By Michael Baxter 8 Dec 2009 [1 Comment | 302 views]
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Banks have been failing for a very long time. Their error wasn’t just mortgage securitisation, they made an even bigger mistake too. They forgot what they were there for.
Yesterday, the great and the good from the investment banks trooped en masse to Number 11 Downing Street for a meeting with our silver chancellor and his good friend Mandy. Alistair has nothing less than plans to revolutionise small business.
If all goes well, Al will be revealing more in his Pre-Budget speech. He may not be chancellor for much longer, and he may have had the misfortune of holding the country’s purse strings through times of trouble, but actually, credit where it’s due, it appears this latest idea is smack on.
Banks are important for this reason. They use money that would otherwise be sitting idle, and supply it to individuals who can use this money to create wealth.
For too long now, banks have only done half of this. They have used money that would otherwise be sitting idle, but then they played with it.
This is what Edmund Phelps, a former winner of the Nobel Memorial Prize for Economics said in an interview with Spiegel back in November 2008: “Increasingly over the past two decades, the banks have tried to make money with mortgages, residential and commercial. As this has proved difficult, the banks will either have to shrink their supply of credit to the economy as a whole or else redirect some their credit to the business sector.
“Unfortunately, the banks for the most part appear to have lost the expertise to make business loans and investments, which they once had in the fabulous years of investment banks such as Deutsche Bank and J.P. Morgan…”
Perhaps the biggest problem with the banking bailout is that because banks were rescued, they had no incentive to mend their ways.
But according to the FT yesterday, representatives from JPMorgan Chase, UBS, Credit Suisse, BNP Paribas, Goldman Sachs and Deutsche Bank descended on Downing Street.
The pink ‘un also reckons the government is trying to persuade Barclays, HSBC and Standard Chartered to join the fray.
According to the FT the banks are being asked to contribute £25 to £35 million each to a new “national investment corporation”.
The challenge faced by entrepreneurs trying to raise money during the boom was scandalous.
If you wanted to borrow money to speculate with property, that was fine. Banks were also more than willing to throw billions at the casino. But if you had an idea for a business which could have in some way created wealth and contributed to UK PLC you were told it was too risky. And if you mentioned something along the lines of a loan under the DTI small loan guarantee scheme, a number of bank representatives would have said something like “what small loan guarantee scheme?”
Even so, there is a question mark over whether traditional bank lending is right for entrepreneurial businesses.
The true wealth creators are businesses that are real innovators.
Yet innovation is a risky business and failure is common.
Banks which lend money in return for a rate of interest are unlikely to find this kind of business investing to be profitable. If the business they back succeeds then they get their money back and make a profit based on a fairly small interest rate. If the business fails, the bank loses its money. The equation is not evenly balanced.
That is why the only type of investment that really makes sense for true entrepreneurial businesses are investments that are provided in exchange for equity, which provide handsome returns if things go well, compensating the backer for the inevitable failures.
Alistair Darling’s scheme could work wonders for UK PLC, but only if some of the money made available as a part of this scheme is invested in business rather than lent to it.
Banks lost their appetite for loans/investment in Companies for two reasons.
1. In the days when the high street banks decided to shrink their operating costs by closing branches they disposed of most of their local staff expertise in the area of business lending, just look at the quality of the personnel you now have to deal with and the lack of business nous that they have and their need to inevitably refer lending decisions to central to people who were completely cold in relation to background knowledge of the banks customer. So many times I have heard from my own clients of problems in raising capital for what are well established companies on extremely sound business propositions.
2. Banks saw financial Services as a much easier way to make profits yet their performance in providing customer value has been appalling, the customer was seen as a milking cow to make big profits for the banks without exposing capital to risk. Instead they were tempted by the casino type lending that has largely brought about this crisis. The fact that they still want to reward these buffoons with massive bonus’s gripes with every taxpayer whose future and that of their families is mortgaged to the hilt.
Line them up outside the Houses of Parliament and I think there would be no shortage of volunteers to act as executioner.