Item Club predicts lending to SME's will fall to six-year low

Ernst & Young’s Item Club reports that lending to small and medium sized businesses (SME’s) has dropped to its lowest level since 2006.

The Bank of England reports that high street banks lent just £44.2 billion to businesses in the first quarter of 2012 and that 38 per cent of loan applications were rejected. This trend means bank lending to businesses in 2012 will slip by 4.6 per cent to £429 billion. This would be the fourth consecutive annual fall.

Carl Astorri, senior economic adviser to the ITEM Club said: “The good news is that 2012 is likely to be the last year of such marked deleveraging in the UK; the bad news is that, once again, SMEs will bear the brunt of it.”

The report says that the drop in business lending will still be less than last year when there was a 6.1 per cent drop and that there are signs of recovery in the financial sector but that lending levels won’t recover to 2008 levels until 2016.

The data shows that despite Bank of England and government efforts to try and encourage lending that would boost investment and help lead the economic recovery, lending has fallen.

The government introduced Project Merlin in 2011 to set lending benchmarks that banks had to adhere too. Although data shows that banks did meet their lending targets, anecdotal evidence from SME’s suggests that businesses are still finding it hard to access finance. The report from Ernst & Young backs this up.

The Bank of England recently introduced its Funding for Lending Scheme (FLS) that aims to incentivize banks to lend to small businesses and homeowners by being able to access funds at below-market rates on condition that they pass on the lower rates to borrowers.

The scheme is still in its infancy and it is too early to judge its effectiveness yet, but early signs are that banks are lending to homeowners with lots of equity and businesses that offer low-risk.

This is prudent behavior and a consequence of the different attitudes in place after the reckless lending that helped to cause the credit crunch, but it is unlikely to help the SME’s and homeowners who need help the most and is also unlikely to provide the spark that the economy needs to move into sustained growth.

However, banks say that demand for loans is low, but many businesses are saying that they are not applying through traditional channels after being rejected in the past.

The ITEM Club says that the government’s efforts to boost lending have been inadequate. It says that the British Business Bank that has £10 billion of funding is insufficient and that the money would run out in six months.

Mr Astorri questioned the effectiveness of the business bank, saying that it would just replace loans that were already being made.

He said: "We expect the business bank will have to compete for projects that are commercially viable, and so we do not think the scheme will have a tangible impact on the economy."

"Government schemes to increase lending may help a lucky few but, as banks are encouraged by regulators to store up more capital and to look again at their forebearance policies and so-called bad-loan books, most small businesses are going to continue to feel the squeeze," he said.