Can Banks & Business Dance To Osborne's Tune?

The latest attempts to shield the UK economy from the worst effects of the euro crisis have received a mixed reception and pose many questions.

 

Will the two schemes announced by the Chancellor, George Osborne and Bank of England governor Sir Mervyn King actually make a difference, given the scale of the challenges ahead?

Because the economy is so weak, is there actually demand from business and households for potentially cheaper loans?

The first initiative is aimed at insulating the British banking sector from the growing Eurozone storm at its door.

The "Banks Extended Collateral Term Repo" was actually announced last December but in his Mansion House speech last night, Sir Mervyn said the time was now right to activate the scheme.

It will make short-term loans of at least £5bn a month available to banks to draw down on against any assets they may have.

It is hoped this will stop them holding on to huge cash reserves in order to pad out their balance sheets because they can be assured funds are accessible to boost their short-term liquidity, should they need it.

Confident they will not experience a credit squeeze, the idea is they will be happy to lend more.

However, after the arguably limited success of Quantitative Easing, it is questionable whether banks will feel comfortable enough to loosen their grip on their cash buffer, even with this facility in place.

The Treasury and the Bank of England are hoping the second initiative, the "Funding For Lending" scheme, will do exactly what it says on the tin.

The detail is sketchy but cheap 3-4 year loans will be made available to banks on the proviso that the money is leant to householders and businesses.

How that will be policed has not yet been clarified.

Indeed, it hasn't been announced how much the pot for this scheme will be, although the Bank of England's target is a 5% increase in lending which would equate to £80bn in loans.

Sceptics argue there is a fundamental lack of demand for loans, especially from small businesses who are fending off the effects of the double dip recession.

Other attempts to stimulate lending, such as Project Merlin, which set statutory targets for bank lending, have had only marginal success so the likelihood such a scheme would be a game changer is perceived as unlikely.

But the move has been welcomed by the Federation of Small Businesses, which says 60% of small businesses want to grow and need loans to do it.

However, it believes the problem won't be alleviated until the banks change the parameters they use in deciding whether or not to lend.

They argue when small firms who have been refused a loan appeal against the decision, 40% win - a sign the banks are too risk averse and don't really want to lend.

All this in the context of a Eurozone crisis approaching a pivotal moment.

The bank's governor and the Chancellor are hoping these liquidity measures will be enough to stop the UK banking system seizing up if the worst happens and the Eurozone starts to unravel.

The test, over the months to come, is one of confidence which is currently in very short supply.