What is going wrong with corporate lending?

Government guarantees, bank recapitalisations and quantitative easing might do the trick for mortgage lending. However, corporate lending is still in the doldrums. There is no big credit expansion here. Gross lending has not increased, while existing credit lines continue to be withdrawn.

Why? Even during the boom, UK Banks didn't like lending long-term to UK firms. It is an aversion that goes back well over a century. Back in the late 19th century, banks preferred to finance trading activities. More recently, personal credit and mortgages have been the preferred option.

The quality of collateral is always a problem with firms. In the event of a default, it is always much easier to sell off a repossessed home rather than a warehouse full of widgets.

This raises a troubling question for the current "boost credit at all costs and inflate the deficit" strategy of New Labour. Lets start with the deficit. Everyone knows it is far too big. We also know that there will be massive expenditure cuts once the election is over next year. This means that in the second half of 2010, the UK will almost certainly hit another recession. Therefore, the Banks are being very prudent avoiding the corporate sector.

Monetary policy is also an incoherent mess. The central bank claims it is trying to prevent deflation, yet inflation has been above target throughout this crisis. It has tried to lower interest rates by printing money. However, financial markets had other ideas. Reflecting higher inflationary expectations, long term rates are beginning to creep up. And despite all the monetary innovations and experiments, credit to the corporate sector is still weak.

A better strategy would be to return to economy to a path that ensures macroeconomic stability. This means cutting the deficit and putting an end to the zero-rate monetary madness of the Bank of England. The corporate sector needs long term stability, not short term fixes that New Labour think will help them during the next election.