Posted on 15/05/2013

Banking requirements negatively impacting on lending, says Policy Exchange

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A new report from Policy Exchange suggests that the primary reason for banks restricting lending is the financial regulators desire to raise the capital requirements of UK banks.

Bank lending to private companies in the UK has fallen every year since the financial crisis. Since 2008 the amount lent has dropped by £57 billion, despite the introduction of schemes aimed at boosting business funding, such as the Funding for Lending scheme.

In order for banks to raise their capital ratios they need to raise capital in markets, retain profits or shrink their balance sheets. Policy Exchange claims that with financial markets virtually closed to banks and profits under pressure banks have been forced to make adjustments through lending.

Whilst the organisation agrees that some adjustment were necessary it believes that the Banks of England (BoE) and Financial Services Authority's (FSA) drive to force bank to raise capital ratios has 'backfired'. The lack of credit growth, the group added, has 'destroyed' the BoE's attempts at easing monetary policy through Quantitative Easing and has resulted in a stalling economy.

James Barty, author of the report, said, "The drive to make the financial system safer through capital ratios is actually causing monetary policy to be less effective and hampering the recovery. It's the Bank of England's own policies that are leading to a lack of credit to small businesses.

"Sir Mervyn King appears to hold the belief that if only the banks had more capital they would lend more. Yet the opposite is the case. It is the Bank's drive to raise capital ratios that is holding back lending."

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The Policy Exchange's report recommends that banks should be allowed to run down their capital ratios and encouraged to use their excess capital to lend. The report added that the proposed ring-fencing of banking activities is not flexible enough. The organisation believes it could damage the competiveness of the banking industry and further restrict credit supply.

A recent survey by RSM Tenon, found that whilst SMEs believe the proposed changes will make banking safer they don't think it will help lending. In fact 36 per cent believe it will actually make it harder for SMEs to borrow money, compared to the 21 per cent who think it will make it easier, echoing the findings of the Policy Exchange report.

Mr Barty continued, "Before the financial crisis it was the case that banks had to hold on too little capital and were too lightly regulated. The pendulum has swung too far the other way. For our economy to recover banks have to be able to lend. We need more flexibility in the regulatory system so that banks capitals can support their lending not just make sure they don't go bust in a crisis.

"The desire to gold plate our bank is actually creating a lead weight for the economy."

Despite the fall in lending negatively impacting on businesses it has had one positive outcome. Alternative sources of finance are now gaining in popularity, such as crowdfunding, giving businesses more options and flexibility.