The Government, or rather the Department for Business Enterprise and Regulatory Reform (BERR), has just announced the introduction of a new Government guarantee scheme, the Enterprise Finance Guarantee. Many papers imply that the taxpayer may ‘commit to guaranteeing up to £21bn of bank lending’ to small and medium enterprises or SMEs.
But don’t worry, we’ll never have to pay this vast amount. Because in essence, the scheme aims to get banks to do what they usually do, which is lending to businesses with very little likelihood of going bust, just like they did before the crunch.
Why? Bear with me while I briefly delve into the loan guarantee schemes. These schemes are principally designed to encourage lenders, e.g. banks, or CDFIs , to lend to enterprises that they normally would deem to be too risky to lend to, for example because the entrepreneur does not have a good credit history, or trades in a niche markets the bank has never heard of before.
In Britain, this scheme has existed for quite some time under the name of the the Small Firms Loan Guarantee Scheme, or SFLG. Under the scheme, the Government guarantees 75% of the loan, i.e if the business goes bust, the bank can rest assured that the write-off is only 25%.
An example may help. Let’s say I want to open a business dealing in something rather obscure, say, in German delicatessen such as Weisswurst. For this, I need a loan of £5000. There isn’t much evidence of the market size in the UK for Weisswurst, and hence the CDFI is reluctant to lend me the money as they can’t be sure I’ll succeed and pay the loan back, interest and all. But because of the SFLG, they will lend me the money anyway as the government will guarantee 75% of it, or £3750. This obviously greatly reduces the potential loss should no one decide to embrace the pleasures of Weisswurst.
BERR’s new scheme ostensibly still does the same – but in fact, it is a much reduced version of the SLFG. At first sight, it sounds like a good deal, because the minimum and maximum loan levels it can be used for have been extended. Under the old scheme, only loans between £5000 and £250,000 would be guaranteed. Under the new scheme, this is expanded to include loans of £1000 to £1m. But, and this is where it gets tricky, there is a claim limit of 13.75%.
This means that if a CDFI lends £100,000 of guaranteed loans, it can only claim a maximum of £13,500. So it loses out, big time. Under the rules of the old scheme, CDFIs could claim £75,000 of the £100,000 back. So the new scheme is a whopping 82% reduction compared to the old guarantee!
This much lower guarantee will prompt lenders to only lend to those businesses that seem to be low-risk – thereby perverting the original aim of the Guarantee Scheme to provide credit to business that is slightly less ‘normal’ than what the lender thinks it is.
Hang on – isn’t this what banks are supposed outside of these guarantee schemes? Err… yes. But they don’t. That’s why they need more incentives. In addition to the billions of pounds of public money they have just received, the interest cuts, etc. So what happens to all those businesses that fall of the way-side of banks’ tight credit scoring?
Given that the definition of what is risky or not lies with the banks, and banks currently don’t seem to be too keen on the old lending business, there may well be thousands of businesses who will suddenly find themselves on the wrong side of the credit score, without any recourse to credit, because the guaranteed loans all went to those businesses that do not present a risk. So they will go bust. That’s exactly what the scheme was supposed to prevent – but is perversely quite likely to encourage. So, our taxpayers money is safe – until it has to be spent to help those millions who have lost their job to find new ones.