How banks can fudge small-business lending data

Will the banks meet their lending targets?

If GDP figures for the economy in the second quarter of 2011 turn out to be as weak as most economists expect, the question of whether the banks are doing enough to support private-sector enterprises will again be asked loudly by politicians and media.

So the so-called Project Merlin lending figures, due to be published next month, will be scrutinised, to see whether Barclays, HSBC, Lloyds, Royal Bank of Scotland and Santander have lent to business what they promised the Treasury they would lend.

But what exactly did the banks promise?

Well, the formal commitment was to provide "the appropriate capital and resources to support gross new lending to UK business...of £190bn", including £76bn for the important small business sector.

Which looks clear enough, except for one thing: the banks use different definitions of business lending; so those targets disguise very different behaviour by different banks.

So, for example, for four of the banks, lending to small and medium-sized enterprises or SMEs relates to lending facilities provided to businesses with turnover of up to £25m a year. However one bank defines SMEs as businesses with up to £15m of turnover.

More seriously perhaps, Royal Bank of Scotland - by far the biggest lender to small businesses - does not include undrawn overdraft facilities in its Merlin data. By contrast, the other banks include undrawn overdraft facilities in their Merlin numbers to a greater or lesser extent.

What that means is that most of the banks have the ability to hit their small business lending targets by increasing the borrowing limits of their existing reliable customers, whether or not those customers have demanded or want an increased overdraft.

And although raising borrowing limits might be useful to those customers, arguably it is not as useful for the economy as providing actual loans to companies wishing to expand, or diversify.

By the way, do let me know if you run a small business and you have been told out-of-the-blue that your overdraft limit has been increased, with no increase in charges.

As you can see, there is scope for the banks to hit the targets without fulfilling the spirit of the Merlin agreement, which was to provide credit to where it is needed most.

Of course, I am not saying that the banks would behave in that way. But it is worth saying that if the banks hit their lending targets for the second quarter of the year - and I am told they are very likely to hit those targets - the significance of that achievement will be hard to gauge.

Don't take my word for it. The Bank of England describes the Merlin numbers like this: "these data are not collected under the Bank of England's statistical code of practice and definitions of data vary across banks".

Or to put it another way, the way the Merlin data are compiled is a bit like allowing football clubs to each have a different method for deciding how many league points they get from matches.