Blogged by John Clancy and David Bailey

The UK banks are overstretched by the massive effort they have made over the last nine months by lending at full capacity to small and medium sized businesses. Or so they tell us.

Funny that the representatives of those small and medium-sized businesses tell us that they can't get loans for love nor...er money; that they are paying through the nose with interest rates at 14% and overdrafts are being pulled by UK (government-owned) banks to solvent small businesses.

The banks say that they still have to go to wholesale markets themselves and borrow money to lend because the government now requires them to hold double the amount of capital reserves (how awful!) and that the interest rates there are much higher than the Bank of England Base rate. They also say that if a loan is marked at 14% that's in order to reflect the risk. It's tough being a sentimental old banker.

The reason we require them to hold double the amount in capital reserves is to reflect our risk (businesses and individuals) in saving the sorry assets of the banks in the first place.

OK, so let's take the banks at face value, then. In the words of Victoria Wood, 'they can't do it'. If they can't do it, we know a man who can: Alistair Darling. If the banks aren't actually being 'economical with the truth' with him (no comment) then Darling has to release the funds directly to invest in small and medium sized businesses. Otherwise there is a danger that any recovery out there could fizzle out for lack of basic funds.

David Bailey and I have blogged before that the government should be doing this anyway. We shouldn't actually be talking about lending to businesses, we should be talking about investing in businesses. The government is already doing this to a limited extent here in the West Midlands through the Advantage Loan Guarantee Fund.

Venture capital companies invest money directly in SMEs in return for preference shares (paid out on and redeemed in preference to other shareholders) which get redeemed over a long-term period (15 years or more). In a similar way the government should put money into businesses using the same mechanisms. Ironically, the preference shares route was the method the government used to bail out the banks themselves (funny that, isn't it?).

In the more short term, the government could simply agree to buy a pre-packaged bond from the business owner (just like it is buying bonds and other commercial paper as part of its quantitative easing programme) which commits the owner to pay a low interest rate and repay either the bond amount or issue preference shares at an agreed valuation in the business at regular intervals during the bond issue period.

Neither of these would mean the government setting themselves up as bankers (which they apparently do not wish to do) - rather they would be Investors in Industry (which is surely a worthy objective for government). How long-term or short-term this is would be is up to the government, but we would advocate the more long term option. A recession is the worst time for quick short-term fixes and the best time for starting a more virtuous cycle of long-termism.

These approaches are not alien, onerous and lengthy time-scale procedures. They're there in the system already. The government doesn't have to set up Darling Bank PLC (although that does have a certain ring to it!)

In the same way we are guaranteeing £350billion-worth of the banks' own assets, so we (or the government) should be guaranteeing the credit of the SMEs, too.

We would argue, though, that there is a much more solid and long-lasting route which Gordon Brown came up with himself. Back in February the Prime Minister made a speech saying that he wanted to set up one of the government-owned banks as an 'Industrial Bank'.

Little has been heard of that since, but the banking business investment shortfall crisis identified by Darling yesterday is the opportunity to do what you said you wanted to do, Gordon. Set up an Industrial Bank now.

Identify, say, the government-owned NatWest, give them extra funding to invest direct on behalf of the state at low interest rates and take shares in those investee businesses. Add it to the quantitative easing package.

Surely this would take the pressure off the hard-pressed existing banks, who are working all hours emptying their coffers of all of their hard earned (well, graciously bailed out) money to small and medium businesses up and down the land? What a sigh of relief they would breathe!

Or perhaps they might realise that real competition in this market might actually prompt them to get off their ungrateful backsides and do their jobs properly.