Bank regulators hold the cure to weak lending volumes

“The banks are just not lending,” one Western business CEO told me earlier this week. And this isn’t just an alleged Canadian funk. According to The New York Times, one of the key drivers of the British backlash against its domestic banking system comes from the perception that “Britain’s banks are not lending as much as they might, thus delaying an economic recovery.”

Entrepreneurs across the continent are constantly starting new businesses of almost all shapes and sizes. As the NVCA is wont to remind, many great U.S. global corporate flag bearers were started during difficult economic times: FedEx, GE, HP and Microsoft come to mind. But ask yourself: if growing companies need loans, which aren’t being fulfilled otherwise, why isn’t anyone starting a new bank?

In a short space of time post-recession, Toronto’s Element Financial (EFN:TSX) has quickly become one of Canada’s largest non-bank lenders in the leasing market, for example. Good credit worthy clients are out there. It can be done.

According to the Bank of England Chief, his banks aren’t doing enough lending. Many U.S. and Canadian politicians have pointed out that far too much cash is sitting unused on the balances sheet of North America’s banking system. The industry’s standing excuse was that the lack of visibility around Basel III capital rules made banks hesitant to put money out; but now that capital ratio expectations are clear, where’s the lending pickup?

Perhaps CFOs aren’t borrowing, and I think in many cases that’s true. Corporate cash balances are high, we’re told, and the perennial economic uncertainty might make Boards hesitant to cut large cheques to expand their businesses. And then there’s the U.S. political climate, which is increasingly being cited as the bane of the C-suite’s existence (from the WSJ):

“If you can’t plan, you don’t spend. And if you don’t spend you don’t hire,” said Paul J. Diaz, chief executive of nursing home and rehabilitation-center Kindred Healthcare Inc., in an interview. “It’s just hard to do budgets.”

On his Aug. 3 investor call, Mr. Diaz resisted analysts’ requests to project 2013 performance, saying he didn’t know whether Washington would slash health-care spending or not as part of the “sequestration” budget cuts that will kick in Dec. 31.

“We can recover, and the only thing holding us back is the inability of these guys to compromise,” Mr. Diaz said in the interview. “It sort of breaks your heart.”

Of course, it’s easy for CEOs to blame Washington and the Europe debt crisis for flagging business results. Search for the word “uncertainty” among earnings calls of the S&P 500 companies, and you will find it cropping up in nearly hal of them. There is a long, if ignoble, tradition of casting responsibility on regulators, Congress, and the weather.

But the remarks from the last two months do show something different. Call it a collective ache.

Robert G. Jones, chief executive of Old National Bancorp in Evansville, Ind., spoke up on his July 30 investor call. Lack of guidance from Washington, he said, was pushing his clients—typically farmers and industrial companies throughout southern Indiana—to postpone making “good, sound, long-term capital investments.”

Mr. Jones also sits on the board of directors of the St. Louis Federal Reserve. In an interview, he said that in the last three months business-survey results from the St. Louis region have shown “bipartisan frustration.”

“Business owners are looking for confidence. That’s what leadership is about. We’re really managing from the fringes more than from the middle. And it’s awful hard to come to the middle.”

Canadian corporate and commercial loan balances have grown over the past 12 months, reaching $188B outstanding as of July (up $10B in 12 months) from the teller wickets of Canada’s charted banking fraternity. But how much of that $10B increase is actual net new lending versus syndicate backwash — ie. a reduction in “holds” of pre-existing Canadian business loans by stressed European banks — is unclear.

But you have to ask yourself, if bank regulators want to encourage more lending to small and medium-sized businesses, the ones that do much of the hiring that is needed to turn around the economy, perhaps they should look in the mirror: how many new bank licences have been issued over the past five years to firms interested in lending specifically to business?

In Canada, the answer is effectively zero. In fact, you have to go back as far as 1997 before you’d find evidence of OSFI granting a new Schedule 1 licence to a new Canadian bank interested in traditional commercial lending. And, even then, it was a vehicle targeted at Aboriginal Lending with a 150 year-old bank serving as the management team’s Big Brother and key financial/compliance partner.

All told, there are just 23 Schedule I licences in Canada, most of whcih are tied up with captive initiatives (LifeCo and Brokerage subs), credit cards (Canadian Tire) and residential mortgage lending. Western Canada seems to get special dispensation from OSFI, with pre-crisis approvals for Canadian Western Bank (1996) and Bank West (2003), to name two Schedule 1’s. But again, they are both long in the tooth and one of them doesn’t venture beyond a focus on farming and Western commercial mortgages.

In the U.S., industry sources say that U.S. regulators have issued nary a single new de novo commercial bank charter since late 2008. Mind you, the U.S. is home to approximately 7,500 banks, so it is hard to argue that licences are the problem per se. But protecting the old from the new is never a good way to grow an economy.

Imagine an industry where new players weren’t allowed to enter the fray. What kind of competition and innovation would there be in the smartphone / telecom industry if the FCC and CRTC had banned new market entrants over the past 5 years?

Or truckers? What would it cost to move goods if the existing trucking industry oligarchy knew that it could charge whatever it wanted per mile, or be late without repercussion, with the comfort that the existing players were protected from new external competition by the Department of Transportation’s refusal to issue new carrier permits to a well-financed start-up trucking company?

Look at what Porter Airlines has done for the travelling residents of places like Halifax, Moncton and Thunder Bay (JetBlue is the perfect U.S. example). If regulatory barriers prevented its launch, travellers would pay more and see reduced service.

I know the financial crisis was traumatic for the world’s banking regulators; but the global financial meltdown was neither caused, nor aided, by smaller, commercially-focused lending institutions. And there’s certainly no systemic risk posed by the future failure of a start-up bank that gets to $1 billion in assets over a 5 year period. I don’t envy the task that either the FDIC or OSFI have, but it takes a village…and they are part of that village.

It’s time for the Regulators to put out the welcome mat to new players, rather than simply add to the chorus who publicly moan and groan about how the current crop of banks won’t lend enough to small and mid-sized businesses.

It won’t single-handedly solve the malaise that’s darkened the North American economy, but it would definitely help.

MRM