The Discouraged Economy

Will Hutton and Paul Nightingale
08 September 2011

This report argues that the UK’s financial sector is systematically failing SMEs, which could provide the greatest source of innovation, jobs and growth. Submitted to the Independent Commission on Banking in July 2011, this report shows that firms with the greatest potential for high growth are the most likely to face financial restraints on their growth. This is leading to a “discouraged economy in which innovation, investment and dynamism are stymied by a self-serving and inflexible banking sector.”

The report calls for rigorous ring-fencing (or ideally full separation) of commercial and retail banking from high-risk investment banking, along with an injection of more capital. This would change incentive structures so that supporting the UK economy, and specifically lending to innovative SMEs, becomes more attractive to the banking sector. Higher capital ratios would lower risk premiums so that any rise in bank funding costs would be trivial. In addition, it would create an environment where SME lending is not seen as a consumer of scarce risk capital with a high opportunity cost of foregone investment banking opportunities. Instead, SME lending would be a useful profit stream in its own right, competing for attention with other profit and revenue streams that all have lower returns.

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