Economy adapting to ‘new normal’?

It may be hard getting a commercial loan right now, but things are going to improve. Right? Alas, maybe not. There is a school of thought which says that the current harsh lending environment may be the “new normal”. This means that, even as the economy starts to grow, it will be no easier to secure commercial loans. The age of easy credit is over.

Tim Kirk, head of financial services at BDO, says we’d better get used to this austere world. “In the future, borrowing will become more expensive. Lending criteria will get tougher. Interest rates will go up. I think entrepreneurs will need to change their mindsets. They need to understand that they are not going to get easy credit.” However, thinking of this as a “new normal” can be misleading, he says, as we’ve been living in a false paradise. “We have gone through an unusual period of low interest rates, huge inflows of cash from emerging markets and generous lending criteria. The situation now is merely returning to the old normal,” says Mr Kirk.

Interest rates will be a major contributor to the squeeze. Anthony Evans, professor at ESCP Europe Business School and a member of the Institute of Economic Affairs’ shadow monetary policy committee, says he’s surprised that the Bank of England has been able to keep rates so low for so long. “I am one of the economists who thought that quantitative easing and low interest rates would lead to inflation,” he says. “They will do, but so far the Bank of England and the government have able to live in a world of delusion. When the effects catch up with us, interest rates will rise and entrepreneurs will need to accept that the bar is going to be raised for getting credit.”

The new capital requirements imposed by the Basel III rules and the Vickers report on banking will both reduce the availability of loans and contribute to higher costs. An Adam Smith Institute report, authored by Tim Ambler, says of the new rules that “large customers will not be affected, but the SMEs [small and medium enterprises] and the more volatile businesses will bear the brunt of both a lower availability of loans and higher rates of interest”. The British Bankers’ Association concurs. Which is grim news for Britain’s entrepreneurs.

Interest rates will be a major contributor to the squeeze

So is there any chink of light to alleviate this misery? Perhaps, as new lenders are entering the market. In the property market, for example, pension funds are seeking to fund deals which previously were dominated by banks. “There are people who are working out that, if they can lend to relatively benign risks on origination at 400 basis points plus, why not do it?” says Chris de Pury, partner at Berwin Leighton Paisner. “So you are seeing an increasing number of institutions – M&G, Prudential, Aviva and AIG – are getting into senior debt. You will see some of those taking up the slack vacated by the Scottish and Irish banks, and some of the Germans.”

But he warns: “Will it be sufficient to bridge the refinancings over the next five years? No. Will it be enough to compensate for the fact that banks are being hit by Basel III and the higher regulatory requirements? No.”

Paradoxically, higher lending criteria may be helpful to the strongest businesses. Professor Evans says: “When interest rates go up, we will see a weeding out of business. The winners will be profitable, responsible businesses.”


Ethical lending does the right thing

Public concern over the behaviour of traditional banks and bankers has led to a boom in ethical lending. The Co-operative Bank, the ethical bank Triodos and the Charity Bank have all enjoyed strong growth in account deposits over the past few years. Triodos (slogan “Greed down; happiness up”) grew its loan book 34 per cent last year and expects to grow it by a further 20 per cent this year.

The Co-operative Bank saw a 73 per cent increase in the number of new current accounts opened in the first half of 2012. At one point, the bank was opening 15,000 new accounts a week, 90 per cent of which were customers migrating from the big five high street banks.

Charity Bank, which lends to charities, social enterprises and community organisations, and is itself a charity, last year enjoyed a 20 per cent rise in deposits. Chief executive Malcolm Hayday says the concept of ethical lending is an easy sell in the current climate. “Investors want to put their money with institutions which are transparent. They want to be able to go to bed at night knowing their money is doing good.”

It is not just the lending criteria that differ with the self-styled ethical banks, but the relationship ethos. “We don’t make quick decisions,” says Mr Hayday. “Normally we’ll get an inquiry over the phone. We invite them to come for a chat. We go through a whole checklist. If they work in a community, we go and meet that community. If they work with disabled people, we meet those people. We meet trustees and the management. It is not unusual for us to say a loan is too early for your organisation, but come back in two years. Customers see us as a critical friend, which is totally different to the way high street banks operate.”

This approach results in rock-bottom default rates. The total loan loss rate at Charity Bank is 0.05 per cent. This is particularly remarkable as many borrowers turn to the bank after being turned down by traditional lenders and they run the organisations part-time or as trustees. The ethical model is now seen as sufficiently robust to attract institutional investors, such as charitable trusts and funds. Mr Hayday adds: “Big funds used to invest their money in traditional portfolios and give the profits to charity. We are seeing a shift, so that they invest with us so we can help charities directly.”