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Phillip Blond and Adam Wildman: Why Risk Waivers for SMEs would help to fire economic growth

Phillip Blond is the Director Of ResPublica. Adam Wildman is a research manager at ResPublica and one of the authors of Risk Waiver.  Follow Philip and Respublica on Twitter.

Screen shot 2013-06-11 at 18.18.15It is no secret that personal and corporate lending has stagnated over the last five years. The credit that our businesses and households need is simply not as available as it was. We desperately need a strategy from Government that combats one of the main causes of this contemporary restriction in lending: unprotected and unaddressed credit risk.

ResPublica’s latest report, Risk Waiver: closing the protection gap and opening the credit flow, explores how the Government and financial industry could better utilise protection products to reduce credit risk and unlock lending to consumers  and businesses.

Lending matters for the economy - it matters a lot. The total gross lending in the UK plummeted from £140.5 billion in the second quarter of 2007 to £60.7 billion in the final quarter of 2012, a reduction of 57 per cent, compared to the lending volume before the credit crunch. Studies in both the U.S and the EU have shown that falling credit supply shrinks real GDP growth.

Five years after the credit crunch, a U.S study has found that if core lending declines by 4 per cent, then real GDP reduces by 0.6 per cent. A European paper studying the same effect found that, in the Eurozone, if core lending declines by 5 per cent there is a long-term reduction in real output growth of 1.6 per cent. Transposing those findings to the situation in the UK gives startling indications of the possible impact on our economy of credit contraction.

Given that the UK’s 2012 GDP was £1445 billion, the American study would suggest a real output loss for the UK between 2007 and 2012 of £123 billion, whereas the European paper would suggest a loss equivalent to £263 billion. On a conservative estimate, since our economy is closer to the Eurozone, placing the UK directly between both studies, the loss in GDP from the contraction in lending between 2007 and 2012 was a staggering £193 billion.

Screen shot 2013-06-11 at 18.31.28It is surprising given the impact that consumer spending has on the economy, which accounts for some 65% of UK GDP, that so little thought has been given to reviving it. It is almost as though, given the current debt crisis, we have given up on thinking how credit might be used and delivered differently. Not only is household spending some way down on its pre-recession levels, household credit availability is also 55 per cent down over the same period.  With an increase in the number of part-time workers in the economy, partnered with what will soon be a ‘lost decade’ in take-home pay, now more than ever households rely on credit not just to answer their immediate cashflow problems but also to start a business, fund education or even move from areas of high unemployment to ones where work is available.

Current Government attempts to resuscitate lending have focused on keeping interest rates low for all debtors and flooding the business sector with large-scale pump-priming schemes, such as Funding for Lending or the Enterprise Finance Guarantee Scheme.  So far, these schemes have failed to generate anything like the increases needed, and an area of extreme concern is the funding for Small and Medium Sized Enterprises (SMEs). Not only has SME lending fallen by 25 per cent since 2009, but loan rejection rates in the UK are twice that of our greatest European competitors, France and Germany.  Given that SMEs represent 60 per cent of private sector employment and 50 per cent of private sector turnover and almost all future jobs,  a failure to lend to SME’s is fatal to the economy’s hope for growth and jobs.

Government initiatives have skirted around the key issues, and have systematically ignored the inherent problems in the current system of SME lending. We have no adequate system of assessing the investment worth and risk of the UK’s SMEs - and no system to deliver the credit to them either.  Government seems to believe that there is a problem with the UK economy’s credit pump -but it’s the circulation of credit that is damaged beyond repair: the credit veins in the economy are hopelessly blocked.

What we need is a new way of getting credit to flow through the economy once again.  Debt waiver, if organised through LEPS and new local banks dedicated to business lending, could help deliver the credit so desperately needed by our economy.  If we were able to assess a small company as a good credit risk and created a waver market that could insure that the lending to it was secured, just imagine how much credit could be delivered to the sector.

To tackle the unaddressed problem of consumer lending, our report proposes that protection products have an important part to play in stimulating lending to ordinary people.  All credit protection products provide a valuable means of safeguarding loans.  But one particularly innovative product currently underutilised in the UK market are ‘debt waivers’.  These products, commonplace in the U.S, offer a waiver facility to the borrower in the event of an insured event.  If somebody who has a waiver is ill or loses their job and so is unable to pay the loan, the debt is waived.

With waivers, instead of the onus being on the customer to take out protection on their loan, it is for the lender to do so and pass on the benefits to their customers in the form of a waiver.  In this way, these innovative products shift the burden of default away from households and small businesses and onto the lender. As such, the waiver is a business-to-business credit arrangement in which the lender takes out the insurance rather than the borrower.

Furthermore, the waiver costs far less than PPI ever did. Average commissions were as high as 59 per cent across all PPI distributors. The OFT found that for a £5,000 loan the headline rate was 5 per cent APR. Once PPI was added the rate, increased by a full 8 per cent to 13 per cent APR. For waivers which attract no commission, the current UK equivalent APR rise would equate to between 0.4 per cent to 1 per cent APR.

The history of debt waiver in the US has consistently been shown to safeguard loans in a transparent manner, whilst at the same time improving the lenders financial results.  Protection products can, therefore, enable the greater availability of credit to the market - people are more willing to lend in an insecure jobs market when they know they will be repaid.

One key recommendation of Risk Waiver is for the Government to make protection on personal and small business loans compulsory for all lenders in a manner similar to car insurance.  This way it can be guaranteed that both customers are wholly protected in the event of illness or injury, and that lenders feel are more secure in the loans that they issue out.

We also recommend that the Government use its influence with the two state-owned banks (RBS and the Lloyds Banking Group) to encourage them to act in the greater good and develop new product innovations that safeguard credit, protect customers and stimulate lending.  Where these two large lenders lead, other will follow. 

The myriad Government schemes currently attempting to get lending going again are clearly not up to the job.  Ensuring adequate protection on the loans businesses and consumers take out would help to create an economy where credit is both more widely available and inherently more secure.  This, we believe, would help to unlock and recreate growth in the British economy.

Risk Waiver: Closing the protection gap for consumers and opening the credit flow for providers is available from Respublica


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