As Outlined in the 2017 Labour party manifesto, Shadow Chancellor of the Exchequer John Mcdonell detailed plans for the introduction of a National Investment Bank (NIB) alongside a network of regional development banks that would issue the necessary funding to ‘small and medium-sized enterprises’ (SME’s) in the UK. This was claimed to be in response to a failure of the UK banking sector to provide ‘longer-term loan funding’ to small businesses; a funding gap which is succinctly emboldened by the negative £59 billion difference between money applied for by SME’s in the UK and the actual loans agreed in 2018. It may simply be that, the reluctance demonstrated by banks is off the back of prolonged post-crash lending caution, perpetuated by regulation such as ‘Basel III,’ which require banks to keep almost twice as much capital against SME loans than they would for lower risk lending, such as on a buy-to-let mortgage.
Nevertheless, many believe that the underfunding of SME’s remains an inhibiting factor in structural investment, so what exactly has some economists and business owners so concerned? The scale of the investment proposed by the bank may appear daunting, given Mcdonell’s proposal to achieve a balance sheet worth £250 billion over a period of ten years, acquired by government issued bonds. Firstly, it is unclear whether or not the public bank would be able to raise sufficient private capital because it is not certain it will be lending at market rates of return to credit worthy companies. However, this proposed form of borrowing by Labour is one being emulated to a lesser extent by current Chancellor of the Exchequer Sajid Javid, as economists interpret the resilience of the UK bond market as a sign that the required funding for the NIB can be achieved; regardless of whether or not investors believe in the policy.
Given that sufficient capital is raised, one only has to look to Germany’s own NIB; the KFW, to see that tangible economic improvements can be derived, in the form of economic growth supported by Investment; as firms gain the confidence and means to invest in capital, with an emphasis on the development of eco-friendly technologies being the ultimate objective. Theoretical social benefits of a NIB would be wide-spread as the resulting economic growth would arguably be tantamount to economic development on issues of inequality and environmental degradation, although this is entirely dependent on the state of confidence in the economy at the time.
There is also one potential distinction between other European NIB’s and Mcdonell’s proposal. In their research paper, economists McFarlane and Mazzucato highlighted that a NIB established by European states would not be defying European State Aid laws ‘so long as it aims to complement rather than compete with commercial banks’. Failure to fulfil this clause would create two prominent preclusions to the NIB’s effectiveness. NIB lending at anti-competitive ‘discount rates’ to ‘cooperatives’ and ‘challenger banks’ might not only undercut the ability of large commercial banks to lend, directly opposing European State Aid laws, but it may also have the potential to crowd out the private banking sector in the long-run. Research indicates that SME demand for low-interest rate loans is high, meaning the loans are likely to be accepted, with the subsequent increase in government borrowing causing a rise in the interest rate; especially given the large scale of fiscal expansion planned. The result of this is lower private sector expenditure and potential negative implications on aggregate demand, which could negate the growth fostered by small-scale investment.
The future is entirely uncertain; however political constraints can very much affect the success of the NIB. As the ever more likely outcome of a hard Brexit draws nearer, Labour are presented with a significant legal obstacle were they to win the December election. Without a free trade agreement with Europe, the UK would be subject to WTO rules, which limit financial subsidies. This indicates that the NIB would operate most effectively under EU law, unless the checks on lending presented by WTO rules helped to regulate the potential misallocation of funds by the NIB, given its large scale.
In reality, the effectiveness and future success of the proposed NIB is ambiguous at best. It’s true that the attainment of capital for SME’s is difficult given current borrowing conditions, despite the cheapest rates of lending for decades; and that this underfunding represents a chasm of potential structural investment in the UK economy. The advantages of investment in this economic sector, in the form of rising wages and increased employment would see an improvement in living standards for households; as has been seen across the continent.
Nevertheless, this outcome is based on the assumption that all underfunded SME’s are capable of expansion. To commercial banks, many SME’s lack the collateral and ability to invest and grow, presenting these banks with a reason to not lend. In this case, NIB lending will lead to large misallocations of capital to companies that are not credit worthy, resulting in bad debts and defaults. It’s arguable that in time, the market will naturally allocate loans to more SME’s, with work having to occur on the side of these businesses also. However, with Britain’s economy already slowing, is there time to wait for a lending equilibrium?
By Josh Chapman
Sector Leader: Maro Sohn