Banks reluctant to increase lending to SMEs

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Banks find it difficult to square governments’ pressure to increase lending with governments’ parallel pressure to reduce bank risk .

In June, US Treasury secretary Timothy Geithner said that he expected the government to begin funding from its small-business lending programme. In September last year, president Barack Obama signed off on a $30 billion fund to banks to encourage them to lend to small and medium-sized enterprises. Interest, however, has been subdued. Only 869 of the 7,700-odd financial institutions that could have accessed the fund have applied to do so, and only $11 billion in loans has been requested.

Lending to SMEs is seen as imperative in boosting economic growth. Evidence shows that a country’s GDP is directly correlated to the number of SMEs (although typically for enterprises with more than 100 employees).

In the UK, there is a similar reticence by banks to lend to SMEs. As part of Project Merlin, four UK banks agreed to increase their lending to SMEs this year by 15% compared with 2010. Trade minister, and former HSBC chairman, Stephen Green, spoke out in June to encourage banks to honour the commitment to SMEs. To date only a quarter of the SME lending target of $76 billion for the year has been met.

Essentially the UK and US governments are expecting the banking sector to be responsible for helping SMEs and therefore boosting employment and increasing productivity.

But banks in the US say it is not so simple. Community bankers say that it is not that they don’t want to lend to companies. Rather, there is little demand for loans. SME owners just do not have sufficient confidence in global growth prospects to warrant investing in and growing their companies. That essentially leaves the banks to be marketers for the loans, and to drum up business.

No bank, however, wants to have that pressure put on it. For a start, they might be offered discounted lending rates through Obama’s funding programme but they are still on the hook if the loans turn sour. Banks that increase their small-business lending by 10% pay a lower rate of interest on the funding – as low as 1%. Banks that increase lending by less than 2.5% pay 5%. That means if a bank decides to tap into Obama’s programme it has an incentive to make as many loans as it can.

Many, which are already working through bad loans, are terrified of making more bad loans, however. With so much global economic uncertainty still, banks will not want to take risks by lending to smaller companies. And isn’t this what governments want? That banks should not take risks? It appears to be a Catch-22 situation.