Adam Posen: Posen's problem

The Bank of England dove says Britain will continue to struggle until it cracks the issue of small business lending

Adam Posen has grabbed his share of the headlines in a traumatic week for the Bank of England's war on inflation, after the rate-setter surprisingly abandoned his call to pump an extra £25bn into Britain's recovery.

The Monetary Policy Committee's dovish chief agitator for quantitative easing since the autumn of 2010 – and a speech called "The Case for Doing More" – now thinks we have done enough, at least in the realm of monetary policy. Markets were shocked. The pound surged.

But besides persistently high inflation, there is another issue bothering the American, on which he definitely still thinks we need to do more: small business lending. Until we crack this, he argues, the UK will continue to struggle. Despite "constructive steps" such as credit-boosting initiatives from the Government, his main pleas – for a small business bank and for an organisation to securitise loans for small businesses – have so far fallen on deaf ears.

The problem of credit supply for small business runs far deeper than the credit crunch and banking crisis, Mr Posen argues.

"It was an underlying structural problem with the economy," he said. "It was made much worse and more obvious by the crisis, but it has been a problem with the economy for decades.

"If you're going to really tackle it then you need more than what we've done. I am hopeful that some form of small business lending securitisations, some set of infrastructure of whatever form, private or public, will come into being."

How the Government goes about it doesn't really matter, as long as it does something, he said.

"There are many ways to skin the cat, although I guess I shouldn't say the cat is only partially skinned at this point as that would get me into trouble with the RSPCA – there are many ways to peel the banana. The banana is only half-peeled."

The issue is pivotal as Britain's 4.5 million small businesses employ almost 14 million people between them.

But even though the Bank believes the economy's underlying performance is better than official figures suggest, the pressure on small business lending is still acute.

According to the Federation of Small Businesses, in the first quarter of this year more than 40 per cent of applications by small and medium-sized enterprises (SMEs) were rejected. Of those who actually managed to secure loans, nearly a quarter were asked to pay interest rates in excess of 11 per cent.

Although £20bn in guarantees are available under the Government's national loan guarantee scheme, the FSB adds that smaller companies still have to vault the high hurdles of the banks' application system, which many of them will fail to do.

There was also depressing news from the Bank of England itself this week on credit pricing. The summary report from its agents around the country said: "Small and medium-sized firms typically found it more difficult than large ones to secure credit. And they continued to be encouraged to use asset-backed forms of lending rather than overdrafts, which many were reluctant to do."

A Bank survey of nearly 500 businesses found lenders passing on the higher cost of funding for banks, with costs for SMEs "a touch higher" than for larger businesses.

Although the overall supply of credit remained stable, existing facilities have been more costly on renewal, arrangement fees have risen, and collateral demands more stringent. Worse still, while the banks are turning the screw, so are customers and suppliers.

The survey added: "Smaller businesses also often reported that corporate liquidity was being squeezed by larger business partners: suppliers were tightening up on payment terms, while customers pushed to extend them."

Legal & General's boss Tim Breedon's recent review into non-bank finance agreed with Mr Posen's line to an extent, as it called for a feasibility study into an agency to securitise small businesses loans. Mr Breedon – who warned of an alarming potential funding gap of £191bn for SMEs over the next five years – said there was "compelling evidence" that access to finance would become more acute as business confidence eventually picks up but banks continue to shrink their balance sheets.

The relative lack of non-bank sources of finance for small businesses – such as peer-to-peer lending and "angel" investors – was recently cited by Mr Posen as one of the reasons why the UK recovery is still lagging behind the US, where more non-bank options are available to provide financing for investment. Hence there has been a bigger recovery in corporate spending across the Atlantic, where banks are also suffering less spillover from Europe's debt crisis and households have not been so affected by deficit cutting.

But for now, the problems with credit supply could feed into the Bank's current inflation headaches with the consumer prices index rising for the first time in six months – to 3.5 per cent – during March. Minutes of the Bank's latest meeting suggested companies could seek to rebuild margins more aggressively than anticipated rather than cutting prices as much, "perhaps with a view to achieving a target for cash flow in an environment of uncertain credit supply".

Mr Posen once compared the economy to a burning building and cast himself in the role of a fireman tackling a towering inferno. Now in his view "the world is a different place and the UK economy is a different place".

But how many billions more will we need to channel into small business? He declines to put a figure on it, saying: "When the economy starts turning around and when the availability of credit for smaller businesses is significantly greater."

For the MPC's former dove the message is clear: the worst of the economic blaze is out, but on lending at least, there's still much more to do.