If the banks resist all this, they need to be given an economics lesson by ministers. Since last week, our banking sector is being kept alive by taxpayers' money. That means the managements of these banks are no longer working for themselves or even their shareholders – they are working for us. And it is in the nation's direct economic interest that they lend. The Government must not accept no for an answer.