Hamish McRae: Restraint in the banks means no cheap money – but is that such a bad thing?

For 2005, funding is very constrained; for, say, 1965, funding is pretty normal

How does an economy grow swiftly if its banks can't lend much money? A few months ago a top official put it to me this way: "It is just bad luck that our biggest business bank happens to be the one that is in the worst shape."

The bank of course is the Royal Bank of Scotland group and we learnt at the end of last week that it was in even worse shape than most of us had fully appreciated, as the fall in the share price indicated. But this is not just an RBS problem nor indeed just a British problem. There is a squeeze in the supply of bank credit right across the European Union and to a lesser extent in the US. Banks everywhere are closing or selling off international operations. Thus, in the past few days, the Danish Danske Bank and the Dutch ACC Bank have both announced they will be pulling out of Ireland, which further reduces competition there.

Prudential regulation has further squeezed the banking sector. We can all see the logic of the argument that we don't want banks that are too big to fail, but if you push that too far you end up with banks that are too small to lend. Here in the UK, the Bank of England has sought to offset the effect of these policies by creating special schemes to boost bank lending. Fortunately we also have a new governor who is not overtly hostile to banking, as he made clear last week. It always seemed a bit rum to have as the chief shepherd someone who hated sheep.

But the harsh truth is that after the excesses that led to the banking crash, there will be a decade or more of ultra-cautious banking throughout the developed world. You can see what has happened in the UK in the graph. There has been a collapse of lending in 2008 and since then there has been a remarkably stable situation of modest net growth in lending to households and modest net repayment of loans by business. The very latest data does show some rise in the supply of mortgages and consumer loans, but there is rather less happening in business lending – maybe a small increase in supply, but nothing material.

You can react to this in one of two ways. The knee-jerk one, which has been pretty evident in recent months, is to lament the lack of supply of credit and to urge banks to lend more to business, particularly small and medium-sized enterprises. There is some practical support for this view because there can be little doubt that there are many SMEs that could grow faster if they had better access to bank funds. One of the really scary things is the extent to which some small companies are relying on the personal credit of their owners. But anyone who urges banks to lend more to small business has to acknowledge that this is statistically one of the riskiest forms of lending. They are urging banks to take on more risk, and given the caning bankers have received for making dud loans in the past, you can understand their reluctance now. You do not advance your career by making loans to borrowers who don't repay.

There is another way of looking at this which seems to me to be more helpful. Instead of fretting about the extent to which the banks have been holding back the recovery, we can focus on the ways in which the recovery has managed to sustain itself without the banks. We are building what will be inherently a much more robust system for business finance, where the banks supply short-term credit – working capital – while companies rely on other sources of finance for long-term investment.

Some of this is obvious. Large companies have turned to the bond market, taking advantage of the historically low rates that are still available, replacing term loans with bonds. Less visibly, companies that are cash-rich have been helping fund suppliers and customers that are cash-poor by changing the terms of contracts with them. Thus you pay the supplier earlier but require a discount on the price for so doing. The supplier relies less on the bank and the purchaser gets a better return on the funds than it would were it simply sticking the money on deposit.

For smaller companies there are problems. Most obviously they do not have access to the bond market, or indeed, below a certain size, to the equity market. There are schemes to close the gap between a business that can be financed by friends and family and one that can get an AIM quote, but this is not ideal. But we are in the early days of this return to conservative banking and I expect the system to adjust further in the years ahead. From the perspective of 2005, funding for business is very constrained; from the perspective of, say, 1965, funding is pretty normal. It will be possible to sustain reasonable growth rates without the banks taking on excessive risk, and as a result growth will be more sustainable.

There are winners and losers in this shift. As we can see in the personal sector, households that have cash resources will benefit vis-à-vis those that don't. At its simplest, young people buying their first property will find it vastly easier if they have a family than can help them with the deposit. Companies that are cash-rich will have opportunities denied to those that are not. But for many people, this is as it should be. Who wants a society where a novice property developer can borrow a shed-load of money from a bank, build some rubbish, and then leave the bank (let's say it was RBS) with the bad debt when the market collapses?