Lending by decree

This article was first published in Global Banking Regulation Review

At the peak of the 2008 financial crisis, the UK government intervened to ensure that the UK banking system withstood the aftermath of the collapse of Lehman Brothers. Fast forward 14 years, and a wholly different set of socio-economic factors are leading to a blurring of the lines between the role of the state and the role of the private financial sector.

For banks who finance businesses, this trend towards greater state intervention has meaningful implications for how their corporate and commercial banking business units should position themselves for the future.

Impact of covid-19

The covid-19 pandemic triggered unprecedented government support for UK businesses of all sizes through schemes such as Bounce Back Loans and the Coronavirus Business Interruption Loan Scheme (CBILS). Banks and financial institutions were the conduit for this, resulting in over £75 billion (US$90 billion) being lent to UK businesses via these schemes.

The return of inflation and the related cost of living crisis has the potential to trigger an even greater response. The UK banking sector continues to represent a potential channel for providing targeted economic support to businesses in times of economic stress and shouldn’t be ruled out as an option to contain the impact of prolonged inflation over the short to medium term.

Climate change

Running in parallel with these economic drivers is one of an entirely different scale – climate change. The UK, together with all other developed economies, is increasingly focusing on the investment required to transition towards net zero. What is becoming clear is that any chance of achieving this goal will require very significant levels of capital investment and finance. That means, by extension, a degree of collaboration between the private and public sectors in the UK that would go beyond anything seen in recent memory.

It is estimated that for the UK to achieve its net-zero targets, capital investment will need to grow fivefold from £10 billion (US$12 billion) per year in 2020 to £50 billion (US$60 billion) in 2030. How this capital will be sourced, and what the UK government’s role in supporting it will be, are topics of ongoing debate, but it is highly likely that delivering this seismic shift in sustainable capital investment will require close collaboration between UK banks and the state.

Implications for banks

The implications for banks of this trend are significant and could trigger changes in almost every aspect of the business and operating models of their corporate and commercial banking arms over the next few years.

Strategically, greater state-level intervention may create more momentum behind the de-globalisation of the banking sector. UK-headquartered banks may feel better-positioned to align to national needs and initiatives than those banks that do not have their core operations and investor base in the UK.

From a business model perspective, greater state intervention may distort the concentration banks will have in certain sectors, regions or segments of the economy. That, in turn, could create greater risk in their corporate and commercial banking arms and a realignment of risk appetite.

Finally, and critically, greater state intervention in how finance is distributed into the economy will require participating banks to take on significantly greater sovereign and political risk than before.

How should corporate and commercial banking leaders respond?

It will be increasingly important for banks to be actively engaged with the industry bodies that act as important conduits between the banking industry and the government, such as UK Finance. They should also develop closer ties with those government entities that are focused on channelling greater private capital, such as the UK Infrastructure Bank or UK Export Finance.

The critical step for banks is to recognise the trend, decide if it is one that their organisation wants to lean into, and then define a strategy around it. A passive approach to incremental pressure from the government for collaboration to provide financial support to UK businesses is likely to lead to a sub-optimal working partnership with the state.

Once banks have a clear strategy in place, they will be able to engage with their key stakeholders – their shareholders, customers, the government and their employees – and can use that as a base from which to navigate what is likely to be an increasingly political operating environment for providing finance to businesses.