Credit Policy, Banks and The State of the UK Economy

A2 Macro – May 2013

Credit Policy – An Important Lever

• Conventional monetary policy economics focuses on the effects of– Changes in market interest rates for borrowers and savers– Changes in the base supply of money in the economy– Changes in the external value of a country’s exchange rate

• Credit policy is becoming hugely important in many countries – affecting growth / recovery– Especially policies that impact on credit supply– Policies on reforming the banking system

Interest Rates and Economic GrowthDeep cuts made in interest rates to avoid a depression and support a recovery in aggregate demand – but growth has remained weak / fragile

Interest rates and investment

Capital spending by businesses has failed to respond to expansionary monetary policy

Bank Lending

This chart is telling – it shows a dramatic drop in the annual rate of growth of commercial bank lending to businesses – the credit squeeze has had a big impact on the availability of finance

EvaluationIs the drop in lending mainly due to a squeeze on credit supply or a drop in demand for loans?

Interest Rates on Loans

There has been a growing gap between the cost of unsecured loans and over drafts and the official policy interest rate set by the Bank of England

Limited Credit Supply

• Banks have lowered their willingness to take risks– Rise in non-performing loans (bad

debts) which have contributed to heavy losses

– Total loan write-offs were over £11bn in 2012

– Higher deposits and tougher checks to get a mortgage

• New (tougher) global rules (known as Basel III) on the amount of capital and liquidity that banks must hold

Key Point:The credit crunch has led to a contraction in the supply of fresh loans to businesses and consumers

Overcoming Credit Crunch 2.0

• Funding for Lending Scheme - August 2012• A subsidy for banks who lend to businesses• Banks can apply to get cheaper funds from the Bank of England

than they would if they went to the wholesale money market to get their funds for future loans

• From 2014 banks will be able to draw down £5 of cheap loans from the Bank of England for every £1 in net new lending to SMEs (small and medium sized enterprises)

• Green Investment Bank (joint venture with Qatar)• British Business Bank set by Vince Cable• Measures to encourage more competition in the

retail banking industry

The Green Investment Bank

Business Finance – Old....

Traditional Bank Finance• Commercial bank loans• Overdraft facilities• Credit card finance

especially for SMEs• Equity raised through stock

market

SMEs have built up their savings deposits in banks but have found it much tougher to get the loans they want .... New finance streams needed

Business Finance..... And New

Growing Financial Options• Corporate Bond Market

including retail bonds• Peer to peer funding

– Funding Circle– Zopa– Crowd Cube

• New banks– Aldermore– Virgin Money– Possible new regional banks

• Invoice discounting facility

Business Finance..... And New

Growing Financial Options• Corporate Bond Market

including retail bonds• Peer to peer funding

– Funding Circle– Zopa– Crowd Cube

• New banks– Aldermore– Virgin Money– Possible new regional banks

• Invoice discounting facility

Retail Bonds

Tesco raised £125m in February with an eight-year bond paying 5.2% a year

John Lewis raised £50m in April through a Partnership bond, though this was reserved for its customers and staff.

Hotel Chocolat raised £4m by selling the bond to members of its Chocolate Tasting Club, who don't get interest but instead receive a box of chocolate each month

Peer to Peer FundingConventional bank lending to business in the UK continues to decline.

Peer to Peer FundingWhere people lend directly to others via online exchanges

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