Margareta Pagano: It's time to try new ways to fill the business funding gap

Midweek View: Crap mortgages brought down Lehmans in the crash. We don't want crap business loans leading to the next
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The Independent Online

For as long as I've been writing about business, the big issue in Britain has been the chronic lack of funding for small and medium-sized enterprises; riskier capital for start-ups through to medium-term lending. The shortage was first highlighted by the Macmillan committee – including Ernest Bevin and John Maynard Keynes – set up in 1929 after the stock-market crash to look at ways of improving finance for industry.

Even then, the committee pointed out that our bankers were failing industry. It's where the phrase the Macmillan Gap comes from, and out of it grew the Industrial and Commercial Finance Corporation, set up with £15m in 1945 as a joint venture by the Bank of England and the UK's biggest banks to provide long-term equity investment funding with amounts of between £5,000 and £200,000 for SMEs.

The ICFC became the biggest provider of growth capital for unquoted companies during the 1950s and 1960s, and by the 1980s had become the leading source of finance for management buyouts. Renamed Investors in Industry – or 3i as it became known – it then made the mistake of floating on the stock market. Inevitably, 3i got greedy, searching out bigger deals, and forgot to mind the gap.

In many ways, Vince Cable's latest wheeze, which has Treasury backing, for a £1bn new business bank is another attempt to plug today's gap, one which has become wider since the financial crash. Research by the Cambridge & Counties Bank, which launched a few months ago, shows that in the second half of 2011, more than 60,000 loan and overdraft applications from SMEs worth as much as £3bn were rejected by the high street banks.

So you can see why Mr Cable's bank proposal, which could open up to £10bn of new lending from the private sector, has had a Marmite-style reception. Either businessmen love it because it shows the government is doing something positive, or hate it because it raises more questions than answers.

First, the new bank is a long-term solution. It won't be up and running for several years yet. Second, and more pertinent, there are concerns the new bank's funding could distort the allocation of credit, leading to the same problems of government-backed securitisation as those that led to the crash. As the Institute of Economic Affairs puts it, government – and the taxpayer – should not be taking the risks from business lending that banks are not willing to bear themselves.

There are much better ways to plug Cable's Gap, and most of the tools exist if only government would get its act together. Part of our problem is not that the banks are not lending, but that they have stopped providing the full range of facilities to SMEs that they used to.

William Tebbit, commercial director at Trade Finance Partners, says the Coalition doesn't get it: "They don't understand the problem so have come up with the wrong answer." Most companies need help with working capital, rather than loans, and with export finance, he points out. These are vital areas where the banks have stopped providing or take so long to decide that companies either lose orders or give up.

Businessmen should be looking for alternative ways to free up working capital such as leasing, invoice discounting, factoring, trade finance and specialist financiers who underwrite the supply chain. It's good, old-fashioned merchant banking, and is already making a comeback in response to the crash.

Crowdfunding is another alternative that gives power back to the public and away from the banks, and should be encouraged – with health warnings. More needs to be done to persuade the wealthy to put their money behind a new generation of entrepreneurs. Instead of making inane comments about taxing the rich, it would be better if Nick Clegg suggested improving the Enterprise Investment Schemes with better tax breaks.

Councils and pension funds should be encouraged to put their money behind brilliant new ventures like the Cambridge bank. Backed by the county council's pension scheme and Trinity Hall, it was set up because local figures were so worried about the shortage in local funding. As Tebbit, who has his father's knack for shooting from the hip, says: "Crap mortgages brought down Lehmans in the crash. We don't want crap business loans leading to the next."

Mr Cable has identified the right shortfall but needs to go back to the drawing board to fill in the gaps. Otherwise we will be writing about this for decades to come.