Mounting outrage about RBS’s apparent ‘mis-selling’ of the Governments ‘Enterprise Finance Guarantee’ (EFG) scheme has been further fueled by news that the bank was calling upon the Directors of borrowing companies to repay debts which had already been repaid by the Government under the terms of the Scheme.
I was once responsible for the central management of the ‘Small Firms Loan Guarantee Scheme’ (SFLGS) for NatWest. This was effectively the precursor of EFG, and we occasionally faced the same issues.
Here’s my summary of what has happened here:
- The Government has felt the need to come up with a scheme to encourage the banks to lend to small businesses. They conclude that there are many viable business propositions which the bank is declining because they cannot get security as an insurance policy if things go wrong. The EFG scheme (like the SFLGS) provided the bank with a form of insurance, which basically says to the bank that if they lose money on such a loan, they will repay 75% of the bank’s loss – critically, once they have exhausted all attempts to get repaid from the borrower.
- The reality here is that there are not many loans that truly fit into this category. Despite the bad press, if a proposition is ‘viable’ then there is a good chance that the bank will lend, despite weak security (less so now perhaps?). If a proposition is weak and could be ‘propped up’ by extra security, there is a good case for saying that the bank shouldn’t be lending in the first place.
- When the Scheme is announced, to great fanfare of course, political pressure is then applied to the bank, at the top, to use the scheme. Targets are set and with the EFG there were penalties applied if the bank didn’t use their ‘allocation’. So ‘messages of encouragement’ (i.e. pressure) is applied to the front line to be look for suitable propositions and sell the benefits of the scheme to borrowers.
- Banks are not very good at cascading complicated messages from Head Office to the front line. A combination of pressure and misunderstanding leads the front-line bankers to understand the scheme as that the borrower is only liable for 25% of the debt. This isn’t true; they are liable for 100% but if they cannot pay then the Government will cover 75% of the bank’s losses. Of course, the borrowers love the sound of this scheme and the reality only comes out when things go wrong.
- You will always get a few ‘bad eggs’ in an organization like a bank. Pressure to hit targets and put on lending can then lead to some ‘mis-selling. That comes in the form of deliberately misleading applicants or (and this is a cunning wheeze) taking an existing borrowing (typically an overdraft) and switching it to the scheme. This of course improves the bank’s risk position and the borrower won’t object of course.
- The outrage about the bank having already been paid by the Government, but then still recovering the funds from the borrower is actually not quite the issue. It takes time to recover funds from Directors of companies and it is quite feasible that they may get recovery after the Government has fulfilled its commitment to compensate the bank after a prescribed time. If funds are recovered from the borrower, the bank then just has to pay back the Government what it has received.
- The issue for RBS is those face to face discussions that took place between the bank managers and the borrowers and what they took away from those meetings as what they were liable for
As ever the ‘devil is in the detail’ – and why is it that when the Government intervenes in any market to stimulate it, there are always unintended consequences?