Why the Small Business Loan scheme will fail

For those of you outside the UK who are focussed on your own part of the recession, this is about the UKGovernment’s, primarily ‘Lord’ Mandelson’s, intention to underwrite bank loans to small businesses.

Banks are not charities. The aim, from their point of view, is to make a profit, and this mostly comes from  interest charged on loans (or more precisely, the differential between interest paid out to depositors and charged in from borrowers).   

The Government scheme intends to make banks more likely to lend to businesses at risk. It will only have any effect if it means banks will lend to those who they would otherwise not have lent, as a bad risk.

Now a bank will always lend so long as it makes a judgement that the risk is acceptable. In recent years that judgement has been overly lenient, especially in the case of mortgage lending. The toxic debt and loss of confidence is what has caused the recession. It must be, as is actually happening, that banks will no longer lend money to individuals or organisations which have a significant risk of defaulting. Consequently the Government’s intention to go against this prudent approach is completely irrational.

I should point out that the Opposition simply want the Government to do more of this crazy approach.