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Funding Small and Medium Sized Businesses

November 9, 2011

Adequate loan facilities for business are essential to get the economy going.

SMEs often need to raise unsecured loans. It is not reasonable in all cases for the owners to offer their homes as security.
SMEs in this position in the UK suffer from a quadruple whammy:
a. Banks reasonably treat unsecured loans as more risky than secured loans.
b. Because of Basel rules, it is rational for banks to require three times as much interest on a business loan as on a secured loan advanced for speculation, in spite of the fact that lending for speculation creates systemic risk – see my post Credit Creation and Allocation.
c. UK banks are no longer organised so that local bank managers or loan officers can establish relationships with local business men and women and hence assess the risks of a business loan properly.
d. The instability caused by banks’ behaviour increases business risk.

Possible remedies:
1. Increase the Basel risk weightings on loans for speculative purposes to reflect the systemic risk.
2. Government guarantees on loans to SMEs: such guarantees would only be available for loans advanced by banks or subsidiaries of banks that such signed up to a code of practice for the assessment of business loans. The guarantee facility would be withdrawn from any bank with a poor record on defaults on its business loans.
3. In the same way that governments bailout banks by buying equity, why could they not do it for SMEs?                                      4. A healthy local banking sector could provide better facilities for loans to SMEs – see Local Banking and Credit Unions.

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