Will UK corporate lending improve in 2011?

By | December 20, 2010

money-1900One of the many interesting new things that I have done in 2010 is to talk to local business associations over the year about the outlook for business credit following the credit crunch.  This started with the Ilkley Business Forum back in January and now, nearly 12 months on and with the Bank of England’s Financial Stability Report being published today, I thought it would be a good time to review how things have gone, and what the outlook is now.

1. Credit conditions remained difficult in 2010

My argument over the year has been that credit conditions were likely to remain difficult.  There were several reasons for this.  First, the government needed to raise substantial money from financial markets, which would result in a “crowding out” of the corporate sector.  Second, the banks would soon be expected to return money under the special credit arrangements that arose during the credit crisis; for example, the Special Liquidity Scheme (SLS).  Third, UK banks have considerable risks on their balance sheet; not least the exposure to the PIIGS of Portugal, Ireland, Italy, Greece and Spain.

2010 has seen corporate credit conditions remain very tight.  In the 12 months to August 2010 – the latest available figure – overall lending to business was down 5.4%.  Mortgage lending has also been largely flat.   There is some evidence of credit conditions starting to improve for larger companies and in wholesale markets, but the SME lending market remains very difficult.

2. Conditions as they stand at the end of 2010

Many of the underlying problems remain.  UK banks are heavily exposed to debt default in the periphery of the Eurozone.  Credit default swap (CDS) rates are a core indicator of the risk here. These can be seen as insurance contracts – the higher the rate, the bigger the risk.

When I spoke to the Yorkshire Independent Financial Adviser Forum in May, CDS rates were 3.26% for Portugal and 7.33% for Greece.  Despite all the Euro bailouts, today these numbers are 4.57% and 9.68% respectively.  This problem makes the news, yet again, today through the Financial Stability Report.   The repayment of finance under the SLS has also kept journalists busy this week.

3. The good news for 2011

The good news is that the UK government is starting to attract foreign investors back into the Gilts market, putting less pressure on domestic investors to fund the government.  If foreign banks and investors can be encouraged once again to provide liquidity to the UK in all sectors, then things will improve.

My forecast for 2011 largely hinges on the Eurozone.  If things quieten down there, then I am more bullish than I was at the start of 2010 – we might expect a slow but steady recovery.  If, though, there is a Euro earthquake, which cannot be ruled out, then the aftershocks will be felt strongly by borrowers in the UK.

What are your views – Euro earthquake or a steady recovery?

About Mark Freeman

Mark joined the School of Management in 2006, following previous full-time academic appointments at the Exeter Centre for Finance and Investment (University of Exeter) and the University of Warwick. He has held visiting academic positions at the Kellogg Graduate School of Management (Northwestern University), the University of California, Irvine, and the University of Technology, Sydney.

Before becoming an academic, he worked as an equity research analyst specialising in the brewing and distilling industries for stockbrokers Savory Milln and James Capel, in London. He also has corporate finance experience with United Distillers in Scotland.

Specialties: Economics of climate change, Long term funding of nuclear power, Pension funds - long term deficits