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What lending matters?

Created:

23 June 2009

Written by:

Chris Dillow

Bank lending to companies is still very weak. A survey of major lenders by the Bank of England last week told us this, and it's likely to be confirmed by figures for all lenders next Monday.

This is partly because firms just aren't investing. But it's also because banks are reluctant to lend; a recent survey by the CBI found that banks are still tightening lending standards to companies, albeit at a slower rate than in the autumn.

Everyone agrees - rightly - that this is an obstacle to a genuine economic recovery (as distinct from one that happens merely because firms stop cutting inventories). What's not so appreciated, however, is that it matters not just for the cyclical question of when we'll get a recovery, but also for long-run growth.

A new paper by researchers associated with Tilburg University estimates that bank lending to companies is a significant influence on long-term growth. They calculate - based on the experience of 45 nations between 1994 and 2005 - that a 10 percentage point rise in the ratio of bank lending to firms to GDP is associated with an increase in GDP growth of 0.2 percentage points a year. This controls for other influences upon growth, including stock market activity.

You might think it trivial that bank lending increases GDP. Not quite. The researchers also found that bank lending to households has no influence upon long-term growth. The rise of American "sub-prime" mortgage lending, for example, did not lead to better sustained long-term economic performance.

This has an important implication. It means that if policy-makers want banks to help the economy, they must do more than just ensure the banks are adequately capitalized and tolerant of risk. They must also get banks lending to firms. There might be votes in stimulating mortgage lending - or more likely nice newspaper headlines - but this is not the source of long-lasting economic performance. This requires that banks step up the dull job of lending to companies.

And there's no sign that this is happening yet.

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