Opinion: The best way to get banks to lend more is to reduce the deficit

From among the blizzard of economic forecast, commentary and political point scoring which presently dominates the airwaves, there is very little consensus but the need to get the banks to lend more is something which brings all sides of the debate together.

The dividing line appears to be on how best to achieve this.

Those who subscribe broadly to the neo-classical or neo-liberal economic world view believe that banks will start wanting to lend as the economy recovers and businesses become more viable. This ‘leave it to the market’ approach is something which Lib Dems should (and do) reject, not just on this issue but on a wide range of others.

Many take the view that since the government ‘bailed out’ the banks, they should be forced, in the ‘national interest’, to lend more.

The weakness of this argument is that it risks merely re-inflating the economy on the back of cheap and easy credit, which would just store the same problems up for the future that we are living with now.

It is in the public interest for capital to be widely available in the economy, if it is not then all that will happen is that those who already have the resources already, whether big businesses or property owners, will be able to continue to dominate the economic activity of the country in their own interests, because any challengers won’t have access to capital.

If the government are not happy with the current level of capital being provided by the banks, and want to see it increased, then they need to ignore any calls to ‘force’ the banks to lend more. Forcing them to do something would be detrimental to the public good as long as the taxpayer has a stake in the banks.

If banks are forced to lend to uneconomically viable entities then the banks will become less economically successful themselves, and thus make less in profit, hitting their ability to pay tax to the treasury, to repair their balance sheets and to repay the taxpayer for the ‘bail outs’ they received.

At present the big banks have two options when it comes to lending. The first is to lend to the private sector, bearing the risk of an economy which, while moving stoutly in the right direction, is still fragile. The second is to lend to the government, potentially at a lower rate of interest than to the private sector but with almost 100% certainty of being repaid.

Whenever the UK Government borrows, in the form of Gilts, banks and pension funds snap them up. This reduces the pool of money available to lend to the private sector.

In economics this is known as ‘crowding out the private sector’, and is a problem which arises in different ways across a number of different economic theories and methods. The latest UK inflation, trade and to an extent unemployment figures showing some signs of moving in the right direction without any major surgery being needed, as I indicated would happen here.

There is however still a huge amount of spare capacity in the economy, with none of the means of production being deployed to their full potential, and a particular problem with labour and enterprise. To do this the government to continue on the path it is on, of reducing its own borrowing requirements, freeing up financial institutions to lend to the best of the private sector.

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4 Comments

  • Guy Patching 25th Apr '11 - 2:03pm

    Is there not a danger that because the banks are not helping to make use of that spare capacity (because its not economically viable for them to do so) the economy will not recover that lost capacity so the treasury will not recoup the necessary taxation to help it to not need to borrow and therefore crowd out the market?

  • Simon McGrath 25th Apr '11 - 3:35pm

    all sensible stuff.Many Lib Dems seem completely obsessed by the idea that for some unknown reason banks won’t lend to deserving businesses. One might thing that after the recent crisis we would be in favour o banks being tougher about lending, not relaxing their criteria

  • Not sure I agree.

    If there is spare capacity in the economy then the problem is that there is insufficient demand in the economy for this capacity to be utilised profitably.

    If the government reduces their expenditure this further decreases demand in the economy.

    The argument that there is a finite amount of money to be invested and that government debt crowds out investment in private enterprise ignores the huge cash piles being accrued in private business and the international nature of investment nowadays.

  • david thorpe 26th Apr '11 - 10:40am

    @ timak

    as for borriwng from international investors, who dont use sterlingas their day to day curreency, the are likley to convert the repayments they recieve from us into their currency, or demadn that the UK treasury repay them in their currency, with the consequence that sterling weakens against the other currency, which contributes to inflation and damages our long term chances of recovery.
    and we dont want private companies to buy our gilts instead of investing in ther core business and creating jobs.
    @ simon
    thanks
    @
    guy
    yes there is that danger, but if we get the deficit down and continue not to need to borrow, then banks will invest in the private sector because they wont have the opportunity to invest in the public sector.

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